ACREL “COOL DEALS 2010”-
SALE AND DEVELOPMENT OF NEW YORK MTA’S WEST SIDE RAILYARDS
By Meredith J. Kane
Partner
Paul, Weiss, Rifkind, Wharton & Garrison LLP
The most valuable piece of undeveloped land in New York City is the John D. Caemmerer West Side Railyards, consisting of 26 acres, or 6 square blocks, of airspace over an operating railyard in midtown Manhattan’s Far West Side. Owned by New York’s Metropolitan Transportation Authority, the world’s largest – and chronically underfinanced – urban and regional mass transit system, MTA had long sought a way to tap the massive site’s development potential and monetize its value to support the transit system.
In May 2010, three years after issuing an RFP for the development of the site, MTA signed a contract under which a joint venture of The Related Companies, L.P. and Oxford Properties, the real estate arm of the Ontario Municipal Employees Retirement System, will pay MTA over $1 billion net present value to lease, develop and purchase the airspace development rights over entire property, which stretches from Tenth to Twelfth Avenues, 30th to 33rd Streets. The Related/Oxford development plan calls for the construction of over 6 million square feet of new office and retail space, 5000 rental and condominium apartments, a new school, new cultural facility, and several acres of publicly-accessible open spaces, including a renovated High Line surrounding the Railyards. The deal, which was originally negotiated in Spring, 2008 before the market collapse, survived with its original price and economic terms intact. The only concession the parties made to the changed economic situation was to permit a delay in the closing until specified economic indices hit levels indicating that development activity would likely return to the market in the near-term.
The Railyards site attracted intense interest from New York’s development community when the RFP was issued in Fall, 2007. Five teams of New York’s top developers submitted detailed development proposals, and competed through additional rounds of price increases. The strong response from New York’s development community to the RFP was an important validation of the years of land use planning and legal work that went into positioning this extraordinary and complex site for development.
Numerous thorny challenges had to be solved to unlock the massive development potential of the Railyards and ensure that MTA would achieve maximum value from the sale. MTA, in cooperation with the New York City government and its Hudson Yards Development Corporation subsidiary, had to assure bidders that development of this airspace site could in fact be made economically, politically and technically feasible. MTA’s charge to the lawyers and planners working on the site was to address as many issues as possible before the RFP issuance so MTA could achieve a sale price reflecting the true market potential of the site, without undue discount for unresolved legal, political and technical complexities.
This paper focuses on two of the major site development challenges that the transaction lawyers had to solve, and how they were addressed throughout the RFP process and the subsequent negotiations with the designated developer:
- Zoning. Half of the site – including the desirable 13-acre parcel along the Hudson River waterfront – was at the time of RFP issuance zoned only for low-rise manufacturing use, and had to go through New York City’s famously-contentious rezoning process before developers could be assured of the development entitlement of the site. Because the rezoning could not be undertaken until after selection of the site developer, the challenge was to create as much certainty as possible during the RFP stage on the site’s anticipated development potential so MTA could achieve the full value of the anticipated zoning entitlement.
- Ownership and Financing Structure. A feasible financing and ownership structure had to be devised to achieve the economic and financial goals of MTA, which wanted a steady stream of ground rent payments commencing as early as possible, and a minimally-disruptive platform construction process – with the divergent economic and financial interests of the developer, which wanted to minimize up-front land costs during the costly platform development period, and retain maximum flexibility in design, construction and project timing to meet market demand. Because the physical configuration of the site required a unitary structural platform to be designed and built over each of the two halves of the railyard, as the foundation for the airspace development, the business deal had to accommodate the extraordinary up-front capital investment required to build the platform before the revenue-generating buildings on the site could be constructed. The legal structure had to enable each half of the 26-acre site to be disposed of as a single development site, to enable unitary design, construction and financing of the platform while allowing individual buildings to be financed, constructed and sold separately. In addition to the financing challenges were the even more daunting engineering challenges and construction logistics of erecting a major, multi-stage development over an active, 24-hour operating railyard that serves the busiest commuter railroad in the country.
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Zoning: the RFP and the “Pre-Nup” .
