ITEM 1. BUSINESS
The Company
JBG SMITH Properties ("JBG SMITH") is a real estate investment trust ("REIT") that owns, operates, invests in and develops real estate assets concentrated in leading urban infill submarkets in and around Washington, DC. We own and operate a portfolio of high-quality office and multifamily assets, many of which are amenitized with ancillary retail. In addition, we have a third-party real estate services business that provides fee-based real estate services to the legacy funds formerly organized by The JBG Companies ("JBG Legacy Funds") and other third parties. References to "our share" refer to our ownership percentage of consolidated and unconsolidated assets in real estate ventures.
As of December 31, 2017, our Operating Portfolio consists of 69 operating assets comprising 51 office assets totaling over 13.7 million square feet (11.8 million square feet at our share), 14 multifamily assets totaling 6,016 units (4,232 units at our share) and four other assets totaling approximately 765,000 square feet (348,000 square feet at our share). Additionally, we have: (i) ten assets under construction comprising four office assets totaling approximately 1.3 million square feet (1.2 million square feet at our share), five multifamily assets totaling 1,767 units (1,568 units at our share) and one other asset totaling approximately 41,100 square feet (4,100 square feet at our share); and (ii) 43 future development assets totaling approximately 21.4 million square feet (17.9 million square feet at our share) of estimated potential development density. We present combined portfolio operating data that aggregates assets that we consolidate in our financial statements and assets in which we own an interest, but do not consolidate in our financial results. For more information regarding our assets, see Item 2 "Properties".
We define "square feet" or "SF" as the amount of rentable square feet of a property that can be rented to tenants, defined as (i) for office and other assets, rentable square footage defined in the current lease and for vacant space the rentable square footage defined in the previous lease for that space, (ii) for multifamily assets, management’s estimate of approximate rentable square feet, (iii) for the assets under construction and the near-term development assets, management’s estimate of approximate rentable square feet based on current design plans as of December 31, 2017, or (iv) for the future development assets, management’s estimate of developable gross square feet based on its current business plans with respect to real estate owned or controlled as of December 31, 2017. "Metro" is the public transportation network serving the Washington, DC metropolitan area operated by the Washington Metropolitan Area Transit Authority, and we consider "Metro-served" to be locations, submarkets or assets that are generally nearby and within walking distance of a Metro station, defined as being within 0.5 miles of an existing or planned Metro station.
Corporate Structure and Formation Transaction
JBG SMITH was organized by Vornado Realty Trust ("Vornado" or "former parent") as a Maryland REIT on October 27, 2016 (capitalized on November 22, 2016). JBG SMITH was formed for the purpose of receiving, via the spin-off on July 17, 2017 (the "Separation"), substantially all of the assets and liabilities of Vornado’s Washington, DC segment, which operated as Vornado / Charles E. Smith, (the "Vornado Included Assets"). On July 18, 2017, JBG SMITH acquired the management business and certain assets and liabilities (the "JBG Assets") of The JBG Companies ("JBG") (the "Combination"). The Separation and the Combination are collectively referred to as the "Formation Transaction." Unless the context otherwise requires, all references to "we," "us," and "our," refer to the Vornado Included Assets (our predecessor and accounting acquirer) for periods prior to the Separation and to JBG SMITH for periods after the Separation. Substantially all of our assets are held by, and our operations are conducted through, JBG SMITH Properties LP ("JBG SMITH LP"), our operating partnership.
Our Strategy
Our mission is to own and operate a high-quality portfolio of Metro-served, urban-infill office, multifamily and retail assets concentrated in downtown Washington, DC, our nation’s capital, and other leading urban infill submarkets with proximity to downtown Washington, DC and to grow this portfolio through value-added development and acquisitions. We have significant expertise across multiple product types and consider office, multifamily and retail to be our core asset classes. We believe we are known for our creative deal-making and capital allocation skills and for our development and value creation expertise across our core product types.
One of our approaches to value creation uses a series of complementary disciplines through a process that we call "Placemaking." Placemaking involves strategically mixing high-quality multifamily and commercial buildings with anchor, specialty and neighborhood retail in a high density, thoughtfully planned and designed public space. Through this process, we are able to create synergies, and thus value, across those varied uses and create unique, amenity-rich, walkable neighborhoods that are desirable and enhance significant tenant and investor demand. We believe that our Placemaking approach will increase occupancy and rental rates in our portfolio, particularly with respect to our concentrated and extensive land and building holdings in Crystal City. Crystal
City’s attractive attributes as an urban-infill location with close proximity to downtown Washington, DC, access to Metro and other key transportation infrastructure and strong surrounding demographics serve as a solid foundation upon which to build the mix of uses and amenities that today’s tenants demand. We believe that the application of our Placemaking approach will allow us to increase Crystal City’s attractiveness to potential tenants and create significant value for our shareholders. Our strategy in Crystal City focuses on creating a 24-hour environment with an active retail heart through the delivery of additional anchor and small store retail and the introduction of a greater mix of uses, including new multifamily and the conversion of certain out-of-service office buildings to multifamily. These elements, combined with thoughtfully planned streetscapes and public spaces, are all critical to the creation of a dynamic place that we believe will help increase occupancy and rental rates throughout the submarket over time. Importantly, the broader benefits of this repositioning should be achievable without the need to invest significant capital in repositioning all our holdings in the submarket.
