Across most of the country, commercial real estate development has pretty much come to a halt. After a decade of debt-fueled overbuilding, there are too many hotels and too much retail space. With the economy generating precious few jobs, there isn’t much need for new office space, either. Debt financing has all but dried up.
But if you wander down to Mount Vernon Square in the heart of Washington and look in almost any direction, you’ll see a new center city under construction — several billion dollars worth of it.
To the east, in a rapidly gentrifying triangle known as NoMa, thousands of apartments and even a “spec” office building, built without any tenant commitments.
To the northwest, the beginnings of a monstrous 1,200-room, $600 million convention center hotel.
And to the southwest, you’ll see a four-square block hole in the ground from which will rise one of the most ambitious and exciting mixed-use development projects to come along in years. It will house nearly 700 residences, two glass-clad office buildings, a hotel and space for the kind of upscale downtown retailing that city planners have talked about for years but never really materialized. Total cost for the two-phase CityCenter development, including streets and utilities: $900 million, all of it private.
Planning for this project began 15 years ago, when the city decided it would build the new convention center on the other side of Mount Vernon Square, demolish the old one and lease the land to a developer who could help make good on then-Mayor Tony Williams’s vision of downtown. In his vision, downtown would not just feature offices and restaurants catering to weekday suburban commuters, while becoming deserted at night and on weekends. Instead, it would become a 24/7 place where people would live, work, shop, have fun and walk their dogs.
I admit that I always had more than a little skepticism when I heard my friend Rich Bradley, head of the Downtown Business Improvement District, talk about the “liveable downtown.” It seemed to me then a classic chicken-and-egg problem: Without the amenities, there would be no residents, and without the residents, there would be amenities.
But in the past decade, something has changed. As a result of the revivals along 7th Street, 14th Street and U St. NW and H Street NE, downtown Washington has become hot the way lower Manhattan has become hot and the old downtown has begun to take off in Los Angeles. Young and not-so-young professionals not only want to live in or near the city center, they are insisting on it, even if they have to reverse commute out to jobs in the suburbs.
In Washington, this demand is fueling a little apartment bubble; about 7,000 apartment units are under construction in or near the downtown area. With that, it’s a good bet that what was once a chicken-and-egg problem can be turned into just the opposite — a virtuous cycle in which an increase in the number of residents leads to more stores and amenities, which in turn leads to even more residents. The spectacular success of the Newseum project on Pennsylvania Avenue and Boston Properties’ new project on Washington Circle in the West End suggest that the tipping point may have finally been reached.
What’s noteworthy about CityCenter is not only its scale and ambition, but the fact that construction began in the midst of a commercial retail downturn without commitments from any major tenants. It was also financed without any debt.
In truth, this project was on life support for a couple of years while one of the developers, Houston-based Hines, scoured the world looking for investment capital. Since the bursting of the commercial real estate bubble in 2008, investors and lenders in commercial real estate have been focused on salvaging the many troubled pieces of their portfolios. This spring, there were signs that the moribund market in securitized commercial real estate loans had begun to revive, but since July, that market has collapsed once again as the economy slowed and investors began to demand higher risk premiums than owners and developers were willing to pay.
What saved CityCenter was an investment of $622 million by the government of Qatar, whose sovereign wealth fund likes the visibility and perceived stability of investing in downtown Washington. It is no coincidence that the convention center hotel is also financed by an equity investment from a sovereign wealth fund — Abu Dhabi’s — creating something of little OPEC colony here in the middle of Washington. Other projects under construction in NoMa are also financed completely with equity, either from cash contributed by the developers themselves or from private-equity funds raised at the height of the real estate frenzy.
One advantage of financing a project with equity rather than debt is that there is less financial pressure to have half the space leased before construction begins, or to lease the rest to any tenants willing to pay enough to cover interest payments. Such pressures are particularly damaging to mixed-used projects such as CityCenter, where the economics really depend on creating a whole greater than the sum of the parts. When such projects are successful, the office buildings are more attractive than other offices because of the proximity to stores and housing, just as the stores are more valuable because of proximity to residents and office workers, and so on. That synergy only develops, however, when developers have the time to get just the right tenants.
Beginning a big project when nobody else would dare to could also be an advantage; when it is finished, there won’t be any other new projects to compete with. That won’t guarantee success if the economy is still in the dumps in 2014. But if it is on the rebound, the developers — Hines Interest and Colorado-based Archstone — could luck out and hit the market at the perfect moment.
With a location hard by the convention center, five blocks from the White House and within easy access to Metro, Hines shouldn’t have too much trouble renting out the two office buildings designed by British architect Norman Foster, even at the asking rents of $80 per square foot. At one point last year, Bill Alsup, the head of Hines’s Washington operation, had Skadden Arps, the blue-chip law firm on the hook before it decided to renew its current lease. The latest reports are that Hines is competing for the venerable Arnold & Porter.
Snaring a big law firm is to a Washington developer what snaring an elephant is to a big-game hunter. If Alsup really wants to distinguish his product, however, he might consider declaring his small community a “lawyer-free zone” and court high-tech companies, architectural firms, advertising agencies and media companies more likely to appreciate the attractive Norman Foster design and more likely to have young employees eager to live downtown.
Given the restaurant revival already going on downtown, CityCenter probably won’t have much trouble filling the dozens of spaces set aside for wine bars and eating establishments. (Islamic investors frown on saloons.) The test will be whether Hines and Archstone can get beyond the all-too-familiar national chains that can afford high rents, but bring little pizzaz or personality.
The bigger challenge will be to attract the upper-end clothing, home furnishing and other retailers that would not only serve downtown residents but would have offerings unique enough to lure older and richer shoppers from suburban enclaves. Over the years, many developers have tried, but aside from Anthony Lanier in Georgetown, none has succeeded. In their place, bank branches dominate the prime corner locations.
But it should say something about CityCenter’s potential that Apple, reportedly, is considering a flagship store for the project. And it is noteworthy that Hines and Archstone have gone to the considerable expense of providing continuous retail on both sides of the project’s pedestrian-friendly streets and alleys, with the kind of two-story spaces and and underground delivery bays that create a much livelier and more-efficient retail environment than what is offered by the typical downtown office building.
It will be a few years before we know whether CityCenter ushers the “liveable downtown” into Washington. In the meantime, several thousand of our neighbors will have good jobs for three years building the project. For this little miracle on 10th Street we can thank the foresight of former mayor Tony Williams, the patience and persistence of Bill Alsup and his colleagues, and the good sense of the Qataris to invest when nobody else would.