The critical first steps towards the development of the West Side Railyards were taken in New York City’s Hudson Yards comprehensive zoning plan, devised early on in Mayor Michael Bloomberg’s first term. That plan envisioned the Hudson Yards area as Manhattan’s third central business district, in addition to Midtown and Downtown, to be served by a newly-extended Number 7 subway line financed with tax revenues generated from new development in the area. To attract businesses there, a comprehensive real estate tax incentive plan was created, with bonuses going to the earliest businesses to locate in the area. The area was also planned to be the centerpiece of New York City’s bid for the 2012 Olympics, with the eastern portion of the MTA Railyards (the East Railyard) to serve as the public square and broadcast center, and the western portion (the West Railyard) to house a new Olympic stadium, which would be home to the New York Jets after the Olympics. The rezoning plan also included thousands of units of affordable housing, as a trade-off for higher density development, in a hard-fought concession to the well-organized and activist west side neighborhood. As part of the Hudson Yards rezoning, completed in 2004, the Eastern Railyard was rezoned with a 19 FAR density, of which 11 FAR could be built on site and 8 FAR was available to MTA to sell to other development sites in the neighborhood to generate revenue for the transit system. The Western Railyard, to be the site of the stadium, was not rezoned as part of Hudson Yards plan, however, because of City concern that the unpopularity of the stadium land use might doom the entire zoning plan. Instead, the stadium was planned to be developed under a special State zoning override, and the site remained with its previously-existing, low-rise industrial zoning.
The loss of New York City’s 2012 Olympic bid led to a rethinking of the planned land use of the West Railyard area. With a new stadium no longer necessary or politically feasible, the MTA and the City turned their focus to more conventional residential and commercial mixed-use development. In a nod to political realities, the City agreed that it would not seek to circumvent zoning with a State override, but would go through a rezoning process for the West Railyard. The City was anxious for the MTA to put the site out for development, though, even before the rezoning was completed, to help jumpstart development in the area and generate needed tax revenues to pay for the already-underway subway line construction.
MTA was loathe to put the site out for RFP with no zoning in place, and with a neighborhood and political officials still bruised by the battle over the unpopular stadium. The neighborhood had declared its intentions to resist dense high-rise zoning on the site, and to advocate for parks and open space, as well as affordable housing, new schools, and other public amenities. The uncertainties surrounding the rezoning process, in which neighborhood interests play a strong role, were too great to allow developers to project and value with any clarity the site’s likely development potential. And the rezoning process was itself too expensive and contentious for MTA to take on without a developer and a development proposal in place. Case law established during an earlier MTA land disposition of New York’s Coliseum site (now Time Warner Center), although not entirely on point, made it difficult for MTA to enter into a contract with a developer for a land price that was contingent on actual zoning outcome.[1]
To create maximum certainty in an uncertain situation, MTA insisted that the basic terms and limits of a zoning plan acceptable to MTA, the City Planning Commission, the City Council and the Community Board – all parties in the rezoning process – would have to be agreed to and memorialized before MTA would issue the RFP for the site. New York’s environmental laws and land use procedures, however, prohibit making agreements on land use before completing the required environmental studies and land use process. Thus, MTA could not achieve a legally-binding agreement among all parties as to the zoning limits.
The agreement finally struck between MTA and the City, with the concurrence of the City Council and the Community Board, was a Memorandum of Understanding, colloquially referred to as the “pre-nup,” the form of which is attached to these materials. In the pre-nup, the City agreed to support a zoning plan for the West Railyard with specified FAR and land uses, open space requirements, affordable housing requirements, and other public amenities. The City also committed to pay for a new school, to set aside land and FAR for a major cultural facility, and to expand the availability of the Hudson Yards commercial development tax incentives to the site. Although the pre-nup was not a legally-enforceable zoning agreement, it was intended to have political suasion should any of the participants later try to renegotiate.
MTA’s had three objectives in negotiating the pre-nup: first (and foremost), to create a reasonable expectation of zoning certainty for a developer, to support a land price based on the negotiated zoning terms; second, to get the City, instead of the developer, to commit to pay for the public goods and amenities that the parties agreed to provide on the site, to prevent the provision of these social goods from detracting from the hoped-for value to MTA of the site; and third, by assuring wide participation in the negotiation of the pre-nup, to forestall potential future litigation challenging the actual rezoning, which would delay MTA’s ability to convey title. It is a testament to the process that the actual rezoning of the West Railyard, which was completed by the City during winter 2010 upon application by The Related Companies, the designated developer, adhered almost exactly to the development scheme outlined in the pre-nup, and no litigation has since been filed challenging the rezoning (knock on wood).
Devising a Marketable Ownership and Financing Structure.
