Chapter 2 - Joint Development

Background

Urban Mass Transit program authority was expanded significantly in 1974, by passage of the "Young Amendment," Section 3(a)(1)(D) of the Urban Mass Transportation Act. This section made joint development projects eligible for grant support. It took some time for the agency to incorporate this potential into its overall mission through what was called the Urban Initiatives Program, and it took even longer for transit systems to begin proposing joint development in conjunction with their planned rail transit projects. Nevertheless, by March of 1978, then-UMTA was reviewing joint development proposals from over 20 cities. The focus of this effort was a region's central business district and, with few exceptions, development around rapid rail stations. Some of the major projects included:

• Miami's Civic Center rail station
• Portland, Oregon's Banfield line
• Cleveland, Ohio, use of air rights near existing stations
• Baltimore, Maryland, around several planned Metro stations
• Washington, D.C. - several Metro stations along the Red Line
• During the 1980's, to prevent transit systems from "double-dipping" on their Federal subsidies, it was decided that Federal transit dollars could be used to defray the "net" costs of a joint development project on the same ratio as an otherwise eligible transit project. The term "net" referred to costs remaining after any economic or other return from the project's private partner. The effect of this interpretation on joint developments was to halt many of them in their tracks. There was very little incentive for transit systems to undertake joint development projects, if the Federal interpretation of "value capture" was going to create a direct substitution effect between private and Federal dollars.

In very short order, the concept of joint development switched from incorporating development plans at the design or preliminary engineering stages, to taking advantage of "discovered" uses of existing property--particularly air rights that had no direct Federal cost component. UMTA viewed leases of air rights for 50 years or less as not being dispositions under the Common Grant Rule and its predecessors, and thus not restricted by the new interpretation of the Young Amendment.

Through most of the 1980's, transit systems undertook joint development projects on a limited basis, rarely planning these within the context of new transit stations. If a joint development opportunity arose once the station was complete, then the transit system could negotiate a revenue from that opportunity. The transit system still had to request UMTA approval of the development, and request specific permission to retain the income from the development, but some transactions were completed. One such project was the Air Rights Building, which, as its name indicates, used the air rights above the Metro station in downtown Bethesda. While the Metro system has not received large revenues from the site (less than $200,000 per year), since the completion of the station the entire surrounding area has been developed as high-density office and retail space of between 10 and 14 stories in height. This has generated many new riders for the Metro system and contributed to the economic growth of Bethesda.

Notwithstanding these few successes, however, most transit systems ceased to look for joint development opportunities. Then, in the late 1980's, a broad-based decline in land values made joint developments even less attractive. Without a secure land value to mitigate some of the risk of joint development, the cost of private capital for these transactions increased sharply. A surplus of commercial real estate made economic returns from joint developments even less likely, and slow economic growth generally extended the hiatus in joint developments.

A New Policy

Another change in administration was marked by a steady, long-term economic growth cycle that increased commercial real estate values. At the same time, the Federal Transit Administration revisited its joint development policy in the context of the Livable Communities Initiative. This new effort was targeted specifically at demonstrating and reinforcing the link between transit and the community that it serves. The concept of joint development, therefore, was reexamined in the context of land use planning and community-building.

On March 14, 1997, FTA issued a revised "Policy on Transit Joint Development." The purpose of this policy was to

"clarify the relationship between transit laws and regulations and FTA policy regarding property disposition, leases of property, and sale of property for joint development. This FTA policy statement affects primarily the treatment of program income with regard to joint development and the definition of "highest and best transit use" in joint development."

The policy statement announced to all transit grantees that real property acquired with Federal grant funds could be used to support a transit-oriented joint development. Further, if the joint development project produced income for the transit system, this was considered to be "program income" as defined in the Common Grant Rule, and freely usable by the transit system for eligible transit purposes. The only restriction placed on such transactions was that the transit system must retain effective continuing control of the joint development for transit purposes. I.e., the property being used for joint development could be sold for this purpose to the developer, but the transit grantee must retain some assurance that the joint development will remain accessible to the transit system during the life of the project.

How Does It Work?

