For Urban Developers, A Hard Row to Hoe: Bethesda Row Is a Hit, but Many Builders Say That For the Effort Required, They'll Stick With Strip Malls

On a cold weekday evening late last year, Sarah Thomas meandered down a bustling brick sidewalk in Bethesda -- daughter Carrita and black Labrador Licki in tow -- that evoked an early 20th-century Main Street, with a crowded mix of stores, restaurants and offices.

They were at Bethesda Row, built over the past several years, where Thomas shops when she can. It is a short walk from her home in Chevy Chase. The many shops are close to each other, and the street has a more appealing feel than the malls or strip shopping centers, she said.

"We'd much rather come here than to most of the shopping centers around here," Thomas said. "It's just more pleasant. I just wish more areas were done like this."

Since the first section of Bethesda Row opened in 1997, it has been a smashing success with shoppers, local residents and architecture critics. Yet for all its accolades, Bethesda Row has not been successful enough for its owners. Federal Realty Investment Trust, the company that built it, said last year that it would not build any more massive developments with the urban feel of Bethesda Row. Such places take so long to build, tie up so much money, and entail so much risk that the company decided they do not make economic sense.

Federal Realty is going back to building suburban strip malls, where the money is better and the headaches are fewer.

Business leaders, environmental activists and regional planners may not agree on much, but they generally do agree on this: The Washington area would be better off if more of the region's growth incorporated densely concentrated "infill" development around mass-transit stops, and placed residential and commercial uses close to each other, so that more residents could go about daily routines without clogging roads and despoiling open land. The high price of real estate in places like Clarendon, Ballston and Bethesda suggests there is a growing number of residents who prefer to live, work and shop in close proximity.

But meeting that demand will be difficult, and not only because of the relative lack of available land inside the Capital Beltway. Developers of infill describe a battery of regulatory and financial hurdles that string out their design and construction for years and scare off real estate investors. The decision by Federal Realty is only a particularly dramatic response to pressures all such developers face.

"There's an unmet demand for infill development, and it will take quite a while to meet it," said John McIlwain, a senior resident fellow of the Urban Land Institute. "And the reason is all the obstacles that stand in the way."

If you want to build a project like Bethesda Row, you have to have lots of lawyers, patience and money.

The regulatory process for getting local governments to approve urban infill projects is often long, arduous and unpredictable, say those who have been through it. Community activists are more likely to delay or block a project in urban areas than in outer areas, developers and those who study the situation say. To a developer with money tied up in a project, that translates directly to higher cost. The longer you have to borrow money to build a project before it is completed and can start generating money, the more interest you have to pay.

In part because of those risks, the banks and other lenders who fund most commercial real estate development are reluctant to lend money for such projects.

Just as developers want cookie-cutter projects that can be completed quickly, those who finance them want to avoid complication and political risk, real estate industry executives said. A bank can finance a suburban shopping mall and have a good sense for the risks involved; with a development like Bethesda Row, not only is the expense higher, but there are innumerable risks that bankers generally do not know how to quantify.

"Real estate finance is a 'keep it simple, stupid' business," said John B. Levy, a Richmond-based real estate investment banker. "When you've got some apartments, some office and some retail all combined into a single project, you've got more moving parts, and that makes it geometrically more difficult to get financing. Three different property types isn't three times as difficult to finance as one type, it's nine times as difficult."

Donald C. Wood, chief executive of Federal Realty, explained the underlying financial decision the company faced. He used another of its local projects, the apartment and retail complex Pentagon Row, as an example.

Pentagon Row in Arlington was built on an empty piece of land, making it simpler in many ways than Bethesda Row, which was built on existing city streets. The company started investigating the 20-acre piece of land in the mid-1990s and won the right to develop the land in 1997. Wood says the company expended millions of dollars and innumerable man-hours before the first construction had even begun on the project.

Federal, like many real estate investment trusts, finances its projects with roughly half shareholder money and half borrowed money. A property must return an average of 9 to 10 percent a year just to cover the cost of that capital.

But Federal Realty did not start receiving rent checks for Pentagon Row until the complex opened in 2001, and it was not filled to expectations until last year. Properties like Pentagon Row and Bethesda Row already fetch higher rents than typical suburban space, but that is needed just to pay for the higher construction costs. Pentagon Row cost Federal $92 million, and other developers say that one could easily build twice as much residential and retail space for the same money in standard strip malls and apartment complexes.

However, to make up for all those years of planning and building when investment capital was earning no returns at all, Pentagon Row would need to earn even higher rent premiums. Wood said he is hopeful that eventually Pentagon Row and Bethesda Row will fetch high enough rents to justify their long, slow gestation. But the evidence is not there yet. "Pentagon Row is a terrific project and will continue to get better," Wood said. "These are not gimmicky projects. They are part of the fabric of the community and will continue to get better. They're financially fine. But are they financially as good as some more traditional development? Certainly not in the short term, and it remains to be seen in the long term."

