The Washington PostDemocracy Dies in Darkness

Developers are making billions off Metro. How that could help save the system.

Developer JBG ‘s new office complex rises in Rosslyn. Already the largest developer in the region, JBG is merging with another firm to focus exclusively on properties near Metro even as the transit system struggles.  (Photo by Nikki Kahn/The Washington Post)

Some of Washington’s most accomplished real estate developers on Monday announced a new company that one described as a “true powerhouse.” Valued at $8.4 billion, the company, JBG Smith, will be the capital’s largest landlord to the federal government and will dwarf any real estate venture the region has seen.

To create it, the principals of two existing firms, the JBG Cos. and Vornado/Charles E. Smith, merged their companies and took what they considered the best 92 properties (including 50 office complexes and 18 apartment buildings) from each. Everything else will be sold.

Although the properties are spread across the region, one characteristic unites them. Almost every one — 98 percent — is within a half-mile of a Metro station. That is, after all, where much of the most valuable real estate in the region is.

[Merger between JBG and Vornado to consolidate power in Washington real estate]

Daily Metro riders might be surprised that the proximity is prized, considering the troubles they endure in their daily commutes. Delays, maintenance shortfalls and security crises rack the system on a routine basis. Its financial and managerial underpinning are in such poor shape that the day after JBG Smith was announced, The Washington Post editorial board wrote that Metro was mired in “what looks increasingly like a death spiral” and argued for a federal takeover of the entire system.

A day later, Metro’s board chairman, Jack Evans, said he had reached the same conclusion, saying “extraordinary powers” were needed to overhaul Metro’s finances, workforce and governance.

But for all Metro’s woes, smart real estate is betting on it more than ever. All of that development leads to property, sales and income taxes that fill local tax coffers. The extra revenue could eventually be tapped to help put the transit system back on solid financial footing.

“I believe JBG Smith has the potential to be the fastest-growing real estate company in the country,” said Steve Roth, a New York real estate magnate, on a call with investors to announce the new company. Roth is founder and chairman of Vornado Realty Trust, an $18 billion real estate empire, and will create JBG Smith by spinning off its Washington unit and combining it with JBG Cos., which is based in Chevy Chase, Md.

Roth said that they “very carefully selected which JBG properties would be included,” ultimately deciding to keep 41 properties valued at $2.4 billion that he and other executives reminded investors again and again were in “Metro-served” markets. That includes properties near downtown D.C. stations as well as those in Bethesda, Silver Spring, Rockville, Rosslyn, Court House and by Silver Line stations (some not yet opened) in Reston and Tysons Corner.

Matt Kelly, a JBG managing partner who will be chief executive of the new company, said on the call that his number one criterion for which properties to keep was their location in “core and Metro-served markets.” JBG will sell off another $3.3 billion in real estate, most of which is not walkable to a Metro station.

Similarly, Vornado will contribute buildings in downtown D.C. and 26 buildings near the Crystal City Metro station but will sell off its Skyline City office complex on Leesburg Pike.

“We deliberately excluded assets that did not meet those criteria,” Kelly said.

Kelly and other JBG managers could be rewarded handsomely for their choices, as they will own 6 percent of the new company, which equates to $504 million.

Meanwhile, Metro imminently faces a $290 million operating deficit in its next fiscal year, which has prompted it to propose service cuts, fare increases and staff reductions. That’s on top of an estimated $12 billion to $18 billion in capital funds needed over the next 10 years for maintenance and upgrades. Since 2010, ridership is down 12 percent (100,000 fewer trips per day), and if proposed fare increases go into effect, Metro estimates that it will lose another 10 million trips next year.

And yet Metro has added 2,000 employees in recent years to help run things.

As crazy as it sounds to invest so exclusively on such a transit system, JBG Smith is far from alone in thinking that Metro stations, even in their compromised state, are poised to be an extraordinary profit center. They produce enormous gains for developers and tax revenue for local jurisdictions.

In fact, the difference in value between Metro-accessible offices and apartments and those that require driving has probably never been greater.

“Regarding the importance of Metro to our industry, it cannot be overstated,” said Gregory H. Leisch, senior managing director at the commercial real estate firm Newmark Grubb Knight Frank.

Take Tysons Corner, where all the cranes are putting up towers near the four new Silver Line stations — many of them to accommodate residents and companies that are moving from just a few miles away.

But that distance, Leisch said, means everything. During the past five years, companies have moved into 700,000 more square feet of space than they have vacated near Silver Line stations. Everywhere else in Northern Virginia it’s the opposite, as companies have vacated 5.5 million square feet more space than they have leased.

Furthermore, Leisch said that Metro is a national leader in attracting investment near its stations when compared with other systems.

“The share of office space in the District and Arlington, so well served by Metro, is unparalleled when compared to other major metro areas,” Leisch said. “It is 44 percent of our inventory. Cities like L.A., Phoenix and Denver, without a subway, average 23 percent of their office inventory in the center city.”

“Metro areas like Boston and Philly, with successful subway systems, have an average of 36 percent. So the vitality of the District of Columbia and inner suburbs is directly dependent on Metro. And [that] does not even count close-in suburbs of Tysons, Alexandria, Bethesda, Silver Spring, etc.”

There is increasing agreement that Metro needs some type of dedicated revenue stream beyond rider fares to return to solid financial footing.

D.C. Mayor Muriel E. Bowser (D) has endorsed a minimum of a 0.5 percent regional sales tax increase; Maryland Gov. Larry Hogan (R) and Virginia Gov. Terry McAuliffe (D) have not outright rejected the idea. They are also focused on seeing improvements in safety and customer service before committing more funds to Metro.

Another idea would be to try to capture some of the value Metro is creating for others by imposing some type of tax on commercial property near stations, a strategy the organization studied two years ago.

A tally last year found roughly $50 billion in real estate development being actively built near Metro stations. That’s five times what it cost to build the original system, so even correcting for inflation, Metro-proximate development has created economic impact well beyond the system’s construction costs.

In some instances, developers have already paid to extend Metro their way. In NoMa, developers agreed to charge themselves to help fund the construction of a new station in 2004.

More recently, the Peterson Cos. agreed to provide $500,000 annually toward the creation of a new Metro bus line serving its National Harbor project from Alexandria.

“Now you’re seeing developers coming to Metro and saying we want to invest in improving the system,” said Nina Albert, Metro’s director of real estate and planning.

A concern with any broader tax on Metro-proximate real estate, Albert said, is that it could inhibit development around stations that have not experienced it yet, further restraining ridership growth. Some balance would have to be achieved.

“I don’t think people realize how important Metro is to the economy of the region,” Albert said. But, she added, “every developer I talk to acknowledges the importance of it.”


Merger between JBG and Vornado to consolidate power in Washington real estate

Editorial: It has come to this: It’s time to consider a federal takeover of Metro

Region’s leaders split over 1-cent regional sales tax to pay for Metro

Follow Jonathan O’Connell on Twitter: @oconnellpostbiz