Development Appraisal Flashcards
What is the purpose of a development appraisal?
- A development appraisal is a tool to financially assess the viability of a development scheme
- Can be used to establish a residual site value / assess the profitability of a proposed scheme and its sensitivity to changing inputs / assessing the viability of different uses, rents, yields or financial contributions, such as s106 and CIL payment
- A calculation to establish the value/viability/profitability /suitability of a proposed development based upon client inputs
Valutation adopts client inputs rather than market inputs
What can a development appraisal be used for?
- Analysis of a development to consider whether the level of required planning obligations is viable
- Assessing whether a development is viable or not based on the projected level of profit
- Assessing the optimum use for a property, or to compare different development options
- Assessment of the viable level of affordable housing contribution that can be funded from a development while still earning a reasonable profit
RICS Professional Standard: Valuation of development property, 2019
This standard provides a definition of a development appraisal:
* A financial appraisal of a development
* It is normally used to calculate either the residual site value or the residual development profit, but it can be used to calculate other inputs
Acquisition/disposal cost
The cost associated the acquisition or disposal of property, usually including legal and agent fees, as well as any purchase or sales taxes
Building costs index
- An index relating to the cost of building work
- It is normally based on cost models of the ‘average building’, which measure the changes in costs of labour, materials and plant that collectively cover the basic cost to a contractor
Cash flow
The movement of money by way of income, expenditure and capital receipts and payments during the development
Comparable property transaction
A property used in the valuation process as evidence to support the valuation of another property
Discounted cash flow
A method of valuation explicitly setting out the inflows and outflows of an investment / development
Developer contributions
- Obligations often tied to the grant of development permissions providing a benefit to the community, either generally or in a particular locality
- They are often mandatory requirements that have to be provided in order to undertake a development
Development profit
The amount by which, on completion or partial completion of a development, the estimated income of a development exceeds the total outlay
Development risk
The risk associated with the implementation and completion of a development, including post-construction letting and sales
Development yield
- The rental income divided by the actual cost incurred in realising the development
- This can be based on either current or future estimates of the rental value of the completed development
Development initial yield
- The development yield calculated over the entire project
- It is defined as the stabilised income divided by the total construction cost (excluding interest and fees)
Discount rate
The rate, or rates, of interest selected when calculating the present value of some future cost or benefit
Gross Development Value
GDV
- The capital value of the completed scheme
Gross external area
The aggregate external area of a building or footprint, taking each floor into account, measured with reference to the International Property Measurement Standards (IPMS)
Gross internal area
- Measurement of a building on the same basis as GEA but excluding external wall thicknesses
- Net sales area is the GIA of a resi dwelling subject to certain inclusions and exclusions
Highest and best use
- The use of the property that would produce the highest value of the asset
- It must be physically possible, financially feasible and legal
Holding cost
The cost involved in owning a site or property, which may include such items as interest on finance used to acquire the asset, maintenance costs, any taxes payable by the owner etc.
