Tag Archives: value capture

Exporting success from Hong Kong’s MTR – rail transit plus development

Hong Kong at night. CC image from Diliff via Wikimedia Commons.

Hong Kong at night. CC image from Diliff via Wikimedia Commons.

If you were to pick a rail transit system to envy, it would be hard to pick one better than Hong Kong’s MTR. The system is known for extraordinary operating efficiency; both in terms of on-time performance (99.9%) and farebox recovery (186%). Intense development around rapid transit stations both provides a market of potential rail users and an investment opportunity for the MTR’s parent corporation.

The MTR corporation, in turn, is looking to export their expertise in efficient transit operations around the world. An article in the Wall Street Journal profiles MTR’s ambitions:

Hong Kong’s MTR Corp. 0066.HK -1.15% is taking its high standards abroad, bidding to run subways in Europe, Asia and Australia. If it wins just a few of the bids, it will become the biggest operator of metro systems in the world. Led by a New Yorker, the company is also considering other projects, including in Germany, another place that puts a high value on efficiency.

“MTR in Hong Kong is probably the best-run metro in the world, and that brand is what they bring with them,” said Nigel Harris, managing director at the Railway Consultancy Ltd., a U.K.-based firm.

The train operator, which exports even its trademark door chimes and train-service announcements, already runs lines in the Chinese cities of Beijing, Shenzhen and Hangzhou, as well as in Melbourne, London and Stockholm. It has been shortlisted to run a train line in Sydney and three more lines in London, including Crossrail, one of the biggest rail projects in the city in decades.

Just how exportable is MTR’s success? Purely operational measures (on-time performance) seem to present the strongest case, particularly with such inefficient operations elsewhere in the world. Financial measures (whether simple metrics like farebox recovery or broader measures of profitability of the entire corporation) depend on the context of the system – not all cities have Hong Kong’s kind of density to support efficient transit. Planning metrics depend on key governance and financial attributes; legal matters complicate things further.

Operations: There is clearly a case for MTR’s ability to make existing operations improve efficiency; the Wall Street Journal article notes that London’s Overground went from 88.4% on-time to 96.7% after a few years of MTR-led operations. Clearly, you can export the expertise to make the trains run on time.

The rail network itself is not particularly expansive – 108 miles of heavy rail, 84 stations, first operating in 1979; not all that different in scope from DC’s Metrorail system of 106 miles and 86 stations (prior to the opening of the Silver Line) first operating in 1976. Yet the MTR sees 4.5 million daily riders, compared to Metro’s modest 780,000.

The Checkerboard Hill blog (named for the old visual marker on the nasty approach to the old Kai Tak airport) provides a nice overview of the MTR system, complete with a link to a track diagram.

Finances: MTR Corporation operates the rail system, owns and develops real estate around stations, and contracts with other entities to build and operate transit systems around the world. The corporation is 76% owned by the Hong Kong government, with shareholders owning an increased share of the company since an IPO in 2000.

Popular myth holds that MTR is only profitable due to real estate investment, but that is easily dispatched with a quick glance at a financial statement shows operating profits on transit operations (the aforementioned 186% farebox recovery ratio) as well as real estate.

An exported version of MTR can directly control operations and make the trains run on time, but they won’t always have direct control over adjacent development. Nonetheless, it’s worthwhile to look at their success. Even without profits from real estate development, MTR’s development plans serve the key role of ensuring transportation investments are paired with supportive land uses. The Atlantic puts it this way:

Like no other system in the world, the MTR understands the monetary value of urban density—in other words, what economists call “agglomeration.” Hong Kong is one of the world’s densest cities, and businesses depend on the metro to ferry customers from one side of the territory to another. As a result, the MTR strikes a bargain with shop owners: In exchange for transporting customers, the transit agency receives a cut of the mall’s profit, signs a co-ownership agreement, or accepts a percentage of property development fees. In many cases, the MTR owns the entire mall itself. The Hong Kong metro essentially functions as part of a vertically integrated business that, through a “rail plus property” model,  controls both the means of transit and the places passengers visit upon departure.  Two of the tallest skyscrapers in Hong Kong are MTR properties, as are many of the offices, malls, and residences next to every transit station (some of which even have direct underground connections to the train). Not to mention, all of the retail within subway stations, which themselves double as large shopping complexes, is leased from MTR.

Payton Chung digs into the numbers on MTR’s retail-heavy revenues:

55.4% of MTR’s total 2012 profits stemmed from property and in-station commerce: 36.1% from rents and management income and 19.3% in for-sale development. Profit margins on the property businesses are certainly healthy: 81.6% on investment property and 89.2% on in-station commercial, vs. 46.1% on Hong Kong transport and just 4.7% on the emerging international transport businesses. A near-90% margin practically qualifies as minting money. (In fact, it’s much better than minting money: the U.S. Mint cleared only 21% seigniorage on circulating currency in 2012.)