Hurdles to 'Smart Growth'

Even those developers who persevere and build such projects find that opportunities for infill development are so labor-intensive that their efforts seem impractical when compared with the rapid building of houses and apartments in the outer suburbs. For example, in the time it takes a developer to obtain financing, buy a Loudoun County farm, obtain the proper permits, and build and sell a few dozen three-bedroom Colonial houses, an urban developer might still be negotiating with lenders over financing for a small site in Arlington.

Tom Bozzuto, a housing developer in Greenbelt, enjoys building projects close to the District. One of them, the Whitney Bethesda Theatre Tower, shows the hurdles to infill development.

The Whitney is just the sort of development that "smart growth" advocates point to as the way to fix the region's traffic and environmental messes. The apartment structure, in the late stages of construction, is built over a historical movie theater, taking advantage of previously unused airspace and the vacant parking lot behind the theater. Located on Wisconsin Avenue near East-West Highway, it is walking distance to the Bethesda Metro stop and innumerable restaurants and stores. The county government and Bethesda residents have generally supported the project.

Yet it has been in the works for seven years and will not open for several more months.

Owners of the car dealerships next door did not like the plans, believing the Whitney would obstruct their ability to get cars in and out of their lots; they sued. Historical preservationists worried that the project above the theater would ruin its historical art deco design; they picketed on the streets. And a handful of residents located behind the property did not like the idea of a big building towering over their homes, not to mention the construction noise and dirt; they fought Bozzuto over zoning allowances.

"There are far more people with a vested interest when you have a close-in site that is adjoining other property," Bozzuto said. "In the distant suburbs, on a 'greenfield' site, you get people who are theoretically opposed to development on philosophical grounds, but their interest is abstract. It's not like they own a house butting right up against the development."

Despite all this, the Bethesda Theatre project is one of the success stories of infill development. It is set to open this spring, and the hurdles it had to overcome were relatively mild, Bozzuto said.

Nonetheless, in the seven years that those 230 apartments have been in the works, Bozzuto has built thousands of units of housing in places like Loudoun County and other outer suburbs.

"Before we even started construction on this project we had $2.5 million of our own money invested and countless time," Bozzuto said. "In a typical suburban situation, one could probably be set to start construction on four times that many units of housing with that same amount of money."

Fortunes in Cookie Cutters

Despite these obstacles, dozens of developers in the Washington area are pushing ahead with mixed-use projects, including at Grosvenor and White Flint Metro stations in Montgomery County, and the Rhode Island Avenue Metro stop in Northeast Washington. But some developers say Federal Realty's decision to pull back from such efforts has given some pause.

When Federal Realty announced that it would not build any more Bethesda Rows, some in the world of urban development took a big gulp. Within the industry, the firm was viewed as one of the most original and successful builders of developments giving visitors a sense of urban life -- and to some, it seemed the firm had given up.

Steven J. Guttman, the recently departed chairman of Federal Realty, who championed Bethesda Row and many similar developments around the country in his 22 years as chief executive, argues that mixed-use urban development still has a bright future. But the people building these developments -- and he plans to be among them -- will have to be patient and creative.

Publicly traded real estate investment trusts must report results to investors every quarter, and shareholders prefer investments that take less than a decade to pay off, Guttman said. He argues that the best chance for big urban infill projects will be forward-looking pension funds and other long-term investors.

"Most developers, if they're only interested in making money, will build the simplest, most cookie-cutter product they can," Guttman said.

"There are developers that have built the same apartment community, with the same floor plans, over and over again. The way great fortunes are made in real estate has been to have a cookie cutter and keep producing it."

But even once developers have the money lined up, problems await. When many different tenants are crammed into one building -- for example, restaurants and stores on the ground floor, and apartments above -- conflicting demands can slow the design.

"A store wants you to move a column a little bit to create more open space. What they don't realize is you're moving it into the middle of someone's living room on a higher floor," said John E. "Chip" Akridge III, a Washington developer whose long-planned Gallery Place mixed-use development is under construction next to the MCI Center.

And the qualities that make dense development around Metro stations attractive to some residents, such as walkways leading to different locations, conflict directly with how the larger area has been planned in the first place.

"A lot of infrastructures are meant to move around traffic quickly, not people," said Bruce Leonard, vice president of Urban Investments Advisors in Washington, which owns property in Dupont Circle, Chevy Chase and Alexandria. "It is designed by traffic engineers, but high-volume traffic is not conducive to pedestrian traffic."

Federal Realty spent a year and a half negotiating with Montgomery County over whether it could install brick sidewalks, instead of concrete, at Bethesda Row. It had to resolve disputes such as how many parking meters would be put in place and how big the trees lining the streets could be.

"Some city governments have standards and tend to rigidly apply them," Leonard said.

Even those who argue most forcefully for dense infill development as the answer to the region's traffic ills acknowledge the economic and political hurdles. Edward Risse, a land-use consultant with Synergy Planning in Warrenton, argues that government subsidies for highways create distorted financial incentives for developers.

"The market is there for transit-oriented, dense development," he said. "That's what they want. The market wants to answer that demand, but we're just not providing the opportunity."

© 2003 The Washington Post Company