Hope value
- An element of market value in excess of the existing use value, reflecting the prospect of some more valuable future use
Interest rate
The rate of finance applied in a development appraisal
Internal rate of return (IRR)
- The rate of interest (expressed as a percentage) at which all future project cash flows will be discounted in order that the NPV of those cash flows (including the initial investment) be equal to zero
- IRR can be assessed on both gross and net of finance
Market comparison approach
Assessment of appraisal inputs and outputs by reference to comparable transaction evidence , which can include land, values and costs
Market rent
Defined in International Valuation Standards as ‘the estimated amount for which an interest in real property should be leased on the valuation date between a willing lessor and a willing lessee on appropriate lease terms in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently, and without compulsion’
Market risk
The uncertainty resulting from unknown future changes in the economy and financial and property markets, irrespective or the property being developed
Market value
Defined in IVS as ‘the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion
Net cash flows
- The cash flows generated by the project
- These can be assessed both gross and net of taxes and both gross and net of finance costs
Net development value
NDV
The GDV minus assumed sale costs
Net Internal Area (NIA)
The usable space within a building measured to the internal finish of structural, external or party walls, but excluding toilets, lift and plant rooms, stairs and lift wells, common entrance halls, lobbies and corridors and car parking areas
Net Present Value
NPV
- The sum of the discounted values of a net cash flow including all inflows and outflows, where each receipt/payment is discounted to its present value at a specified discount rate
- Where the NPV is 0, the discount rate is also the IRR
NPV method
A method used in discounted cash flow analysis to find the sum of money representing teh difference between the present value of all inflows and all outflows of cash associated with the project by discounting each at a specified discount rate
Opportunity cost
The return or benefit foregone by pursuing an alternative action
Optionality
Often referred to as a real option being the right but not the obligation to pursue a particular course of action i.e. sell, hold/retain or develop a property
Outturn model
A development appraisal that has been adapted to project various inputs, usually both in respect of values and costs
Oversailing licences
An oversailing licence allows a structure - a crane, for example - to overhand public or privately-owned property
Pre-lets or pre-sales
Where a developer of a project, usually prior to implementation, has agreed lettings with occupiers or sales of part of the whole of the development prior to commencement or during the development
Profit on cost
The profit of the project expressed as a percentage of total development costs
Profit on value
The profit of the project expressed as a percentage of the project’s NDV
Property- or project-specific risk
The uncertainty attached to the intrinsic development of a site or property in addition to the general market risk
Residual valuation method
- Based on the concept that the value of a property with development potential is derived from the value of the property after development minus the cost of undertaking that development, including a profit for the developer
- GDV - total development costs (including profit) = residual land value
Residual site value/residual land value
The amount remaining once the gross development cost of a project is deducted from its GDV and an appropriate return has been deducted
Return (on capital)
The ratio of annual net income to capital derived from analysis of a transaction and expressed as a percentage
Risk adjusted return
The discount rate as varied to reflect the perceived risk of the development
Sensitivity analysis
A series of calculations where changes are made to individual inputs e.g. build costs and sales values, to see how these affect the profitability or viability of the scheme
Speculative developments
Developments that are generally commenced prior to any agreed sales or lettings
Stabilised income
- The sum of the rental income, additional rent revenue and turnover (percentage) rent
- It is assessed for one year from the earliest lease start date
Standing investments
Properties that are income-producing, usually with a tenant in occupation
Target profit
The level of acceptable profit considering the risk of the particular project normally expressed as an individual sum
Target/required return
The level of commercially-acceptable return considering the risk of the particular project expressed as a periodic rate of return
Tender price index
Index relating to the level of prices likely to be quoted at a given time by contractor tendering for building work
Total construction cost
All costs of base construction and construction breakdown from project start to the earliest lease start date
Total development cost
The total cost of undertaking a development excluding profit and land
Vacant possession
The attribute of an empty property, which can legally be exclusively occupied and used by the owner or, on a sale or letting, by the new owner or tenant
Value change
The amount of growth or decline in the capital or rental value of elements of the project, normally projected for the purposes of the valuation/appraisal
Value in alternative use
The market value with the special assumption of an alternative use to the existing use or permitted highest and best use
Value in existing use
The market value assuming the property continues in its existing use with no expectation of that use changing in the foreseeable future
Weighted average cost of capital
The minimum return a company should earn in respect of an asset by reference to relative weight of equity and debt within its capital structure
Yield
- Yield can be applied to different commercial elements of a project, for example, office, retail, leisure etc.