Transit projects of all kinds have been funded with Federal grants since the late 1960's. This has, of necessity, included the acquisition of real property. The new FTA policy is intended to make it easier for transit systems to "capitalize" on the increased value of property acquired for their transit service. The increased value comes from two factors--the basic function of transit as a collector and mover of people, and the ongoing economic growth of communities served by transit.¹⁰

Transit systems are permitted in 49 U.S.C. 5309 (a)(1) - (5)[former Section 3 (a)(1)(D) of the Federal Transit Act] to use grant funds to also support

"transportation projects which enhance the effectiveness of any mass transportation project and are physically or functionally related to such mass transportation project or which create new or enhanced coordination between public transportation and other forms of transportation, either of which enhance urban economic development or incorporate private investment including commercial and residential development."

The Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA) added Section 3&127(a)(1)(F), now codified at 49 U.S.C. 5309(a)(7), to the Federal transit laws. This section allows FTA grant funds to support any "other nonvehicular capital improvements that the Secretary may decide would result in increased mass transportation usage in the corridor."

FTA is encouraging transit systems to undertake transit-oriented Joint Development projects either under new grants or with property acquired under previous grants, whether the property is associated with a rail, bus or other transit facility. The purpose of this Joint Development should be both to secure a revenue stream for the transit system and to help shape the community that is being served by the transit system. Where the grantee retains effective continuing control over the joint development for mass transportation purposes (such as an easement, or a contractual arrangement), all proceeds of sale, lease or other incumbrance of the property will be treated as program income for use by the transit system to meet capital and operating needs, for as long as the joint development lasts.

This is a departure from previous policy in two areas. First, FTA will now define all revenue derived from such joint development to be program income as defined in the Common Grant Rule at 49 CFR, Subtitle A, § 18.25. Second, grantees may use the new concept of "highest and best transit use," as an alternate to "highest and best use," in valuing real property for transit-oriented joint development. To accomplish this change, the FTA Master Agreement has been expressly modified to include joint development as an eligible activity in all capital grants to which it applies. Further, grantees may request amendment of grants issued prior to FY 1997, as desired, to expressly include joint development within the scope of such grants.

In accordance with this new policy, transit agencies have three options, as outlined in the chart on the next page: they can sell property as excess for non-transit use; they can lease the property for incidental, non-interfering use by others while the property is held for a future identified transit use; or they can undertake a transit-oriented joint development on the property. In the case of a sale without a continuing transit use, property disposition rules under the Common Grant Rule at 49 CFR, Subtitle A, §&12718.31 apply. That is, the pro-rata Federal share of the net proceeds of a sale at fair market value are returned to the U.S. Treasury.

Transit-oriented joint development ¹¹ can be accomplished through a sale or lease of federally funded property, or through direct participation of the transit agency in the development e.g., as a general partner, depending upon the needs of the project. To qualify as a "transportation project," the transit agency must retain sufficient continuing control over the property to ensure its continued physical or functional relationship to transit. ¹² This control may be exerted through any number of legally enforceable contractual arrangements, ranging from a simple easement to ensure unimpeded access between the development and the transit facility by transit patrons, to a covenant, or perhaps some form of reverter clause to take effect in the event access becomes unreasonably curtailed. Any legally enforceable arrangement between the transit system and the developer which preserves the defined physical or functional relationship between the development and the transit facility should satisfy this requirement. As long as such control is maintained, the transit agency may retain all revenues from such joint development as program income.

JOINT DEVELOPMENT DECISION TREE

Until this year, a strict interpretation of the Common Grant Rule would have required transit systems that "disposed" of land in support of a joint development to return a pro-rata share of the cash price of the land to the U.S. Treasury. In many cases, a developer may not be able to secure financing at reasonable cost unless a mortgage can be granted on the land involved. This requires a sale, rather than a lease or other form of interest in the property. However, since the Federal transit laws recognize joint development as an eligible grant purpose, FTA has interpreted the sale of land to facilitate a joint development as being an eligible activity under most transit grants, and therefore, not a disposition.

Issues

Cross-cutting Requirements - Federally-supported projects generally must meet requirements such as environmental protection, labor protection, and domestic content. These are called cross-cutting requirements. Since joint development is likely to involve a Federal decision (in the form of an approval), this invokes many of the cross-cutting requirements that affect grant activities. If Federal dollars are used, for example, to build a parking lot or common foundation for the development, the Davis-Bacon and related labor laws apply. If the use of the land changes significantly from what was proposed when the grant was first made, then an environmental review may need to take place. These requirements must be addressed clearly and directly with any potential developer. The most feared requirement, from the developer's standpoint, is probably the environmental impact analysis--primarily because of its potential to slow the project and increase its costs.

