11 Development Appraisals Flashcards
What is a development appraisal?
Used to financially assess the viability of a development scheme
Apart from assessing viability, what else can a development appraisal be used for?
Used to assess the profitability of a proposed scheme and it’s sensitivity to changing inputs
E.g. uses / rents / yields / financial contributions (S106/CIL)
What is the method used in a development appraisal?
Gross Development Value - Total Development Costs
What is a residual appraisal?
Used to establish the residual site value (at the valuation date for a specific purpose)
I.e. the market value of a site based on market inputs
What is the method used in a residual valuation?
GDV - (Total Development Costs + Developer’s Profit)
When establishing the GDV, how should rents and yields be established?
Comparable method of valuation
What type of yield should be used?
All risks yield
What is an all risks yield?
A growth implicit yield that reflects all of the risks and rewards of the property
What are included in total development costs?
- Site preparation
- Construction costs
- Professional fees
- Planning costs
- Contingency
- Marketing costs
SCP PCM
What is included in site preparation?
- Demolition
- Remediation works
- Landfill tax
- Services
- Site clearance
- Levelling and fencing
What is included in the construction cost?
Total cost of building works
Sources:
- Quantity surveyor’s Cost Plan
- RICS BCIS (Building Cost Information Service) (based on GIA)
What are included in Professional Fees?
- Masterplan Architect
- Architect & Principal Designer
- Landscape Architect
- Transport Consultant
- Structural & Civil Engineer
- MEP Consultant
- Fire Engineer
- Sustainability Consultant
- Ecology Consultant
- Façade Engineer
What % of construction costs are professional fees?
10 - 15%
What are included in planning costs?
- Planning Consultant fees
- Planning Application fees
- S106 obligations
- CIL payments
- AH %
- Planning obligations (open space, play requirements, public art, financial contributions, contributions to local services)
- Section 278 payments (highways)
- Building regulation fees
- Specialist report like ES
What % is contingency of construction cost?
5 - 10%
What are included in marketing costs and fees?
- Cost of EPC
- NHBC warranty
Typically what are lettings fees of annual rent?
10%
Typically what are sales fees of annual rent?
1-2%
What interest rate can be applied to an appraisal?
- SONIA rate
- Base rate + premium
- Rate the developer can borrow money
What might a developer need to borrow money for?
- Site purchase (include purchaser’s costs)
- Construction cost
- Holding costs (to cover voids until disposal, such as service charge and interest)
What shape does each cost take?
- Site purchase (straight line using compound interest, over length of dev period)
- Construction cost (S curve)
- Holding costs (straight line basis using compound interest, from PC to disposal)
What is the principle of an S curve?
- Payment of construction costs adopts the profile of an ‘S’ shaped curve over the length of the development project
- Assumption is to halve the interest that would be borrowed for all of the construction period
- Reflects when monies would be drawn down
Typically what % is developer’s profit?
15-20% of GDV or CC, depending on risk
Usually GDV if residential
The % required has gone up due to riskier market conditions
How else can you calculate profit?
Return on capital employed
I.e. Margin on Cost
What is included in purchaser’s costs?
- SDLT
- Agents fees
- Legal fees
- Includes VAT
How do you treat purchaser’s costs?
When you buy an asset you have to pay additional costs for SDLT and agents / legal fees
These should be deducted from the GDV too (they come out of the profit)
What should you always do once you have undertaken a residual appraisal?
Cross check with comparable sites
What is development finance?
The way a development is funded
What are the two methods of development finance?
- Equity (selling shares in a company / JV, or own cash used)
- Debt (loan from bank / institution)
What is LTV?
Loan to Value
What is the LTV ratio?
60% Loan to Value
In a harder market, could be 60% Loan to Cost
Interest calculated on a rolled up basis (added to the loan as the project proceeds)
What is senior debt?
First level of borrowing
What is secondary / mezzanine debt?
Second level of borrowing (above LTV)
What is a swap?
Derivative hedging rate for interest rates
What is a swap rate?
Market interest for fixed term loans
What are other ways of arranging finance?
- Equity
- Debt
- JV
- Forward sales
What is overage?
- Sharing of extra profit above what was expected
- Shared between vendor / landowner
- Known as ‘claw back’
What is VAT payable on?
All professional fees
What is a profit erosion period?
