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Fixed-Income Insights

Billions of dollars in tax-exempt bonds have helped spur major projects.

[Note: This article is from the October 2017 edition of The Muni Quarterly.]

The New York City (NYC) metropolitan area, with more than 20 million people, is in constant flux, and many people might not realize that tax-exempt bonds have long played an integral role in its economic development. Among the most recent examples are major projects aimed at revitalizing neighborhoods and infrastructure: 3 World Trade Center (WTC), LaGuardia Airport Terminal (LGA), the office/residential complex Hudson Rail Yards (HRY), and American Dream (a shopping and entertainment center in New Jersey). Here, we take a closer look at these immense, high-profile undertakings, and the tax-exempt financing that supports them.

3 World Trade Center
Non-rated bonds are financing the $2.6 billion construction of a 69-story office building, which is scheduled to open in 2018. The bonds are secured by rental income and a leasehold mortgage on 3 WTC, which has been projected to be worth potentially $2 billion after construction is completed and $3 billion when fully occupied. Risk associated with construction and lease-up are mitigated by strong property values in lower Manhattan, as well as the experience of the owner, Silverstein Properties, in developing and managing office buildings. Bondholders should benefit from the redevelopment of the World Trade Center area, which already has seen the opening of several buildings, including 7 WTC (2006), the 9/11 Memorial Museum (2011), 4 WTC (2013), One World Trade (2014), and the Oculus Transportation Hub (2016). The World Trade Center has excellent access to the Metropolitan Transit Authority (MTA) subway system and NJ Transit PATH trains. In 2016, a huge, below-ground mall opened in the World Trade Center, with restaurants and shopping options, making the area an attractive place for business offices.

The municipal bonds financing this project, which in aggregate represent one of the largest issuers in all municipal high-yield indexes, had a unique structure. When this deal was structured, there were three different bonds with varying levels of security. So, even though all the bonds were non-rated, they still had different levels of credit quality. This unusual circumstance meant that careful and thorough credit research was required before making any investment decision regarding these securities.

LGA—Terminal B
LaGuardia Airport (LGA) has long been considered one of the worst airline hubs in the nation, placing near the bottom in a 2016 ranking of U.S. airports by J.D. Power. The airport is undertaking a $4 billion construction project to replace its Terminal B with a new building, set to open in 2022.1  Bonds (rated 'Baa2'/'BBB') are secured by a leasehold interest in the terminal as well as lease payments from airlines, including American, Southwest, and United—along with restaurants and stores. Bondholders stand to benefit from the strength of New York City as business center and a tourist destination, 100% pre-leased airline gates, and the finite number of airport terminal gates at the three New York City area airports: LaGuardia, John F. Kennedy International, and Newark Liberty International (in New Jersey). The terminal project is a public/private partnership between the Port Authority of New York and New Jersey and LaGuardia Gateway Partners, which is managing the construction. Construction risk should be mitigated by the selection of a highly experienced contractor and a fixed-price contract with strong financial incentives to complete the project in a timely manner.

At first glance, the credit ratings on this investment might appear to be low relative to the airport’s standing as a major, heavily used transportation hub. Anyone today who passes through LaGuardia would quickly realize that the overcrowding in the terminals reflects strong demand from the population of the largest city in the United States. Two major points, however, make these bonds more challenging to analyze. First, the airport must remain fully functioning while the new terminal is being built in order for airport revenues to remain constant during the construction. This has taken some very careful planning.  Second, the costs of the construction are elevated, given the high costs of doing business in the New York City area, so the fees charged to airlines will have to rise to cover the costs. This requires detailed analysis to become familiar with the revenue projections for the bonds. So, this can be another interesting investment, but one that needs to be fully vetted by an investment team before it decides to purchase the bonds. 