FTA will review new joint development proposals on a case-by-case basis, to determine what level of environmental review will be needed. In some cases, the joint development will have been planned with the transit project, and a "finding of no significant impact" may be issued. In other cases, the joint development will result in an increase in activity on the property (as from an office tower), but the environmental impact will not increase significantly. In some instances, however, the proposed new use of the property will have significant new environmental impacts--e.g., if the property was acquired over 10 or 15 years ago, and the environmental impact statement (EIS) only addressed transit use of the property.

The uncertainties surrounding environmental impact and other cross-cutting requirements will be minimized if the transit system plans for joint development potential as it plans and designs its transit system. Then, even if there is a ten-year lag before the land becomes developable, many of the environmental issues will have already been addressed.

Effective Continuing Control - For many legal and practical reasons, FTA cannot allow the

transit systems to freely dispose of property acquired with Federal funds. However, as stated above, FTA has determined that joint development is an eligible project activity in a transit  grant. Therefore, transit grantees are allowed to transfer title to land purchased with Federal grant funds, to support a joint development. The title may be transferred free and clear of any incumbrances--allowing the buyer to then mortgage the land at favorable interest rates if necessary--as long as the transit system retains some assurance that the development will remain transit-oriented. That is what FTA means by "effective, continuing control."

The assurance may take the form of an easement, or it may be evidenced by a physical connection between the transit facility and the development. This may be a covered sidewalk, an ornamented walkway, a tunnel, an escalator, or any kind of architectural feature. Effective continuing control may also be evidenced by clauses in a contract that is totally separate from the land transaction. For example, the transit system may be given an equity position in the development, as payment for the land. As part of that documentation, the transit system would expect a clause assuring it that the "physical or functional relationship" to the transit system would be maintained for the life of the project.

To state this issue in a different way, FTA must approve a joint development under this policy, finding that it is physically or functionally related to transit and that it is likely to increase transit use. Effective continuing control in this context would be evidenced by a contractual agreement between the developer and the transit grantee that the developer would actually proceed with the development as approved by FTA.

This policy has led some transit systems and developers to raise the issue of how long the grantee must retain effective continuing control over the project. For the purposes of this policy, and to satisfy the Common Grant Rule, the control should be retained indefinitely. It is not FTA's intention to anticipate or forecast economic or development market conditions. During the life of a development, real estate values, land use policies, transit system service levels, and many other circumstances may change significantly. Such changes would affect the potential next use of the joint development property. Without knowing how these changes will occur, FTA will not attempt to formulate a "reuse" policy at this time. However, current laws and regulations affecting property bought with Federal grant funds are quite clear--a grantee is allowed to dispose of the property (cede effective continuing control) only if it returns the pro-rata share of the net sales proceeds of the property to the U.S. Treasury.

This means, practically, that the transit system is expected to maintain its assurance of the transit-oriented nature of the project in perpetuity. If an unforeseen event occurs, such as a bankruptcy of the development, forced sale, seizing by eminent domain, etc., the joint development agreement would be expected to lapse, and the transit system would be expected to re-establish its legal claim to the property involved. FTA recognizes that this requirement is in conflict with some types of joint developments, and it will seek to address this in future authorizing legislation.

Timing - Transit systems and developers have widely differing timeframes with regard to developments. The transit system must identify an opportunity, propose the concept internally, seek approval of its board to proceed with exploration of the concept, then begin to seek a partner to undertake the development. Once it decides to go forward with a particular developer, the transit system must initiate an environmental review and seek approval of its board once more. The whole process may take a year-and-a-half to complete.

