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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
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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 minimallydisruptive 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
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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
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In the Matter of the Municipal Art Society of New York v. Haskin, 173 Misc.2nd 832,
522 N.Y.S.2d 800 (Sup. Ct. NY County, 1987)
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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 Battery Park City. 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
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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.
There were multiple rationales for the lease/purchase deal structure, which
were beneficial for both MTA and the developer. From MTA’s perspective, a ground
lease structure during the construction period enabled MTA to take advantage of the
exemption from state and local sales taxes on construction materials for a building built
on MTA-owned property, and to charge the developer a payment-in-lieu of-sales taxes
that effectively captured an 8.875% (the sales tax rate) payment on construction costs for
MTA’s coffers, adding to the deal’s value to MTA. The structure also offered security
for payments to MTA – because the unitary lease would not be severed until the tenant
was ready to construct a building, the tenant effectively had to pay rent and complete the
platform across the entire site, and could not cherrypick the more desirable sites, as any
failure to pay rent on the whole parcel would lead to a default and loss of the entire deal.
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From the developer’s perspective, the lease structure, with a generous rent
abatement in the early lease years, minimized the developer’s cash requirements during
the period when the platform is under construction, and there are no rent-generating
tenants. It also obviated the need to obtain a large acquisition/construction loan for an
up-front land purchase and platform construction. Because the developer can choose the
time of fee conversion of individual ground leases during the ground lease term, the
developer can compare the cost of financing for a fee purchase with the amount of
ground rent over time, and choose the most advantageous moment to convert. Because
severed leases can be converted individually, the developer can elect some parcels to
remain under ground lease while purchasing others, facilitating choice of the most
advantageous financial structure for each building. MTA is financially indifferent to
whether a site remains under lease or there is a fee purchase, because the net present
value of the payment stream to MTA is the same in either case.
In addition to the lease/purchase payments structure, MTA also insisted on
certain guaranties of payment and performance from creditworthy affiliates of the
developer. Ground rent is guaranteed for a specified period from closing until platform
construction begins. After platform construction begins, there is a guaranty of
completion of construction of the entire platform. Each building, once begun, has a
guaranty of completion of construction. Thus, MTA’s worst-case transaction scenario is
that the developer never commences construction of the platform following the lease
closing, in which case MTA either receives continuing ground rent, or is entitled to a
guaranteed amount of rent and takes back an undeveloped site on lease default. When the
developer commences the platform, and then a building, MTA is assured that a
creditworthy guarantor will complete the improvements in question, and MTA will
additionally have full ground lease remedies on a default, subject to lender cure
provisions.
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These are just a few examples of the many, many complex deal terms
involved in putting together the deal for the largest development transaction in New York
City. As the parties move towards design and engineering of the platform, planning for
an upcoming closing under the contract and putting together financing for the
construction of the platforms and the individual buildings, the deal documents provide a
continuing framework for cooperation, compromise, and aligned interests, to better
ensure that all parties accomplish a successful transaction.
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