- Length of time for the profit to be eroded from holding charges following completion of the scheme
What is a limitation of the residual appraisal?
- Relies on accurate inputs
- Does not consider timing of cash flows
- Sensitive to minor adjustments
- Implicit assumptions hidden and not explicit (unlike a DCF)
- Must cross check with a comparable site
What are the three forms of sensitivity analysis?
- Simple sensitivity (yield, GDV, build costs, finance rate)
- Scenario analysis (development content, timing, costs such as phasing the scheme or modifying its design)
- Monte Carlo simulation (using probability theory, using software such as ‘Crystal Ball’)
What RICS guidance is relevant to development appraisals?
RICS Professional Standard: Valuation of Property Development (2019)
What does RICS Professional Standard: Valuation of Property Development (2019) set out?
- Supplements IVS 410 “Development Property”
- Sets out that assumptions and special assumptions must be identified
- If assessing Market Value (possibly subject to assumptions or special assumptions), there is an assumption of optimum development, which should take into account current and prospective economic and planning conditions
- Valuations by the comparable method should be cross checked with the residual method (avoid a single method)
- For lengthy / complex developments, a DCF might be used, whereas a basic residual can be used in other cases
Talk me through your L2 example of Viability?
Viability of Plot XX:
- GDV by analysing comparable evidence in local area, which I verified with local agents
- Total Development Cost included land cost, construction cost, professional fees, planning costs, marketing cost, finance cost, and contingency
- Deducted TDC from GDV to calculate profit, which demonstrated the plot was viable
(I’ve said I used comps so it can’t be Plot 6 as this is affordable and we don’t use comps we use MA)
High level, what was the development stack for your L2 example of ‘Viability’?
Need to do an OMS DA
What type of things are included in the construction cost?
- Net trade (cost before everything added)
- Prelims (costs that won’t be part of asset, like welfare / security / hoarding)
- OH&P (overheads and profit)
- Preconstruction services (services to help developer)
Talk me through your L2 example of ‘Value Engineering?
Value Engineering of Plot 1D2D:
- Objective was to improve MoC
- Reviewed Cost Plan with Quantity Surveyor to identify potential cost savings
- Identified ‘Plant and Balcony Screening’ provided no acoustic / other benefits
- Also identified ‘Windows in the second staircase in the second core’ did not contribute to dual aspect of dwellings
- Input revised Construction Cost to calculate the MoC, which improved
- Instructed DT to make changes
High level, what was the development stack for your L2 ‘Value Engineering’ example?
GDV: £141m
TDC: £138m
Profit: £1.5m
(MoC improve from 1.81% to 2% after VE)
How much did the MoC improve by?
From 1.81% to 2%
So 0.9% in total, which equated to £255,000
How much money did you save through the VE?
£255,000 in total
- £175,000 for the Balcony and Plant Screening
- £80,000 for the Windows
How often are Cost Plans updated?
They develop in detail and accuracy throughout the RIBS Stages as more info about the design becomes available and actual prices from supplies are gathered.
At LL we have one produced for the end of each RIBA stage.
What other options could you look at to provide acoustic benefits to the residents instead of Plant and Balcony screening?
- Minimum compliance with Approved Document E (regarding walls primarily)
- External: Sealing gaps to ensure noise doesn’t travel through
- Internal: Use soft furnishings to absorb sound / soundproof curtains
What building regulations are related to acoustics?
Approved Document E
Is there any legislation around dual aspect?
London Housing Design Standards (2023), which is written by the GLA:
Dual aspect homes have opening windows on two external walls, which may be on opposite sides of a dwelling / adjacent sides of a dwelling.
Homes should be dual aspect unless there are exceptional circumstances (e.g. if one side was exposed to excessive noise or air pollution).
What are Lendlease’s targets around dual aspect?
In a plot 62.5% of units should be dual aspect
What are typically the largest areas of VE?
- Structural
- MEP
- Facade
Did you look at any other options for VE and why weren’t these noted?
- Refinement of kitchen specification
- Review floor finishes
- Review bricks
- Review façade treatment
- Remove painting on hand rails
- Replace double balcony doors with single doors
At what RIBA stage does the Contractor take responsibility for the design?
RIBA Stage 4
Please talk me through your L3 example of ‘Improving GDV’?
Improving GDV of Plot 78
- Sensitivity analysis to determine optimal bedroom mix
- Ran three scenarios in the appraisal that included different mixes
a) studios / 1 beds
b) 2 beds / 3 beds
c) Mix - GDV was highest for a) studios / 1 beds
- However LBN want b) 3 beds in their Local Plan but b) Local Agents advised against solely 2 beds / 3 beds
- ADVISED c) Mix to balance GDV, Planning Risk and Market Demand
High level, what was the development stack for your L3 ‘Improving Viability’ example?
GDV: £327m (BTR element is £251m)
TDC: £289m
Profit: £38m
(MoC: 13.4%)
What was the difference in GDV between the three options?
a) Studios / 1 beds: £269m
b) 2 beds / 3 beds: £242m
c) Mix: £251m
£18m difference
What is Sensitivity Analysis?
- Yield
- GDV
- Build Cost
Can you explain the rationale for why studios / 1 beds typically generate a higher GDV?
Higher £psqft to rent which in turn drives GDV higher
Why is it sensible to adhere to the Local Plan guidance?
The Local Plan forms the basis of whether a planning application will be approved
Why did the Local Agents advise against solely 2 beds / 3 beds?
Eliminates a portion of the market
Please talk me through your L3 example of ‘Improving Viability’?
Improving Viability of Plot 1D2D:
- Objective was to improve viability
- Plot was fully affordable apart from ten townhouses
- Firstly reviewed the Master Agreement between Client and RP to understand if some apartments could be switched from affordable to private
- Not an option because a certain number of AH must be delivered per plot in Phase 1
- Undertook analysis into comparable evidence to understand whether the townhouses’ internal layouts could be made more efficient to increase the £psqft
- On analysis of competitors floorplans, reconfiguring the townhouses so the living room was on the first floor would enable them to become 3p6b rather than 3p5b
- This improved viability
High level, what was the development stack for your L3 ‘Improving Viability’?
GDV: £141m
TDC: £138m
Profit: £2.5m
(MoC: 1.81%)
Please can you explain the different types of Affordable Housing?
Two key types:
- Affordable / Intermediate
- Social
What is Affordable / Intermediate Rent
Affordable: 20% less than Market Rent
Intermediate: Between Market Rent and Social Rent
What is Affordable / Intermediate Ownership?
Affordable: 20% less than Market Value
Includes Shared Ownership
What is Social Rent?
Social: 50% less than Market Rent
Owned and managed by Registered Providers (receive funding from Homes England or the GLA)
What is the definition of a townhouse?
One of a row of similar houses that are usually joined by a shared wall
What does the Master Agreement?
- Contract between TSP and TGP
- Stipulates 721 (10%) buffer have to be delivered in Phase 1
- Contributes to level of AH across the Masterplan (currently 50%)
- LBN Local Plan AH target is 35%
What is the difference between a 3b5p and 3b6p?
The difference is specified in the NDSS:
3b5: 99sqm GIA
3b6p: 108sqm GIA
Rather than two double rooms and a single room, we could have double rooms.
What is the typical cost of a Shared Ownership apartment to buy?
Plot 6:
1b: £230,000
2b: £322,000
What is the typical cost of a LAR apartment to rent?
Plot 6:
1b: 196,000 per annum
2b: 274,000 per annum
What is the typical £psqft for a BTR apartment?
Plot 78:
At the time of instruction, it was £34 psqft. It is now £42 psqft.
Studio: £1,670 pcm
1b: £1,975 pcm
2b: £2,475-675 pcm
3b: £3,150 pcm
What is the typical £psqft for OMS?
£688 psqft
What are the typical BTR assumptions?
- 5% regen premium
- 2% voids
- 4.5% yield
- 1.8% purchaser’s costs
What is the typical build cost?
1D2D: £310
78: £329
What is the difference between an affordable, OMS and BTR appraisal?
How is the timing of revenue different for different tenures?
What is the difference between GDV and NDV?
Gross Development Value
Net Development Value
Value of completed development, net of purchaser’s costs
What is indexation?
What is escalation?
Inflation
What are void periods?
Period of ‘void’ when asset is unoccupied
- Loss of rental income
- Expenses like council tax and bills
- Maintenance
- Marketing fees
What would happen to revenue if your yield went from 6.5% to 5%
Revenue at 5% is lower than revenue at 6.5%
You would receive less revenue at lower yield
How do you choose an affordable housing provider?
Tender
How does SO work?
TGP dictate value of SO flats in MA
- TSP apply to GLA for an Affordable Grant
- GLA give TSP a Grant
- TGP give TSP a Grant too
- TGP build homes and sell back to TGP
- TGP own % of unit, buyer owns % of unit
How does LAR work?
OPP S106 dictates the Rent Cap (either 50% (3&4 beds) or 80% (1&2 beds) of Market Rent)
- TSP apply to GLA for an Affordable Grant
- GLA give TSP a Grant
- TGP give TSP a Grant too
- TGP build homes and sell back to TGP
- TGP charge rent to residents and keep revenue
Do you have any commercial space across the masterplan and if so, what are the assumptions?
Retail:
£175,000 per annum
£32 psqft
6.5% yield
20 years
6 rent free
£16-80 psqft cap con
5th, 10th and 15th year rent reviews
Shell
Talk me through a DCF?
- DCF is a valuation method used to estimate the Present Value (PV) of an investment, using its future cash flows.
- It is based on the ‘time value’ of money in that the PV is worth more than the Future Value (FV), because money available now can be invested immediately to get returns / money in future may be of lower value due to economic conditions like inflation.
- DCF evaluates the viability of a development using a discount rate. The asset is viable if the NPV (of expected future cash flows) is positive.
- NPV is calculated by discounting future cash flows using the discount rate. The discount rate reflects 1. time value of money because investors are getting paid in the future rather than present 2. the risk premium because future cash flows carry the risk that they may not come at all. The discount rate is typically a firm’s WACC (weighted average cost of capital), which is the required rate of return.
E.g.
- Initial investment of £3,000
- The initial investment is predicted to give investment returns of £1,000 per year for 1-5 years (the cash flow)
- The total return is not £5,000
- Assume the discount rate is 10%, so year 1 return is £1,000 but PV is £909 (discounting is exactly the same concept of compounding, just in reverse)
- Each year the PV is lower, so in year 5 the PV is £621. In total, the returns are £3,791 rather than £5,000
- The NPV is calculated by taking the total returns and minusing the initial investment, so £3,791 - £3,000 so NPV is £791 which is positive, so it is a good investment
- If your initial investment was £4,00, it would be negative and not worth it
What are the advantages of using a DCF?
- Considers entire hold period, including cash flows and potential profit
- Allows for sensitivity analysing by varying assumptions about future cash flows and discount rates
- Used to model a wide variety of scenarios and assumptions, including unique assets where comparable evidence is inconsistent or limited
In your viability example, how do you benchmark professional fees?
- Professional fees are typically 10-15% of construction cost
- Work out estimate of CC based on previous plots budgets
- Then each fee is a % of Net Trade
In your viability example, did you prepare the budget?
Yes, based off the previous plots budget
In your VE example, you mentioned screening and internal windows. Were there any other areas of VE you looked at?
- Bathrooms (can’t reduce number, but can reduce the number of pod types to gain economies of scale)
- Balconies (standardise)
- Windows and doors (standardise / review supplier)
- Kitchens (reduce type number)
- Stair finishes
- Exposed ceilings
- Floor finishes
- Landscaping
In your VE example, did the removal of the screening require a return to planning?
No because it was prior to planning
In your improving viability example, what is the difference between a 3b5p and 3b6p unit? How did that increase improve the viability of the plot?
3b5p - Min 99 sqm across 3 floors
3b6p - Min 108 sqm across 3 floors
What is Construction Cost made up of?
- Net Trade (build cost)
- Pre-lims
- OH&P
- Other Costs
- Contingency / risk
- Welfare contribution
What are pre-lims?
Costs essential for a construction project
- Site clearance / access permits / welfare
- Temporary works / scaffolding / temporary power / toilet facilities
- Site supervision / project management
- Temporary storage
- Tools / machinery
- Insurance policies
What is OH&P?
Overheads and profit for the Contractor
- Overheads: Salaries, rent, utilities, insurance
- Profit
How often do you require a cost plan?
Every RIBA stage
What VE might have led to a return to planning?
A material change
What is the finance rate made up of?
Base rate + developer’s risk
4.5% + whatever their risk appetite is