The developer, on the other hand, looks for opportunities that are "ready" in the economic sense. This may involve land owned by the transit system, but more often it involves any land in places where economic development is anticipated soon. The developer "pencils out" a development of the kind necessary to fit the current economic requirements, then seeks to acquire the land necessary to make the development happen. The transit system may own or control one of the potential parcels. The following scenarios may be encountered:

• The transit system may like the development plan, but its original environmental impact statements did not include development impacts--the developer must wait six months or more for a new EIS.
• The transit system may have plans for the land that differ from the developer's, and has sought the necessary zoning to fulfill its plans. A compromise between the two will likely take time to negotiate, and will reduce the market value of the land. ¹³
• The developer may bring a proposal to the transit system, which must then explore the concept, seek local and Federal approvals, and present the proposal to its board for ratification. All of this, not including a new environmental review, may take several months to complete.
• In each of these cases, the developer has ample time to seek other, less problematic land. Even when it has brought a proposal to the transit system, interest rates and economic factors may change sufficiently over three or six months to make another property more remunerative for the developer. It will have no incentive to wait for the transit system. However, proximity to a passenger facility provides significant advantages to property that may be a candidate for development. Transit systems may overcome many of the circumstances in the preceding scenarios by planning ahead to capitalize on these advantages. This may require expanding the basis for an environmental assessment, or "pre-qualifying" a joint development opportunity with the transit system's board of directors, so that when an offer is presented it can be acted upon expeditiously. In this way, transit systems may plan to preserve (and capture) the enhanced value of the property around their facilities.
• Differing Goals - Transit providers will plan joint developments to help shape land use around their transit systems, to make it easier for the surrounding communities to use the transit system, and to serve a greater number of passengers at lower cost. The developer wants to build the optimal development for the property at the least risk. The developer may recognize that the transit system's goals will eventually enhance the value of the development--through integration of economic activities, residential use, and transportation--but its immediate goal is profit. Thus, if the developer calculates that the lowest-risk development is a strip shopping center, but the transit system insists on medium-density housing instead, the developer will seek mitigation for the increased risk of the development. If the financial risk appears too great after mitigation, the developer will look elsewhere for opportunities. Once again, the transit system may mitigate the perceived risks to the developer by advance planning. Since the developer's risk is quantifiable, the transit system may increase the certainty of profit by postponing its required financial return for a time, or by taking an equity position in the development, or even by providing subordinated debt (if this is allowed in its local laws). Each of these steps will either reduce or delay the developer's cash outlays and project costs, thus reducing its financial risks.
• Highest and Best Transit Use - FTA originated this concept in its policy statement. It is defined as that combination of residential, retail, commercial and parking space that results in the highest level of transit support from a combination of project revenues and increased use of the transit system. The term is intended to combine the concepts of highest and best use in real estate assessment with transit-oriented development. In some circumstances, the highest and best use for a property, i.e., that use resulting in the greatest cash price for the property, may not be transit-oriented. Secure storage for construction equipment, or a coin-operated car wash would be examples of non-transit- oriented developments. Fences, heavy machinery, multiple car lanes, all act as barriers to access for people who walk to the transit system. And, the people who would bring their cars to the car wash may be less likely to use the transit system. FTA does not intend to limit the local community's ability to define social or other benefits that it wishes to achieve through a transit-oriented development. Thus, locally preferred plans for "highest and best transit use" may be acceptable even if they do not generate the highest possible level of financial return, although the transit system is expected to realize some financial return (i.e., not transfer the property for $1) in a development.
  
  This issue has been explored particularly in Portland, Oregon, where the local planning agency (Portland Metro) has implemented an urban growth boundary. Part of this plan involves fostering joint developments around several light rail stations. Because it has significant zoning authority, Portland Metro has been able to influence the zoning of specific parcels of land in ways that increase their density of use, and provide synergies with other nearby activity centers (offices, banking, restaurants, etc.). However, the zoning anticipates by several years the traditional patterns of density growth that are necessary to ensure financial success of a new commercial project. Thus, the developers who may be involved in these projects devalue the land based on the increased risk of project failure. For example: In one property, the highest and best use was considered to be a 9-unit, median income townhouse condominium, with built-in parking for all units. The metropolitan planning organization, Metro, had calculated that social, economic and environmental benefits in that area would be maximized by a rental apartment development, for low-to-moderate income residents, with structured parking for 40 percent of units. Developers maintained that, while the Metro plan could eventually prove economically viable, the current market would not support the higher density plan. The risk of substantial non-payments of rent, and resulting default on project financing, was considered too high. Thus, the value of the land would have to be reduced to reflect this risk. In discussions with Metro, FTA indicated that while the price of the land was to some degree negotiable, FTA would not accept a zero or negative valuation of property to make the project feasible. Portland Metro is working with the developers to achieve property prices that reflect the true value of the real estate to the overall joint development projects.
  
