Development appraisals Flashcards

1
Q

What is the difference between a development appraisal and a residual valuation?

A

• Development appraisal: establish the viability/profitability of a proposed development using a client’s inputs

• Residual valuation: establish the market value of a site using market inputs

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2
Q

What is the methodology for calculating residual site value?

A

Gross development value (GDV) - Total development costs (TDC) = Gross site value

Gross site value - purchasers’ costs = Residual site vale

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3
Q

What costs would you allow for as part of total development costs?

A

• Site preparation
• Planning costs
• Building costs
• Professional fees + VAT
• Contingency
• Marketing costs & fees
• Finance costs
• Developers profit

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4
Q

What would be included in your estimate for site preparation costs and how would you estimate them?

A

• Demolition, remediation works, landfill tax, site clearance, levelling and fencing
• Obtain a contractor’s estime for these works

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5
Q

What would be included in your estimate for planning costs?

A

• Section 106 payments under the Town and Country Planning Act 1990
• Community Infrastructure Levy (CIL) charged by most Local Planning Authorities
• Required percentage of affordable housing 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
• Costs of planning consultants
• