TOD for Dummies: Allan Kotin Simplifies Transit-Adjacent Real Estate Development

Good afternoon. I’m not a legislator. I’m a real estate economist, and I’ve been professionally engaged with TOD’s for roughly  30 years, specialized in PPJV’S—public/private joint ventures between government and private real estate development. 

I have worked on about 15 TODs. I actually worked on one proposal for an LA, high-speed railway that was proposed in the late 1980s and the early 90s between LAX and the Palmdale Airport that never happened. I also teach the development process, so I’m very well aware of all the obstacles that basically are in the way of getting things done. My orientation is creating transactions that work for both the public sector priorities and the transit priorities, in this case, that work in terms of the real estate market.

There are two major types of stations in a high-speed rail system. They’re going to be in-town or downtown stations, which are pretty critical. There will be some suburban or lower-density stations where they can serve a different purpose. They both have real problems that mitigate near-term realization of substantial real estate returns. 

In-town locations have very expensive land and real parking challenges. Suburban locations can provide service parking, but they don’t have the market forces that initially, at least, create really high real estate values. Most California TOD developments have required subsidies, usually from redevelopment agencies, which don’t exist anymore. Yet even so, the history of rail generally, and some high-speed rail experience suggests, that there are real premiums to be captured over time. The presentation you just saw, for Sacramento, shows you the kind of land-use changes that can occur—they don’t occur immediately though.

Three truths about all transit adjacent development in California—and I say California because the rules are a little different in Boston and New York, where they are less car dependent. TOD development depends on non-transit demand, and transit passengers will always be a minor part of the total market. With the possible exception of your little lunch stand, the vast majority of the demand will not come from the people who get on and off the station, because that is, in almost all cases, too small a market except for specialized retail. Transit use among initial tenants will almost always be a minority, and often a small minority. This is particularly true for residential developments. 

This will change over time, but remember: real estate decisions are made with short time horizons. The developer never looks beyond five or ten years. And sovereignty, which is the fact that transit agencies can go in and condemn land without having to deal with zoning issues and stuff like that, that doesn’t apply when you’re doing private development. If you want to get your real estate values and this kind of thing from private development, if you want to get some revenue coming in, you have to go back to the cities and deal with all the zoning and citizens issues. Recognizing the development land or airspace that yields value premiums is separate from transportation property requirements. 

I worked on one of the largest and most successful TODs in the state, the Pleasant Hill Bart station, also called Contra Costa Center, and one of the things that was so tense there was the different standards that the transit agency had from traditional construction and parking demand. If you don’t understand this, it can really mess up the apparent real estate benefits. Different constituencies, while they may overlap, seek different priorities. Passengers and transit operators want it to be convenient and efficient. Tenants want traffic, which may be congestion, if they’re retail, and privacy and access if they’re office or residential. This last bullet is really important. To buy enough land, beware of parking fallacies, and with transit parking, transit parking is neither free nor necessarily compatible with private uses. Recognize that not all land will be developed initially—I’m going to come back to this with my concluding slide, about the fact that the decision to pursue real estate is not a transparent one. 

Let’s continue with challenges. Suburban sites, the route construction, and safety standards are at least a little easier to deal with because in a suburban area you’re more likely to have horizontally separate uses as opposed to something like the in-town sites where you’re actually putting your private uses on top of transit uses. Different constituencies pose less of a challenge because they’re also physically further apart. Once again, buy enough land. This is easier because land is cheaper, and large surface parking lots can be reservoirs of future development. But be aware that converting surface parking to private use is often very expensive—it is not free land since, first, all the parking has to be replaced with a structure or subterranean spaces. The BART land that was used for Contra Costa Center station was a parking lot. By the time they paid for the parking, it was over 50 bucks a foot for ‘free land’. 

Study the plan for changes and parking demand as a result of changes in transit use. Now this is a really interesting one, because the classic mode is to say, “Well we have to cut the parking requirements for housing or retail if we’re having a transit station.” Nope. If you don’t have the parking requirements, you won’t be able to finance it. What you have to do is think about the fact that over time, you may need less parking. 

This slide shows a simple decision tree for thinking about getting real estate projects. I’ve done enough transit work to realize that most of the things I’m recommending here are not done, or if they are done, they’re almost done accidentally. Decide early if private real estate development is to be a source of revenue. You can’t think of this after the fact—you have either the planning or the land. If yes, go on. If it’s not worth the money and the stress—and there’s a lot of both that’s involved in getting this—stop. 

Identify the additional property required and determine if funding is available. Can you buy it? If you don’t have additional property, you’re going to fall into that parking lot fallacy where you think, “Oh we can make a lot of money on parking lots.” But by itself, you cannot. So if funds are available, go on; if not, stop. In the short run (and this is something that a few agencies are beginning to do) expand your planning staff. Deepen and change your liaison with local authorities to cover non-sovereign action. If you’re going to make money from private real estate development and realize, over time, increased values, you’re going to have to be just like other property owners. You’re going to have to go in and deal with community opposition and a long, often complex entitlement process. Identify requirements around new land, and explore the land-use changes needed. If you can do all of this, you can go on. If you cannot, you stop. In the long run, design and implement a disposition strategy to maximize long-term real estate returns.

This is my second-to-last-slide. And this is one strategy—it’s a strategy I’ve seen used successfully, and it says you use long-term unsubordinated ground leases. Don’t sell land, and don’t become a partner with developers. You design the leases to accommodate the developments needed to show feasibility early while preserving for the transit agency participation in long-term value growth. 

The impact of rail and any form of transit on property values is a long one. It’s a powerful one, but it’s also a long one. This means lower than target rent initially. It does not accommodate the tradition fixed-rate return. There’s a kind of knee-jerk attitude in a lot of transit agencies, which says, “Well, we get an appraisal for our land and we lease it at 8 percent.” That doesn’t work if you really want to encourage the growth of real estate values because you want to get the developers in there with higher value projects that will create more value over time. The way you do that is to lower the going-in rent. 

Now, how do you get that rent back? You have percentage rent, preferably applied to gross-revenue, and many of the good leases now have what are called Capital Events Participation—you share the profit on the sale of a project. 

That third bullet is a toughie because it happens over and over, every TOD or transit thing I looked at: keep social priorities separate. There will be pressure for sub-optimizing uses such as affordable housing, childcare, etc. When I say sub-optimizing, remember, the title of my talk is real estate value. It’s not public policy: it’s real estate value. While these cannot be ruled out, and they shouldn’t be ruled out, local governments and the transit agency developers need to jointly identify other funding sources. One of the key things is that the core function of any transit agency is to deliver transportation, and at least in my view, not necessary social benefits. 

So that’s my quick view. I can’t believe I fit it in ten minutes! People who know me—I’m not known as particularly brief! 

This is my second-to-last-slide. And this is one strategy—it’s a strategy I’ve seen used successfully, and it says you use long-term unsubordinated ground leases. Don’t sell land, and don’t become a partner with developers. You design the leases to accommodate the developments needed to show feasibility early while preserving for the transit agency participation in long-term value growth. 

The impact of rail and any form of transit on property values is a long one. It’s a powerful one, but it’s also a long one. This means lower than target rent initially. It does not accommodate the tradition fixed-rate return. There’s a kind of knee-jerk attitude in a lot of transit agencies, which says, “Well, we get an appraisal for our land and we lease it at 8 percent.” That doesn’t work if you really want to encourage the growth of real estate values because you want to get the developers in there with higher value projects that will create more value over time. The way you do that is to lower the going-in rent. 

Now, how do you get that rent back? You have percentage rent, preferably applied to gross-revenue, and many of the good leases now have what are called Capital Events Participation—you share the profit on the sale of a project. 

That third bullet is a toughie because it happens over and over, every TOD or transit thing I looked at: keep social priorities separate. There will be pressure for sub-optimizing uses such as affordable housing, childcare, etc. When I say sub-optimizing, remember, the title of my talk is real estate value. It’s not public policy: it’s real estate value. While these cannot be ruled out, and they shouldn’t be ruled out, local governments and the transit agency developers need to jointly identify other funding sources. One of the key things is that the core function of any transit agency is to deliver transportation, and at least in my view, not necessary social itinerary. 

So that’s my quick view. I can’t believe I fit it in ten minutes! People who know me—I’m not known as particularly brief!