  By allowing the application of this concept of highest and best transit use, FTA is hoping to help bridge the gap between developers' and transit systems' goals. The transit system can negotiate the final value of the land contributed to the development, and the developer can mitigate some of the development risk through reduced land cost. There may be instances where the transit system will undertake most of the development risk, i.e., act as the developer, because of a lack of interest from the development market, but FTA has not reviewed such projects as yet.
• Time Value of Money - Transit systems can offer developers a significant benefit, in the form of delayed repayment. Since the transit system owns the land, and has already paid for it, it is not under as much pressure as the developer to realize immediate cash benefit from the sale of the land. In a situation where the desired development anticipates the market by several years, the transit system can mitigate the developer's risk by allowing the postponement of proceeds from the sale of the land. This postponement is a form of credit enhancement, as far as the developer's bankers are concerned. Suppose that the transit system sells a $1 million parcel of land for joint development. The developer seeks a mortgage on the land to help finance the development. If the transit system postpones receipt of its land sale proceeds for just 5 years, this is equivalent to providing $500,000 in additional credit to the project. This credit enhancement may reduce the developer's borrowing costs by as much as 100 basis points. On a $25 million project this is worth $250,000 per year.
• Risks - From the transit system's perspective the risks are significant. They include local political risk, risk of failure, project delays, and unmet expectations.
• There is political risk in the relationship between the transit system and the community that it serves. Some communities may oppose any kind of "Transit Oriented Development." Some transit systems seek to generate revenues by proposing tax-increment financing. This has often been an unpopular method. The transit board may not feel that it is appropriate for the transit system to be involved in local land use issues. Or, there may be a strong local planning organization that will view transit joint development as an intrusion on its own areas of responsibility. Any of these factors may delay or defeat a planned joint development program.
• The joint development project may fail financially, even though it produces some or many of the desired social or economic benefits along the way. This may take the development out of the hands of the transit system, through a foreclosure sale, or it may force the transit system to buy out the development. This would require entirely local funds, and likely would be viewed by the local community as a failure for many years afterward.
• Project delays, particularly from environmental reviews and labor negotiations, or disagreements with other local jurisdictions, may reduce projected returns to the developer. This, if it persists, may cause the project to fail before it is even completed. The developer will preserve its ability to withdraw from the development if certain financial milestones are not met.
• The transit system must avoid the temptation to "oversell" a joint development as it seeks to build local consensus. If the project fails to meet expectations, it threatens future joint development opportunities, which may have even greater potential benefits.

FTA believes that with this clarified joint development policy, more transit operators will be willing to examine the possibility of initiating joint development projects around their transit facilities. This opportunity exists particularly with regard to facilities that provide a logical activity center, such as a tourist information kiosk, multi-mode transfer center, or bus system transfer center. Such facilities often provide substantial traffic flow for potential businesses in the surrounding areas. If properly planned and integrated in the local land use plan, such transit facilities and their joint developments may act as catalysts to ongoing economic development in their surrounding communities.

However, the greatest benefits will be generated from those joint development projects that are planned (at least at the conceptual stage) when the transit facility is first being designed. This allows a more detailed environmental impact analysis as well as better site design and utilities location in anticipation of the potential development. Better planning will eliminate many uncertainties that might otherwise drive away potential private partners. Joint developments take long enough to negotiate and implement without having to address planning, environmental and zoning issues.

Footnotes

10. There has been a long-running debate on which comes first--the transit service or the urban density that requires transit service. However, the more appropriate debate may center on how transit service relates to local density and community structure. Recent studies indicate that transit service enhances the value of residential and office space, thus making increased density in the area around the transit service economically viable.

11. The term "Transit-oriented joint development" refers to a joint development project undertaken in concert with an existing or new transit facility. A discussion of how this concept fits with the global concepts of Joint Development or Livable Communities is contained in Appendix B.

12. Effective, continuing control of the property for transit purposes does not substitute for the grantee's obligation to ensure ongoing access by the general public to the transit facility.

13. By definition, if the developer is identifying the highest possible return on the land, any variation proposed by the transit system is likely to be less than the highest possible return.