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JBG Smith Plans To Break Ground On 2M SF Piece Of HQ2 Within The Next Year

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A rendering of the north section of Amazon's National landing, including parts of Pentagon City and Crystal City
A rendering from November of the north section of Amazon's National Landing, including parts of Pentagon City and Crystal City

The developer building Amazon HQ2 in Northern Virginia has unveiled new details on how the massive project will move forward. 

JBG Smith, in its first quarterly earnings report since landing HQ2 in November, told investors it plans to break ground within the next 12 months on the first 2M SF of Amazon's planned 4M SF campus. 

The first new development for the campus will be the Metropolitan Park 6, 7 and 8 sites, located near the Pentagon City Metro station. JBG Smith is selling the land to Amazon and will stay on as its development partner.

Along with the sale, which it expects to close later this year, JBG Smith said it has entered into a contract to acquire a D.C. multifamily building, allowing it to structure the deal as a 1031 exchange for favorable tax treatment. 

"I think it's a good idea, particularly to 1031 those proceeds into more multifamily," said Green Street Advisors analyst Daniel Ismail, who covers JBG Smith. "Seeing where multifamily REITs trade at and where office REITs trade at, today's public market is more willing to pay a higher price for multifamily assets." 

Amazon will also buy the nearby Pen Place development site from JBG Smith, a deal the REIT expects to close next year. Construction on that site will follow the Metropolitan Square property and will include 2.1M SF of development. JBG Smith said the two sales combined will generate $294M in proceeds. 

As the developer goes through the design phase for the 4.1M SF of new development for Amazon, it is also currently renovating the three buildings near the Crystal City Metro station where Amazon will lease 537K SF. 

JBG Smith Matt Kelly
JBG Smith CEO Matt Kelly at the Nov. 13 Amazon HQ2 announcement

A significant chunk of the REIT's portfolio is centered around the National Landing area, and it expects Amazon to have a major impact on the market. Roughly 43% of JBG Smith's overall holdings are within a half-mile of the HQ2 site, it said, including 6.9M SF of future development. The REIT said it owns 71% of the total office stock in the National Landing submarket. 

"We believe that Amazon's presence, combined with the recently enacted infrastructure and education spending that accompanies its move, will change the center of gravity of the entire Washington Metro market in the years to come, and we are fortunate and energized to be in the middle of it," JBG Smith CEO Matt Kelly wrote in a letter to investors. 

Kelly, who will speak Thursday at Bisnow's Amazon HQ2-Apalooza event, began the letter by noting that the National Landing campus will now be the only HQ2. But he otherwise did not address Amazon's decision to back out of its New York City plans, an omission Ismail found surprising. 

"I didn't really see a change in strategy by JBGS post-Amazon's departure from Long Island City," Ismail said. 

Outside of National Landing, JBG Smith has continued its stated strategy of selling assets to take advantage of what Kelly describes as a seller's market. The REIT generated $875M last year through asset sales and recapitalizations, surpassing the $700M it had originally planned. It is aiming to generate another $400M through sales and recapitalizations this year, Kelly said. On the acquisition side, the REIT is taking a measured approach. 

"The acquisition environment remains competitive, and many asset classes, particularly downtown office, are priced aggressively," Kelly said. "Consequently, we remain cautious, and we are currently net sellers."

Given the weakness of D.C.'s office leasing market for commodity Class-A buildings and the strong asset pricing, Ismail said it makes sense that JBG Smith would sell those properties and shift its profile toward multifamily with a heavy concentration in the National Landing area. 

"There is, I think, a question of concentration risk, but when the return profile of what you're reinvesting in is head and shoulders above the competitive landscape of the assets you're selling, I think it makes sense," Ismail said. "Particularly if it's disposing of non-core commodity office properties in the D.C. Metro to invest in multifamily in National Landing. I think that's an attractive trade." 

JBG Smith's same-store net operating income was down by 7.4% in Q4 compared to the previous year. The metric, which shows how much the REIT brought in from existing properties, fell from $82.9M to $76.8M. 

It attributed the income drop partially to increased ground-lease payments for two buildings in Arlington's Courthouse neighborhood, but also to a shift in its portfolio from existing office buildings to development sites. The REIT said its opportunities for future income growth remain strong, and Ismail said he expected to see some negative income performance. 

"I think their operating results are reflective of a still-challenged D.C. office environment as well as their changing portfolio," Ismail said. "As they continue to dispose of non-core assets and reinvest in development, you're going to have a period where their near-term income is lower than it otherwise would be." 

The REIT's stock price fell Wednesday morning following the release of the earnings report. As of 1:45 p.m. ET, JBGS traded for $40.19/share, down 1.7% on the day. Ismail said it is roughly in line with how other office REITs have performed Wednesday and doesn't see it as a negative response to JBG Smith's earnings report.