Note that in-station commercial offers the richest margins; over half of this business unit’s revenues come from in-station retail, with the rest from advertising and telecom fees within stations. MTR collected US$276.4 million on 608,729 square feet of in-station retail, for an unbelievable-for-the-US (but not for HK) average rental rate of $454/foot, well over twice the rents garnered per foot of investment property above the stations. Averaged across MTR’s 84 heavy-rail stations, that’s 7,247 square feet of retail per station.

This kind of in-station retail isn’t dependent on the kind of development rights seen elsewhere in the MTR system (though other cities might will certainly struggle to meet that ‘unbelievable for the US’ rent without Hong Kong-like density). Some in-station retail isn’t that different from examples around the world; making better use of empty spaces fronting streets in stations and under viaducts.

Street-facing retail spaces beneath the station mezzanine. Image from Google Maps.

Street-facing retail spaces beneath the station mezzanine. Image from Google Maps.

Other examples are internal to the station, and not different in concept from small-scale retail you’ll find in a shopping mall or at an airport:

Mezzanine level retail spaces in MTR's Kowloon Bay station. CC image from Wiki.

Mezzanine level retail spaces in MTR’s Kowloon Bay station. CC image from Wiki.

MTR’s practice of intense and extensive development around stations ensures maximum linkage between the investment in high-capacity transit and the land use to support that investment. Land is leased to MTR at pre-rail values (all land is owned by the government). This extends beyond just TOD; it represents the full integration of transit planning and development. The corporation both captures value created by the transit system, but also earns a long-term source of revenue to augment the system’s operational revenues.

Current US practice for TOD and joint development is barely integrated by comparison. Too often, the transportation-only focus (and a healthy dose of auto bias) leads to extensive park and ride lots rather than dense development around stations. Where dense development does happen, the transit agency isn’t always a direct beneficiary. Speaking to an audience at Harvard’s Kennedy School (as reported by Capital New York), MTR CEO Jay Walder put it in terms of financial sustainability:

“If the infrastructure is not self-sustaining, then the reality is that it cannot rely on public funding always being there,” Walder said Thursday, at Harvard’s Kennedy School. “At some point politics simply diverts the money elsewhere. And you might say it doesn’t have to be that way, but that’s just the reality of the case.”

In Hong Kong, the independently run MTR Corp. buys the land adjacent to future rail lines from the government at pre-development prices and then, once the line is built and the land alongside developed, captures the growth in value of that land and uses it to fund rail operations.

“In that way, the increase in the value of the property becomes a proxy for the broader public benefit and aligns the financial basis with the societal benefit that is being created,” said Walder. “And it also ensures that subject to normal business risk … that the corporation has the proper resources not just to be able to build a rail line, but also to be able to operate it, maintain it and renew the systems and equipment over time.”

Speaking of New York’s Second Ave Subway, Walder has no doubt it “will create a tremendous amount of value,” but that within the current financing scheme “we don’t have any mechanism to capture that back.”

Proxies for such integrated transit and development might include models we see in the US already, such as TIF or other special assessments to finance new infrastructure with development revenues. Yonah Freemark argues there might be a “residual fear” of urban renewal in allowing a public agency to directly develop real estate. Likewise, backlash against the use of eminent domain for economic development might torpedo integrated TOD before it gets started. It’s one thing to re-develop existing parking lots or air rights above key rail yards and other infrastructure, but the politics of land development and property rights will be difficult in the US.

Governance: Other elements of the MTR model (transit plus development) aren’t anything new to the US. Plenty of transit operators in the US also historically developed land to provide riders to their systems (or, on the other side of the coin, built transit to improve the access to their land). Privatized transit operations isn’t a new idea either. However, the current US system of public agencies and authorities operating transit isn’t set up to take advantage of land development around stations.

There are plenty of examples of successful land use intensification around stations; Metro’s Orange Line in Arlington, VA stands out. However, Metro did not develop any of that land. Joint development agreements for private sector developers to make use of WMATA land returns marginal rent to the system, despite huge increases in value from the presence of the system.

MTR’s corporate structure allows the company the autonomy to build a development team capable of delivering world-class real estate projects; current transit authorities would not have the expertise to develop real estate. While the government owns a majority of the corporation, it is publicly traded and has access to capital markets for both real estate and transit projects often unavailable to existing authorities.

As noted in the discussion of finances and land use, none of this is new for transit in the US. However, associating that kind of development with government agencies or public authorities would be new ground.

Planning: Emulating MTR’s operations is one thing; it still doesn’t guarantee the kind of ridership success seen on the MTR system. Hong Kong’s geography is well suited to efficient transit; high-density, compact development built among a series of geographic choke points (mountains, water bodies) that offer an opportunity for transit to gain an edge on other transport modes. These same principles apply elsewhere, but likely to a lesser degree.

Value capture & private transit financing

NoMA Development. CC image from bankbryan.