Our primary business objectives are to maximize cash flow and generate strong risk-adjusted returns for our shareholders. We intend to pursue these objectives through the following strategies:
Focus on High-Quality Mixed-Use Assets in Metro-Served Submarkets in the Washington, DC Metropolitan Area. We intend to continue our longstanding strategy of owning and operating assets within urban-infill, Metro-served submarkets in the Washington, DC metropolitan area with high barriers to entry and key urban amenities, including being within walking distance of the Metro. These submarkets, which include the District of Columbia; Crystal City and Pentagon City, the Rosslyn-Ballston Corridor, Reston and Alexandria in Virginia; and Bethesda, Silver Spring and the Rockville Pike Corridor in Maryland, generally feature strong economic and demographic attributes, as well as a superior transportation infrastructure that caters to the preferences of our office, multifamily and retail tenants. We believe these positive attributes will allow our assets located in these submarkets to outperform the Washington, DC metropolitan area as a whole.
Realize Contractual Embedded Growth. We believe there are substantial near-term growth opportunities embedded in our existing Operating Portfolio, many of which are contractual in nature, including the burn-off of free rent, contractual rent escalators in our non-GSA office and retail leases based on increases in CPI or a fixed percentage, and the commencement of signed but not yet commenced leases. "GSA" refers to the General Services Administration, which is the independent federal government agency that manages real estate procurement for the federal government and federal agencies.
Drive Incremental Growth Through Lease-up of Our Assets. We believe that we are well-positioned to achieve significant internal growth through lease-up of the vacant space in our Operating Portfolio, including certain recently developed assets, given our leasing capabilities and the tenant demand for high-quality space in our submarkets. As of December 31, 2017, we had 51 operating office assets totaling over 13.7 million square feet (11.8 million square feet at our share), which were 88.0% leased at our share, resulting in approximately 1.4 million square feet available for lease.
Deliver Our Assets Under Construction. As of December 31, 2017, we had ten high-quality assets under construction in which we expect to make an estimated incremental investment of $766.0 million at our share. Our assets under construction consist of over 1.3 million square feet (1.2 million square feet at our share) of office space and 1,767 units (1,568 units at our share) of multifamily, all of which are Metro-served. We believe these projects provide significant potential for value creation. As of December 31, 2017, 62.1% (61.8% at our share) of our office assets under construction were pre-leased. We define "estimated incremental investment" to mean management’s estimate of the remaining cost to be incurred in connection with the development of an asset as of December 31, 2017, including all remaining acquisition costs, hard costs, soft costs, tenant improvements, leasing costs and other similar costs to develop and stabilize the asset but excluding any financing costs, ground rent expenses and capitalized payroll costs.
Develop Our Significant Future Development Pipeline. We have a significant pipeline of opportunities for value creation through ground-up development, with the goal of producing favorable risk-adjusted returns on invested capital. We expect to be active in developing these opportunities while maintaining prudent leverage levels. We have a future development pipeline consisting of 43 assets. We estimate our future development pipeline can support over 21.4 million square feet (17.9 million square feet at our share) of estimated potential development density, with 96.5% of this potential development density being Metro-served based on our share of estimated potential development density. The estimated potential development densities and uses reflect our current business plans as of December 31, 2017 and are subject to change based on market conditions. We characterize our future development pipeline as our assets that are development opportunities on which we do not intend to commence construction within 18 months of December 31, 2017 where we (i) own land or control the land through a ground lease or (ii) are under a long-term conditional contract to purchase or enter into a leasehold interest with respect to land.
Our future development pipeline includes eight parcels attached to assets in our Operating Portfolio that would require a redevelopment of approximately 341,000 office and/or retail square feet (207,000 square feet at our share) and 316 multifamily units (177 units at our share), which generated $2.9 million of net operating income ("NOI") for the year ended December 31,
2017, in order to access approximately 4.7 million square feet (3.1 million square feet at our share) of total estimated potential development density.
Redevelop and Reposition Our Assets. We evaluate our portfolio on an ongoing basis to identify value-creating redevelopment and renovation opportunities, including the addition of amenities, unit renovations and building and landscaping enhancements. We intend to seek to increase occupancy and rents, improve tenant quality and enhance cash flow and value by completing the redevelopment and repositioning of certain of our assets, including the use of our Placemaking process. This approach is facilitated by our extensive proprietary research platform and deep understanding of submarket dynamics. We believe there will be significant opportunities to apply our Placemaking process across our portfolio.
Pursue Attractive Acquisition Opportunities. We are well known in the brokerage community and have deep relationships with the most active brokers and sellers in the Washington, DC market. In addition, we believe we have developed a reputation for fair dealing, performance and creative deal-making, making us a preferred counterparty among market participants. We believe that our longstanding market relationships, reputation and expertise will continue to provide us with access to a pipeline of deals that are often compelling, off-market opportunities. We will continue to pursue acquisition opportunities with a disciplined approach and will place an emphasis on well-located, public transit-oriented assets in improving neighborhoods that have strong prospects for growth and where we believe that we can increase value through increasing occupancy and rental rates, re-marketing tenant space, enhancing public spaces, employing Placemaking strategies and improving building management.