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Payback time

New transport links increase the value of the areas they serve. Shouldn’t they get something in return?

David Blackman
26 September 2017

Telecommunications, transport, power and water: McKinsey Global Consulting estimated in 2013 that $57tn would be needed to bring global infrastructure up to scratch by 2030 to keep pace with economic and population growth. The problem is that cash-strapped governments, still reeling from the global financial crisis and facing competing pressures for scarce resources, are ill-equipped to furnish such investment. 

There is little doubt, however, that improved transport facilities often drive up property values. Research carried out in June 2015 by Groundsure and Property Week found that, along the route of London’s Crossrail line – due for completion in 2018 – house prices are estimated to have risen by as much as 73% between 2013 and 2015. And there is growing interest worldwide in how these uplifts in property values can be captured to help pay for new transport infrastructure.

The problem, though, is one of chicken and egg. Without up-front investment, infrastructure cannot be delivered, meaning no knock-on rise in property values. But until land values have increased, sites will not generate the kind of cash needed to pay for what are, by their very nature, costly and complicated projects. 

Hong Kong provides an example of how these problems can be solved. The self-governing territory’s public transport agency, MTR, uses the profits from real estate development to pay for the costs of extending Hong Kong’s mass transit rail network. The results are illuminating for those struggling to get transport projects off the ground elsewhere in the world. Over the past 40 years, MTR has built hundreds of kilometres of rail lines without using a single dollar of public subsidy. 

Once it has worked out how much a new line will cost, MTR draws up masterplans for the land surrounding the stations along the route, and then sells the sites to developers at values based on how much they will be worth once developed. 

Nicholas Brooke FRICS, Chairman of Hong Kong-based Professional Property Services and past President of RICS, has been involved with MTR rail and property projects since the concept was developed. He explains: “The government sells the sites to the MTR on a greenfield basis: they pay on the basis that there’s no railway there. They then sell on development rights with the benefit of the railway they are going to build.”

“There are clearly significant gains to be made by developing above a station: you take your cash up front and then sell the development rights.” - Nicholas Brooke FRICS

Once it has sold development rights, MTR then extracts further value by entering into profit-sharing agreements with the developers, which it generally takes either in the form of a cash payment or a chunk of the development. 

MTR has accumulated a substantial real estate portfolio since it was granted development rights over the land above or next to planned railway stations 30 years ago, which helps it generate around $386.5m in rent a year. Each station development usually includes a three- to five-storey shopping centre that sits immediately above the site. On top of the retail space, MTR and its partners build up to 10 towers. While in suburban locations these will chiefly comprise flats, those in more central areas generally include a mix of hotels, office and residential accommodation. 

MTR’s approach to funding has sparked disquiet among Hong Kong residents about the “sweetheart” nature of the deals between what is now a privatised company and the territory’s government. However, the flipside is that MTR has been able to support the city’s growth while keeping the city moving. Focusing development so tightly around stations has helped increase the use of the territory’s mass transit network, which carries nearly half of all franchised public-transport journeys made in Hong Kong.

MTR is now exporting its model to the Chinese mainland, where it is developing two “rail and property” projects. Its influence has been seen in the UK, where then-chancellor George Osborne used his March 2016 Budget speech to ask Transport for London (TfL) to investigate the use of land-value uplifts to pay for transport network upgrades.

London’s transport agency has established a string of joint ventures to redevelop its spare and underused property assets. It has already imposed a top-up business rate on the capital’s large occupiers to help fund Crossrail’s construction. And it is using a tax increment finance (TIF) scheme to pay for an extension of the Tube to serve SP Setia and Sime Darby's redevelopment of Battersea Power Station. 

Such integration of transport and development can be a powerful spur for regeneration, says Laura Mazzeo, a partner at architect Farrells, which designed Hong Kong’s Kowloon station scheme. “You are in a better-connected place to start with than on greenfield sites, because you are straight away connected into existing services and high streets,” she says. “When Kowloon was built there was nothing round it. It was built on the assumption that if you built a transport hub meaningful development would come.” 

“If you can get a deck built, you could say it’s just another brownfield site to spring off,” says Martin Rowark FRICS, a management consultant at the Nichols Group and a former TfL commercial director. However, he cautions that the civil engineering challenges involved in building railway stations are far from straightforward. “Infrastructure has a reputation for being very, very expensive: you can see the margins shrink in front of your eyes.”

Rowark, who is also Chairman of the RICS Infrastructure Forum Steering Group, says the final costs of station redevelopment projects can be very unpredictable. “It’s not because people in infrastructure are grossly incompetent, but because you are dealing with far more interfaces than you would ever expect in a building.”

These headaches often include trying to run a public transport system alongside a construction project. “If you could just close a station like London Euston for six years it would be just another brownfield building site, but if you try doing it while several million people are using it on an annual basis, you build it in a completely different way, piece by piece, which is incredibly expensive,” Rowark adds.

These complexities and costs mean that governments cannot be expected to rely on property redevelopment to fully shoulder the burden of providing new transport projects, particularly in less dynamic markets where uplifts will be smaller, such as the north of England. 

However, Alexander Jan, Director of City Economics at Arup, believes there is plenty of unexplored scope to capture more of the value that is generated by transport improvements. “We know that Crossrail has created windfall gains in terms of value uplift, which hasn’t been captured by the business rate supplement.”

He says more value could be captured by creating transport investment zones in a radius of up to 1km surrounding station redevelopment projects, with the knock-on benefits that these could then be built to a higher specification. 

Real estate professionals may bridle at being asked to furnish a bigger share of the public spending cake, but in this case at least, it could turn out to be a win-win situation. 

Funding models: Incremental arithmetic

The idea of harnessing land value increases to help pay for new or upgraded transport infrastructure was pioneered by the state of California in 1952. Since then, local authorities in some of the US’s biggest cities have set up tax increment finance (TIF) zones to pay for upgrades. In a TIF scheme, any uplifts in property-tax revenue increases within a ringfenced area can be used to pay back upfront investment in transport infrastructure projects or other improvements at a later date. 

A TIF has been set up in New York to help pay for the 1.6km extension of the No.7 subway line from its Times Square terminus into Hudson Yards. This project involves building a 17.5m ft2 (1.63m m2) mixed-use development on a deck over 28 acres of in-use rail sidings. A new Hudson Yards station opened in 2015.

“Bonds have been issued, which are guaranteed by the city or the state and the revenue is generated from increased values that will come from the real estate in the area,” says Alexander Jan, Director of City Economics at Arup. He compares the Hudson Yards project with the ongoing regeneration of the area around London's King's Cross station. 

Looping back to California, TIF is also being used to provide a portion of the funding for the $4.2bn Transbay Transit Center in San Francisco. Construction of the multimodal transport terminal is now under way, and is expected to serve 100,000 passengers per day on its completion later this year. 

A TIF set up to capture increased values resulting from the regeneration of the area around the terminal is expected to generate $1.4bn over the next 45 years. Around 3m ft2 (279,000 m2) of offices would be developed, along with 100,000 ft2 (9,300 m2) of shops and 2,600 homes.

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