The key physical challenge for development of the Railyards -- the need to design and build a unitary, integrated structural platform over the operating railyards, to serve as the foundation for the development – drove both the business terms and legal transaction structure for the deal. The platform, which will cover about two-thirds of the 26-acre site, will serve as both a structural floor for the buildings above the deck, with integrated below-grade foundation and building cores and a structural roof for the railyards below, with integrated mechanical systems to provide adequate utilities, ventilation, and headroom to serve the trains below the deck.
From a value perspective, MTA had long recognized that it would achieve maximum value and demand from developers if it could build the platform and infrastructure itself and then sell individual, construction-ready building pads over time as market absorption permitted, a similar model to that which New York City and State used for the development of BatteryParkCity. Two major factors thwarted that plan, however. First, it was simply not possible as an engineering matter to design and build a generic platform that could accommodate alternative development programs on the site. Far from being a simple foundation for the buildings above, the platform had to be structurally engineered as an integrated part of a master-planned development to carry the particular design loads of a specific building program above, as well as to have integrated structural and mechanical design across the entire site. Second, the political and fiscal realities of the MTA’s role as public transit agency dictated that all of MTA’s capacity for capital investment go into transit improvements, and not be invested in what some politicians considered a speculative real estate project.
Thus, the physical and fiscal realities required MTA to dispose of the site in a single transaction to a single master developer that would design and plan the entire large-scale development. MTA also wanted, from an operational perspective, to have the platform built in a single continuous development phase, to minimize interference with the operations of the railyards that would inevitably be the byproduct of major structural construction taking place in the yards.
The challenge for MTA’s lawyers was to devise a feasible financing and ownership structure to enable each of the two halves of the 26-acre site to be disposed of as a single development so that a single structural platform could be financed and built over the railyard, but that would allow individual buildings to be financed, constructed and sold separately. The business deal also needed to be structured to accommodate the extraordinary up-front capital investment required to build a platform over the entire site before the revenue-generating buildings on the site could be constructed.
MTA decided to solicit proposals for the optimum deal structure from developers themselves, as part of the initial round of RFP proposals. MTA stated in the RFP that it was willing to offer either a fee conveyance or a ground lease, with or without a purchase option, of the airspace over the railyards, and asked developers to propose their preferred approaches. Without exception, every RFP respondent proposed a fee purchase and not a ground lease. However, none of the respondents was willing to offer an all-cash purchase price to be paid at closing, given the difficulties of financing a pure land purchase. This was especially the case given the expected up-front costs to construct the platform – really a piece of the land cost, because the site (the airspace) was not buildable without the platform – would require several hundreds of millions of dollars of construction financing. So, each of the developers proposed that MTA finance the land cost during the initial development period of both platform and buildings, with a cash payment due at the completion of each building.
In reviewing the RFP responses, the task of MTA’s lawyers was to analyze the structures proposed by developers to determine what was needed to make the deal work from a financial market perspective, and then devise a comprehensive response that melded the developers’ financial needs with MTA’s financial goals for the transaction: to achieve maximum net present value, certainty of payments, and security for completion of the platform construction. Based on this, MTA opened the second round of bidding by proposing to all bidders a comprehensive transaction structure that it would seek to implement with any winning proposer, including detailed legal deal terms. Given the enormous complexity of the deal, it was not possible to draft and negotiate full deal documents before selecting a winning proposer, the way that bidding is often done with sales of existing assets. But MTA did draft and present to each proposer a very detailed term sheet for the deal, including summaries of the major terms of each of the major transaction documents. A copy of the term sheet proposed to each bidder for the West Railyard is attached to these materials.
The deal structure that MTA proposed to all bidders in the second round was a unitary ground lease of each railyard, with annual net ground rent payments, that would be in effect during the platform construction phase. On the developer’s commencement of construction and financing of each individual building, a separate, non-cross-defaulted ground lease for the individual building would be severed from the unitary lease, with a pro rata financial obligation based on the relative square footage and use for each building. At any time following substantial completion of a building, the ground tenant had an option to purchase fee title to the severed site, with the completed building, at a price based on the discounted remaining rental stream and reversionary value of the severed lease parcel. If the tenant elected not to purchase the fee, then the ground lease would remain in effect for 99 years, with periodic, specified net rent bumps, and fair market resets every 25 years. Severed leases could be sold or assigned individually, and purchase options on each severed parcel could be exercised, or not, on an individual basis.