- It is usually calculated as a year’s rental income as a percentage of the value of the property
- Variations include capitalisation or cap-rate, all-risks yield, equivalent yield, income yield and initial yield
A development property is defined in IVS 410 as:
Interests where redevelopment is required to achieve the highest and best use, or where improvements are either being contemplated or are in the progress at the valuation date
Development valuation process
- Instructions and terms of engagement
- Site investigations - inspection & market research
- Data collection
- Handling
- Interpretation
- Application to the valuation
- Reporting - market value
In the case of the valuation of development property, any assumptions or special assumptions should be set out clearly in the valuation report
These assumptions can have a significant impact on the valuation outcome and therefore should be as clear and consistent as possible
Market Value
- Will often be the appropriate basis of valuation
- In assessing market value, there is an assumption of optimum development, taking into account current and prospective economic and planning conditions
IVS 105 identifies 3 main approaches to valuation
- Market approach
- Income approach
- Cost approach
In the case of the valuation of development property, valuations are normally undertaken in two ways:
- The market comparison approach
- The residual method
Best practice avoids reliance on a single approach or method of assessing the value of development property
The extent of factual information necessary for a valuation is determined by a range of factors including …
- The stage at which the valuation is being prepared
- The purpose and the individual characteristics of the property being valued
- Any assumptions or special assumptions made
RICS Property Measurement, Environmental risks and global real estate, International Property Measurement Standards, and International Construction Measurement Standsrds: Global Consistency in Presenting Measurement Costs
Development can take a number of different forms and this creates a variey of options concerning what is developed and when. It may be appropriate to fully explore these various options and the value of each of these mary vary in relation to the different scenarios
- Development property may be included in a zone earmarked for future development of a particular type
- The property may have detailed or outline permissions for development
- The particular planned project of development may be uncertain
Matters that should be considered when determining the form and extent of physical development that can be accomodated on the site:
- Permissable and potential land uses
- Density of development - massing and scale
- Topography and site development factors including infrastructure etc.
- Building-related issues such as the period of time estimated to complete the new buildings
- Development consent issues such as planning obligations attached to the permission to develop
- Adjacent land
- Accessibility of the development property
- Environmental issues (RICS Environmental risks and global real estate)
With larger sites that will take longer to develop, options within the development process become more likely and ought to be considered. Four key options are apparent in most development property:
- Develop
- Develop in phases
- Sell or dispose
- Defer or wait
Residual method can be used to determine other outcomes
Such as the surplus available for the developer’s profit if the price of the land has already been fixed
Two different applications of the residual method:
- Discounted cash flow - more complex assets with phased construction or disposal where the timings of events needs to be fully accounted for
- More basic application of the residual method - used for less complex assets or early in the development process to consider optimum development
Typical inflows and costs to be considered in residual valutions include:
- Gross development value - appropriate basis of value of the completed development without adjustment for any sale costs
- Net development value - appropriate basis of value of the completed development net of any sale costs
- Site clearance, remediation or preparation costs
- Costs of construction, including any contingencies
- Professional fees related to construction
- Costs and professional fees relating to planning
- Any planning obligations or levies linked to the development
- Finance for the development, including the site
- Developer’s profit
Discounted cash flow application
- The basic application of a discounted cash flow is to caluclate the NPV of the estimated costs and revenues over the duration of the development project
- With all other costs and revenues accounted for, the NPV will be a current estimate of the residual land value
- Profit is represented as a IRR and the NPV, assuming it is positive, is then the residual land value
- If value/cost projections are used, this should be explicitly stated together with an explanation of the assumptions underpinning those projections
- Other assumptions including target rate of return should also be explicitly stated
Risk analysis
- Simplest form of risk analysis is sensitivity analysis, which is used to evaluate how chnages to individual inputs (such as construction costs or sales values) might affect the valuation of development property
- Scenario modelling can also be used to evaluate how different combinations of inputs can affect the valuation
Enables the inputs that have the most impact on the outcome to be evaluated and gives some measure of volatility between different types of investment and development to inform the decision on the appropriate level of development profit
Profit as a residual
- If land price or value is known, the land price becomes a cost to the development
- Land sale takes place at the beginning of the development
- All other costs and values are assumed at the end of the development period - costs are assumed to accrue at the borrowing rate and both development costs and interest are paid off at the end of the development
- The IRR of the cash flow becomes an estimate of the developer’s return (i.e. before finance)
- If the valuer wants to determine the profit as a single lump sum at the end of the development, the land value is again inserted at the beginning of the cash flow
- Interest on this land price together with interest on all other development costs is compounded to the end of the development period (assuming 100% borrowing)
- After deducting accrued income within the cash flow, any surplus at the end of the cash flow is the expected profit at the end of the development
There are two basic approaches to valuing land in the course of development:
- The value of the land plus the costs expended at the valuation date
- The completed development value minus the costs remaining to be expended at the valuation date
In some cases both approaches could be employed as a check against the other
Reporting the valuation
- For most purposes, the valuation should be reported as a single figure
- Where risk anaylsis has been applied, the valuation should still be reported as a single figure but the potential for significant variation should be reported in an appropriate manner
- Valuers may find it useful to refer to the process by which the valuation was produced and highlight issues that contribute to any uncertainty surrounding the valuation, including the different options that may have been identified
What RICS guidance must valuers be mindful of when inspecting a development site that may contain many hazards?