NoMA Development. CC image from bankbryan.

Jarrett Walker’s weekend links post directed me to this article in The Atlantic by Chris Leinberger, asking if we might return to the days when private interests invested in transit as a means to facilitate real estate development.  Our own urban history is one of linked transportation and land use planning, accomplished through the market and real estate development:

How did the country afford that extensive rail system? Real-estate developers, sometimes aided by electric utilities, not only built the systems but paid rent to the cities for the rights-of-way.

These developers included Henry Huntington, who built the Pacific Electric in Los Angeles; Minnesota’s Thomas Lowry, who built Twin City Rapid Transit; and Senator Francis Newlands from Nevada, who built Washington, D.C.’s Rock Creek Railway up Connecticut Avenue from Dupont Circle in the 1890s. When Newlands got into the rail-transit business, he wasn’t drawn by the profit potential of streetcars. He was a real-estate developer, and he owned 1,700 acres between Dupont Circle and suburban Chevy Chase in Maryland, land served by his streetcar line. The Rock Creek Railway did not make any money, but it was essential to attracting buyers to Newlands’s housing developments. In essence, Newlands subsidized the railway with the profits from his land development. He and other developers of the time understood that transportation drives development—and that development has to subsidize transportation.

The result of these transportation and real estate investments were the now ubiquitous streetcar suburbs.  Leinberger proposes to return to that model, where the value added to a given area of land from transit can be re-captured through some means and invested in the transportation network.

When the streetcar/real estate barons controlled the entire system, such value capture was merely an exercise in accounting.  Additionally, the ease of developing greenfield sites on the rapidly expanding fringe of the city (Leinberger’s DC example of growth along Newlands’ Connecticut Ave rail line represents the first real urbanization of that space) makes things much simpler than dealing with already established urban environments.

With those key differences in mind, Jarrett throws a wet blanket over Leinberger’s nostalgia for the way things used to be. Rightly, Jarrett notes that we won’t be able to re-create the environment of those private real estate and transportation investments.

Nevertheless, Leinberger is talking about a broader concept – one of leveraging the value transit has and capturing that value as a means to finance the infrastructure itself.  Jarrett’s follow-up on the subject concurs – the same basic concept of capturing that value is the core of the issue.

Leinberger cites a of local example, the New York Avenue Metro station and the subsequent development of the NoMA area:

How would the private funding of public transit work? Most states already have laws in place that allow local groups of voters to create “special-assessment districts,” in which neighborhood property owners can vote to fund an upgrade to infrastructure by charging themselves, say, a onetime assessment, or a higher property-tax rate for some number of years. If a majority of the property owners believe they would benefit from the improvement, all property owners in that district are obligated to help pay for it. These districts can vote to fund new transit as well (potentially, the transportation-financing agency could even receive a minority-ownership stake in the district’s private property in return for building new transit). In the late 1990s, property owners paid for a quarter of the cost of a new Metrorail station in D.C. using this approach; after the station opened, an office developer told me he believed his investment was being returned manyfold.

The idea of a transit or government agency owning a stake in real estate development is another interesting idea – Hong Kong’s MTR Corporation both operates the rail system and develops/manages real estate around stations.   However, vesting this kind of authority in the government can be problematic, as mixing of eminent domain capabilities and the desire for private, transit-oriented real estate development can be a touchy subject, as some experience from Colorado shows.

Existing mechanisms for value capture, such as tax-increment financing (again, as Jarret notes) do work, but are limited.  As one of the commenters at The Atlantic notes, Leinberger’s example of an infill Metro station only works because the value of such a station is that it provides a link to an existing, robust transit network.  Such a mechanism wouldn’t work for starting a system from scratch.

The current battle over how to re-shape Tysons Corner is illustrative of many of the issues.  In Tysons, many land owners have agreed to tax themselves in order to add transit.  This works because they’ll be adding a linkage to Metro’s already robust and successful network.  At the same time, the initial plans aimed to maximize the return on the transit investment by substantially upzoning the area and increasing density – but now some parties are getting cold feet.

The other piece that Leinberger raises (as well as several commenters on Jarrett’s post) is reforming the federal piece of transit financing to be more responsive and agile in partnership with private capital:

We could hasten the process by making a much-needed change in federal transportation law. The federal government typically provides 20 to 80 percent of the money for local transportation projects (with local and state governments paying the rest). Yet federal funding of projects that involve private partners is extremely rare—in large part because federally funded projects typically take years to approve, and private developers usually can’t tie up their capital waiting for the government wheels to turn. Over the past few years, private corporations and foundations in Detroit raised $125 million to help build a light-rail line, and have been working for some time to secure federal funds to complete the project. Fixing federal transportation law to expedite transit projects would allow faster development at lower public cost.

None of these mechanisms is perfect, but each will likely be a part of future transit financing discussions – value capture, tax-increment financing, public-private partnerships, upzoning, etc.