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Amazon’s HQ2 in Virginia leaves a real estate firm poised to cash in

Two years ago, Matt Kelly could not have known that a failed merger involving his real estate firm would propel him towards a central role in Amazon's expansion plans.

[NEW YORK] Two years ago, Matt Kelly could not have known that a failed merger involving his real estate firm would propel him towards a central role in Amazon's expansion plans.

In May 2016, Mr Kelly and his firm, then known as the JBG Companies, had an agreement to merge with a large real estate investment trust based in New York. But shareholders of the New York fund baulked and the deal collapsed.

A few months later, JBG, based in Chevy Chase, Maryland, had a new partner. In a deal valued at US$8.4 billion, JBG merged with a Washington unit spun off from the real estate behemoth Vornado Realty Trust.

The new company, JBG Smith, with Mr Kelly as chief executive, became the dominant landowner in a Northern Virginia region now being called National Landing, a dilapidated area that includes parts of Crystal City, Pentagon City and Potomac Yard. Amazon announced on Tuesday that it was choosing this area, along with New York City, for two new headquarters, with 50,000 employees between them.

Since Amazon started its search for a so-called HQ2 more than a year ago, the Washington region has been considered a front-runner. The region gives the company access to a large, tech-savvy workforce and the transportation and infrastructure it wanted. Additionally, Amazon's chief executive, Jeff Bezos, has a home in the area.

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For Mr Kelly, Amazon's decision validated a plan that he had been selling for the better part of a year: revitalising Crystal City and its neighbours.

Mr Kelly's pitch was to turn a ghost town, as it has been described, into a thriving hot spot, including public green space and hip new retailers and entertainment venues. The plan relied on redeveloping 1970s-era office towers into sleek residential buildings.

Sceptical investors have become believers, sending shares of JBG Smith up 7 per cent in the past month.

Analysts warn that Amazon most likely flexed its muscles to negotiate a deal with highly favourable terms, possibly pushing for below-market leases in an area that already trends well below national and Washington averages.

For JBG Smith, the HQ2 deal may pay off in an uptick in occupancy and rents for residential, retail and other properties it owns adjacent to Amazon's new offices. But it could take five to seven years for this bonanza to arrive, said Danny Ismail, an analyst and lead of office coverage for the real estate research firm Green Street Advisors.

"This isn't going to be an overnight thing," Mr Ismail said.

Amazon said it intended to lease 500,000 square feet of office space in three buildings owned by JBG Smith. Amazon has also agreed to buy numerous plots of land held by JBG Smith that could be developed for an extra 4.1 million square feet. The purchase price of the land and other terms were not disclosed.

JBG Smith officials did not respond to requests for comment. But in the announcement on Tuesday, the firm said it planned to accelerate construction on other projects in the area, including developments that would create more office and retail space as well as hundreds of residential units.

Amazon's move is a chance for JBG Smith to turn lemons into lemonade.

For the past year, JBG Smith's publicly traded real estate investment trust has trailed its peers, largely because of Crystal City and adjoining areas, which make up about a third of JBG Smith's portfolio.

Charles E Smith Commercial Realty developed Crystal City in the 1960s and 1970s, and Vornado acquired that company in 2002. The Crystal City holdings eventually became an albatross for Vornado.

Crystal City was once a thriving hub of government agencies and military contractors, but its fortunes sank after a 2005 mandate, in part for anti-terrorism concerns, to relocate thousands of jobs from suburban office buildings to nearby military bases. In the following years, Crystal City lost 17,000 jobs, and 4.2 million square feet of office space became vacant.

Since then, occupancy rates in the Crystal City region have hovered around 85 per cent, among the lowest in the country, analysts say.

JBG traces its roots to the late 1950s when three lawyers — Benjamin Jacobs, Donald Brown, and Joseph Gildenhorn — started a law and real estate firm in Rockland, Maryland. Through the 1970s and 1980s, the firm acquired and developed a number of high-profile properties in the Washington area, including the Four Seasons hotel in Georgetown and projects for the World Bank and the insurer Geico.

In the 2000s, JBG began raising money from institutional investors for a series of funds that it used to invest in commercial real estate around Washington.

JBG redeveloped part of Shaw, an inner-city neighbourhood that was devastated by the 1968 riots after the assassination of Martin Luther King Jr. It called the area North End Shaw, a neighbourhood geared towards millennials that featured stylish apartment buildings, trendy retailers like the eyewear company Warby Parker and a movie theatre with a bar.

In the spring of 2016, JBG was looking to expand. It announced a merger with New York Reit, a deal that would have made JBG a public entity, making it easier to raise money to buy properties. The deal also would have diversified JBG's portfolio into the New York City area. But New York Reit investors balked and by the end of the summer, the arrangement had been terminated.

A few weeks later, JBG was being courted by Vornado.

It was not their first flirtation. A few years earlier, Vornado's chief executive, Steven Roth, raised the idea of merging the firm's Washington property portfolio with JBG to form a separate, publicly traded business, according to a 2016 transcript from a Vornado earnings call. But JBG was not sold on the idea of going public and talks broke down.

But the second time around, they struck a deal. The merger made JBG Smith a commanding player in the Washington market and, this week, a potential big winner in Amazon's plans.

"While hard to quantify," analysts at Stifel Financial wrote in a note to investors on Tuesday, "this clearly drives up the value" of JBG's future development pipeline.


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