Hudson Rail Yards
In a rising and dramatic addition to the Manhattan skyline, the Hudson Rail Yards (HRY) is the development of 26 acres of air rights above the MTA’s LIRR rail yard in Midtown West. The MTA sold $1 billion in bonds (rated ‘A2’), secured by property of the HRY—an innovative way to finance transit projects around the city. The bonds are secured by a mortgage on property, ground rent from tenants, and purchase fees from condo buyers. Bondholders should benefit from the location, which has views of the Hudson River, access to the newly opened 7 train subway station, and proximity to the High Line Park, which connects Hudson Yards with the Chelsea neighborhood and the Meatpacking District. Strong demand and high property values in Manhattan should mitigate the risk of prolonged construction.  Development is well underway, with a residential condominium building, 15 Hudson Yards, scheduled to open in 2018. According to the developer, various corporations, including BlackRock, KKR, Time Warner, and Wells Fargo, have purchased office condominiums in a planned commercial building, 50 Hudson Yards, which is set to open in 2022.

The bonds for this project carry ratings well into the investment-grade range, but the longest maturities are very long, meaning that payback of principal will take a while. This will put less pressure on HRY to fill leasable space quickly, but it also means that demand for the real estate must remain attractive for a long time. There was a lot of support around New York City for the construction in this area, so the credit rating reflects the belief that this location will see heavy demand from both businesses and individuals.

American Dream
Tax-exempt bonds will finance the $3.6 billion construction of a major shopping and entertainment center adjacent to MetLife Stadium in the New Jersey Meadowlands—a project, however, already plagued by problems under previous developers during the last 15 years.2 There are two different series of bonds (both non-rated), which are secured by different revenue streams. The first series is secured by payments in lieu of taxes, which is similar to property taxes. The other series of bonds is secured by sales taxes generated by retail stores. American Dream, which is slated to open in early 2019, will include a fully enclosed indoor entertainment complex, including an amusement park, indoor water park, and ski slope, which will be available year-round. Bondholders should benefit from proximity to New York City, with its large population and high tourist volume. Risks to bondholders, including construction, property value, and retail sales, should be mitigated by the successful track record of the owners, who have developed a similar shopping and entertainment experience at the Mall of America in Minneapolis. There is already strong interest from retailers, with 70% of the mall pre-leased, as of the summer 2017.

This bond offering was among the largest high-yield deals in the market this year. There were many intriguing parts to it, since American Dream is a unique project. First, even though the project is located in New Jersey, the bonds were issued through the Public Finance Authority in Wisconsin. This was mainly due to project sponsor’s ability to get faster approval through the Wisconsin entity and because the deal was not a good fit for any of the municipal bond-issuing authorities in New Jersey. Second, there was very strong demand for the bonds, which made sense due to robust flows into municipal high-yield funds this year (as reported by Lipper) and low overall municipal bond market supply. Because of this demand, the bonds have performed very well; one of the two issues, initially priced around $102.75, recently traded at just under $116.00.

Building an Investment Case
While the projects associated with the bonds featured in this article generally have construction risk, the developers are bound by contracts that place limits on construction costs, assess penalties for delayed completion, and provide for several levels of insurance. The issuers have the potential to become stable credits once the building phase is completed and the projects are occupied.  Bondholders have the potential to benefit from exposure to the New York City metro area’s real estate and economic development, while also gaining higher yields than high-grade credits such as the New York City General Obligation (‘AA’/’Aa2’), New York City Municipal Water Finance Authority ('AA+'/'Aa1'), the Port Authority of New York and New Jersey ('AA-'/'Aa3'), and Metropolitan Transportation Authority ('AA-'/'A1').  

One final observation: The bonds linked to two of the projects listed above—3 WTC and American Dream—do not carry ratings from the major credit rating agencies. In all cases, but particularly these, it is especially important for asset managers to have access to thorough and complete credit research when making investment choices. We at Lord Abbett incorporate our own rigorous credit analysis into every decision to buy and sell municipal securities—whether rated or unrated.

 

1Press Release, “Port Authority and Delta Air Lines Advance a $4 Billion Project for Second Phase of the Creation of a New LaGuardia Airport,” Port Authority of New York & New Jersey, July 21, 2016.
2John Brennan, “The Long and Winding Road That Has Been American Dream Meadowlands,” NorthJersey.com, May 4, 2017.

 

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The October 2017 edition offers insights from our analysts on key topics for municipal bond investors, along with essential market information.

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