Assembly Square in Somerville is one of Federal Realty Investment Trust’s latest mixed-use projects in the predevelopment stages. A new Orange Line T station will be created, and new public parkland along the Mystic River also will enhance and improve the riverfront.
Developing mixed-use properties is one of the biggest trends in real estate, but developers looking to build these types of projects need to understand that creating true mixed-use is more complicated than simply stacking office space or residential units over retail stores. Rockville, Md.-based Federal Realty Investment Trust, an equity real estate investment trust, began developing mixed-use projects in the late 1990s after recognizing a strong move back to the urban core was taking hold in the country as empty-nesters no longer needed large homes and young professionals were seeking social interaction.
The company’s first mixed-use project was Bethesda Row, located in Bethesda, Md. The development began with the construction of office space over ground-floor retail without partners, but Bethesda Row benefited from being located along the Metro transit line and having a county-owned parking garage. Since the project began with a strong community familiarity and with infrastructure for a mixed-use project already in place, little risk was encountered and success was experienced rather quickly.
Soon after, Federal Realty began developing two similar projects with different strategies: Pentagon Row in Arlington, Va., where the company partnered with Post Properties, who owned the residential component, and Santana Row in San Jose, Calif.
At Pentagon Row, Federal Realty assumed having a development partner would mitigate the company’s financial risk while adding expertise. Post’s residential experience in multifamily housing enhanced Pentagon Row, which consists of more than 500 apartments above 296,000 square feet of retail. However, such a partnership must be structured properly. As co-owners directing the general contractor, timing and cost risks in development were shared, which affected overall yields. With Santana Row, Federal Realty’s $500 million investment was equivalent to approximately one-quarter of the company’s total value at the time, a huge commitment for any single deal. Although the Silicon Valley housing market was booming in 1997 when the project started, the developer couldn’t have foreseen the dot-com bust or the events of Sept. 11, 2001, which resulted in a major drop in residential and hotel values. In August 2002, a devastating construction fire delayed the opening, further impacting the project’s return. In addition, Bethesda Row had existing public infrastructure, which Santana Row and Pentagon Row lacked. As the master developer, Federal Realty invested millions of dollars to establish parking and utilities at Santana Row and Pentagon Row.
Timing Is Everything
Mixed-use projects also present timing risks. It can take years to assemble the land, develop and then build the project, which often may be delivered in an undesirable leasing market. Retail may be hot during a residential slump; hotels and offices might be out of favor. As a result, a company that builds multiple uses also takes on exponentially greater risk. The tradeoff for 100 percent control is 100 percent of the downside when something goes wrong.
After the three initial projects, Federal Realty realized that it could mitigate risk in two ways: by involving the public sector as a partner in master planning and land assembly, and by transferring the development rights to a third-party partner to mitigate construction risks.
The company did just that with its next mixed-use development, Rockville Town Square in Rockville, Md. The square is a true public/private partnership with the city of Rockville, Montgomery County and residential developer RD Rockville LLC. The project includes 180,000 square feet of lifestyle retail and restaurants, 650 residential units, a cultural arts center and a county library. The land was contributed jointly by Federal Realty and the city of Rockville. Federal Realty acted as master developer and the city provided both the infrastructure and the cultural facilities. The development rights were sold to RD Rockville, who built the structures and then sold the completed ground-floor retail back to Federal Realty at a fixed price. The company’s $42 million investment in Rockville is less than 1 percent of the company’s total value, and provided strong absolute and risk-adjusted returns.
One of Federal Realty’s new mixed-use projects in the predevelopment stages is Assembly Square, located in Somerville. The company is examining every scenario for project execution through the filter of past experiences. Its strong relationship with the MBTA will create a new Orange Line T station, a critical piece of transportation infrastructure funded by both private and public entities. The developer is collaborating with the Massachusetts Department of Conservation and Recreation to create valuable new public parkland along the Mystic River that enhance the project and vastly improve the underutilized riverfront. Finally, the company is working in close partnership with the city of Somerville to expedite the project and secure necessary funding to offset the costs of infrastructure required to rejuvenate this blighted commercial area into a vibrant, mixed-use destination.
Developing mixed-use projects requires expertise and experience in multiple forms of real estate development. In order to be successful, you have to be willing to partner with the right players. Doing so requires a critical evaluation of what your company is good at, what it is great at and where you need outside experts.
Working with third parties provides some benefits, but can also create new challenges – choosing the right partner, structuring the deals and coordinating the different elements. Picking the right third party is the most important part of a joint development. Each group has different objectives and mutual trust and complementary skill sets are critical to a successful partnership. Being selective in choosing partners and having the courage to walk away from projects when the deal structure wasn’t working or expectations were not in alignment can make a tremendous difference.
As populations grow and people are looking for more interaction with their neighbors, mixed-use projects are growing larger and more complex. They are now small cities, and require a sense of place and skill sets that often are beyond one individual. Mixed-use developments require the right team in the right place at the right time.
SANDI WOLCHANSKY is director of development for Rockville, Md.-based Federal Realty Investment Trust.