Surveying Safely
Physical inspection of the development site. Noting the …
- Potential for contamination
- Rights of access to public highways or other public areas
- Availability or and requirements to provide necessary services e.g., water, drainage or power
- Any off-site infrastructure imporvements
- Presence of archaeological features
- Evidence of waste management obligations
Generic principles and issues to address when undertaking a development valuation. These include:
- The existence of any particular development plan or elements of zoning of land for different uses
- The existence of any current permissions to undertake development - this may be in outline or in full and may include conditions or reserved matters
- Where the permission is time-limited, it should be established whether it is still valid
- Any special controls that may apply to the site or buildings (e.g. heritage/conservation of sites or buildings)
- Any requirements for view corridors / sight lines
Income-producing assets in development project’s inputs include
- The timing of lettings
- Rent free periods
- Capital contributions etc.
Development Costs
Planning costs
- Town and Country Planning Act 1990 Section 106 payments - a legal agreement for planning obligations (e.g. affordable housing, infrastructure costs, new school etc.) to gain a planning consent
- Community Infrastructure Levy (CIL) is charged by most LPAs
- Local planning policy will set out the required percentage of affordable housing required for a new residential development in the form of social, intermediate and key worker housing
- Section 278 payments for highway works
- Planning application and building regulation fees
- Cost of a planning consulant
- Cost of any specialist reports required by the LPA (e.g. Environmental Assessment)
Development Costs
Site Preparation
- Demolition, remediation works, landfill tax, provision of services, site clearance, levelling and fencing
- Obtain a contractor’s cost plan for these works
Development Costs
Building costs
- Estimate total cost of building works
Sources of building costs:
* Client information
* RICS Building Cost Information Service (BCIS) usually based on a GEA basis. BCIS obtains updates from QS/BS sources and recent contract prices/tenders agreed
Development Costs
Professional fees
- 10% - 15% plus VAT of total consruction costs for the professional fees for architects, M&E consultants, project managers, structural engineers etc.
- Architects are usually the largest proportion of total fees
- Remember CDM Principal Designer Costs
Development Costs
Contingency
5-10% of construction costs depending upon level of risk and likely movements in building costs
Development Costs
Marketing Costs & Fees
- Assume a realistic marketing budget (use evidence/quotes)
- Cost of an EPC
- National House Building Council (NHBC) warranty for residential schemes
- Normal sale fee around 1% - 2% GDV & normal letting fee around 10% of initial annual rent
Calculation of finance
Choice of interest rate can include:
* The current SONIA rate (Starling Overnight Index Average)
* Bank of England Base rate plus premium
* Rate at which the developer can borrow the money
There are THREE elements for finance: the developer needs to borrow money for the:
- Site purchase (include purchaser’s costs) - compound interest (straight-line basis)
- Total construction and associated costs - calculation based on an S-curve taking half the costs over the length of the build programme
- Holding costs to cover voids until the disposal of the scheme (empty rates, service charges, and interest charges) - compound interest on a straight-line basis
Method of finance calculation
- Assumes 100% debt finance
- Finance for borrowing the money to purchase the land is calculated on a straight-line basis using compound interest over the length of the development period
- Rolled up method of calculation is used (compound interest)
- To calculate the finance required for the construction period, assume total construction costs (including fees) over half of time period using an ‘S’ curve calculation
‘S’ curve
- The principle of the ‘S’ curve is that as the payment of construction costs adopts the profile of an ‘S’ shaped curve over the length of the development projects, the usual assumption is to halve the interest that would be borrowed for all of the construction period
- The purpose of the ‘S’ curve is to reflect when monies tend to be drawn down
- Calculate any finance required for on-going holding costs from completion of construction until disposal on a straight-line basis using compound interest
Developer’s Profit
- Percentage of GDV or total construction cost - say around 15%-20% depending upon risk
- GDV more frequently used as a base for residential use
- If scheme low risk (or pre-let/sold) a lower return may be required
- The percentage of profit required has recently risen given the current riskier market conditions
- Other methods to calculate the profit required is it base it on the return upon capital employed
- Deduct the TDC from the GDV to establish the site value having allowed for normal purchaser’s costs
- Cross check the site value with a valuation of comparable site values if possible
Development Finance
2 main methods of funding are
- Debt finance - lending money from a bank or orther funding institution
- Equity finance - selling shares in a company or joint venture partnership or own money used
Loan to value ratio (LTV)
Typically in the region of 60% but in difficult markets, lenders may adopt a Loan to Cost (LTC) ratio (e.g. of 60%)
How is interest calculated?
Interest is calculated on a rolled-up basis - i.e. added to the loan as the project proceeds
Senior debt
First level of borrowing which takes precedence over secondary/mezzanine funding
Mezzanine funding
Additional funding for the additional monies required over the normal LTV lending
What are swaps?
- Swaps are a form of derivative hedging rate for interest rates
- A swap rate is the market interest rate for fixed rate, fixed term loans
What are the other methods of arranging finance?
- Joint ventures - 2 or more parties join to develop
- Forward sales - where completed scheme pre-sold to either an investor or occupier
Overage
- This is the arrangement made for the sharing of any extra receipts received over and above the profits originally expected as agreed in a pre-agreed formula
- It can be shared between the vendor/landowner and developer in a pre-arranged apportionment
- Also known as a ‘claw back’
VAT
Remember VAT is payable on all professional fees
Profit Erosion Period
This term relates to the length of time it will take for the development profit to be eroded by holding charges following the completion of the scheme until the profit from the scheme has been completely drawn down, due to interest changes, and the scheme is loss making
Limitations of residual valuation methodology and financial modelling
- Importance of accurate information and inputs
- A residual valuation does not consider timing of cash flows
- Very sensitive to minor adjustments
- Implicit assumptions hidden and not explicit (unlike a DCF)
- Always cross-check with a comparable site valuation if possible
THREE forms of sensitvity analysis
- Simple sensitivity analysis of key variables - such as the yield, GDV, build costs and finance rate
- Scenario analysis - change scenarios for the 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’
Advice on the calculation or profit
- Consider whether you adopt profit based on cost or profit based on GDV
- A profit on cost approach is more accurate than based on GDV as the calculation of the GDV is more subjective and accurate construction costs may have been provided by the client
- The advice to the client will depend on the objectives of the client
RICS Professinal Standard: Financial viability in planning: conduct and reporting, 2019
- Sets out mandatory requirements on conduct and reporting in relation to Financial Viability Assessments (FVAs) for planning in England, whether for area-wide or scheme-specific purposes
- It recognises the importance of practitioners acting with impartiality, objectivity and transparency when reporting on such matters in order to support the statutory planning decision process
- Ascertaining the viability of a development involves making valuation judgements, e.g. in the inputs and outcomes of an appraisal
- Practitioners must therefore employ: evidence-based judgement, standardised approach and chartered surveyors must include sensitivity analyses and non-technical summaries in their reports
Local planning authority (LPA)
This includes both local and regional planning authorities, including metropolitan cities where a mayor presides in determining, or informing decisions on, planning applications
National Planning Policy Framework (NPFF)
Sets out the government’s planning policies for England and how these are expected to be applied. Changes to planning policy included (2023):
* Meeting the challenges of climate change and coastal erosion
* Wind farm planning policy
Proposed revised version in 2024. No timetable yet for the proposed new legislation. Proposals include:
* Policy objectives
* A new standard method for assessing housing needs
* Brownfield, grey belt and green belt designations
* Supporting green energy and the environment
* Delivering affordable, well-designed homes and places
Section 106 Agreement
- Introduced under the Town and Country Planning Act 1990
- Planning obligations which are set out in a legally binding agreement enforceable by the LPA adn are site specific impact related only
- The agreement has be entered into before the planning consent is granted
- Relate to various forms of community gain and can be either specific works or the payment of a financial contribution to the LPA
- They are negotiated on a one-to-one basis taking each development on its merits with no fixed charging schedules
- Examples include contributing to the cost of a new school, community facility or open space
Viability assessment
- An assessment originated on behalf of an applicant
- An assessment on behalf of an LPA
Definition of development
- Set out in the Town and Country Planning Act 1990
- Planning permission required for development
- The definition of development is ‘the carrying out of building, engineering, mining or other operations in, on, over or under land, or the making of any material change in the use of any buildings or land’
- ‘Building’ includes demolition, rebuilding and structural alterations
Two types of planning applications
- Outline - to establish the principle for development
- Full - for full consent
Community Infrastructure Levy (CIL)
- Community Infrastructure Levy (CIL) is a charge (or ‘tax’) that councils, authorities and the Mayor of London can apply to new developments like new houses or flats, residential extensions and commercial development
- It is sought to support infrastructure needs arising from approved developments within the Borough (eg school places, health and community facilities, transport networks)
- Most new non-domestic development which creates net additional floor space of 100 square metres or more, or that which creates a new dwelling, is potentially liable for the levy
- It is usually due a short time (usually 60 days) after a development has commenced, and so developments which do not commence will not have to pay the CIL
CIL (Amendment) Regulations 2015
Deals with the detailed working of CILs, covering such issues as LPAs being able to consider setting differential rates for alternative models of social housing provision, how instalment policies can assist the viability and delivery of development and restrictions for pooling s.106 planning obligations
CIL (Amendment) Regulations 2019
Requires all local authorities in England to produce an annual report on how much money has been collected from s.106 and CIL payments and where the money has been spent
Main differences between CIL and s.106 Planning Obligations
CIL
* For all infrastructure necessary to support the development
* Cannot be used to secure affordable housing
* A charging schedule must cover the whole area
* Tariff based charging system based on the increase on floor area of the scheme
* Viability is tested at district-wide level at the evidence gathering stage then charges are mandatory
s.106 Planning Obligations
* Only justifiable if necessary to make the development acceptable in planning terms, directly related to the development and reasonable in relation to the scale of the development
* Can be used to secure affordable housing
* Site specific charge
* By negotiation
* VIability testing undertaken on a case-by-case basis
Town and Country Planning (Use Classess) (Amendment) (England) Regulations 2020
- The Regulations came into force on 1st September 2020
- Aim is to allow businesses more flexibility in what buildings can be used for. Changes include: Class E for commercial, Class F1 for learning and non-resi institutions, and Class F2 for local community areas
- PDR may not apply in Conservation Areas, AONB and National Parks
- Class B - Industrial
- Class C - Residential
- Class E - Commercial, Business and Service
- Class F - Local Community and Learning
Permitted Development Rights
- For some forms of development, planning permission is not required and there are now many PDR for change of use
- The current legislation for permitted development is the Town and Country Planning (General Permitted Development) Order 2015 which has been amended several times (in 2024)
- Various changes planned for PDR include for householders to extend, develop upwards, demolish and rebuild residential property, and install vehicle charging points and air source heat pumps
Listed buildings
- Buildings included in a list under the Planning (Listed Buildings and Conservation Areas) Act 1990
- Considered to be of national architectural or historic interest
- Listed building consent may be required for any changes/new development
- It is an offence to carry out works to a listed building without prior listed building consent
THREE grades of listing
- Grade 1 (buildings of exception interest)
- Grade 2* (buildings of particular importance)
- Grade 2 (90% + of all listings - buildings of special interst)
Section 73 Town & Country Planning Act, 1990
This process allows for the LPA to agree to a request to remove, vary or discharge a planning condition following the grant of a planning consent
