Northgate Development Jeopardized by Credit Crunch

As a follow up to a piece I posted on February 27 on the Status of the City Center Development, I was asked to comment on the status of the Northgate/Hekemian Development. This is the planned mixed-use development, in the 400 block of North Washington Street being undertaken by Hekemian & Co. It consists of some 95 apartments, 10 rental townhomes, 22,000+ sq. ft. of ground floor retail space, and 14,000+ sq. ft. of office space.

After going through the public vetting/approval process for the better part of 2007 the project was finally approved by all the appropriate boards and commissions and the City Council in 2008. This project, like the City Center project, would appear to be in jeopardy as well, victimized by the current credit crunch. The lending environment for new developments is virtually non-existent at this point in time. To the extent Hekemian can find financing, the amount of equity required (of the investors/developers by the lenders) will be a lot higher than the amounts required one or two years ago, making the project’s economic viability (the investor’s internal rate of return, or IRR) more questionable.

Hekemian has all the approvals needed to proceed and is apparently anxious to do so despite the difficult economic environment. But they must make a decision about whether to wait for more favorable borrowing conditions or go forward under these much less favorable terms, assuming they can even get them at all. Today lenders are demanding far greater equity in a project for a construction loan and permanent financing is extremely difficult to obtain. Even if the current economic crisis abates, lenders are still unsure how to value a property in the future which is how they calculate their risk/reward making the negotiation of terms very difficult for all parties. Projects such as this are valued using a set of assumptions about rental prices, occupancy rates, and “secondary market” prices (what institutional investors would pay for a fully mature property some years down the road) and all of these assumptions are in a state of flux and uncertainty today.

Meanwhile, Hekemian continues to absorb burdensome carrying costs for the project as they already own the land and/or options, tying up their own capital. The value of the land is probably less in today’s market than what they paid for it. And the value of the entire development, when/if completed, is most certainly less today than a year or two ago the combined impact of lower net operating income (lower rents) and higher capitalization and discount rates (to account for greater perceived risk).

All this being said, they continue to shop the project around to potential lenders, still believing that the market for higher end apartments is very strong at their N. Washington St., Metro-walkable location. I understand they have hired a broker to work with them to fill the ground level commercial space with tenants that reflect a theme of healthy living. For example, they will target health food stores, spas, yoga and Pilates studios, weight loss centers, along with cafes and restaurants. But, another hurdle, Hekemian will most likely have to include tenant improvement dollars to “turnkey” the retail space because retailers, large and small, have been shut out of the market due to the inability to obtain loans for FF&E (furniture, fixtures and equipment), inventory, and working capital.

The overall project design and mix of component uses for Northgate remain the same as originally planned and approved. It was enthusiastically supported by the EDA and, I think, most of the boards and commissions when it went through the approval process. Personally I think it would create an impressive gateway to the city from Arlington. And it certainly would add considerable net tax revenues to the city. As bad as the current recession is right now, turn-arounds can come quickly and unexpectedly. Hope springs eternal.

I hope this adds some clarity to an admittedly cloudy situation, and as always I welcome any corrections if I have mis-stated something, more facts, updates, and feedback from all.