REITs Strong in Equity Office Deal's Wake

Several real estate industry watchers are scratching their heads on the lofty valuation of the Equity Office Properties(EOP Quote) buyout by the Blackstone Group. But just because there are valuation concerns, it's not time to become bearish on real estate investment trusts.

The huge flow of institutional capital into the space will dictate the group's performance for the rest of the year.

"In the short run, it is impossible to be bearish," says Mike Kirby, director of research with Green Street Advisors, an independent REIT research shop.

Blackstone's purchase of Equity Office, which shareholders approved Wednesday, is valued at $34.5 billion including debt. The deal, set to close this week, will be the largest real estate transaction ever.

Kirby remains concerned about valuations among REITs, particularly the office stocks. He calculates that the initial yield on the Equity Office purchase by Blackstone is 4.4% after deductions for capital expenditures.

Blackstone plans to flip a portion of the properties. On Wednesday, press reports said the company has struck a deal to sell $7 billion of Equity Office's New York City properties to Macklowe Properties, a large privately held New York City office owner.

For the properties Blackstone keeps, the firm is betting that the returns can be boosted over time. However, it won't be easy for the fund to turn those low initial yields into a long-term 7% internal rate of return, which is considered a more acceptable yield, Kirby says.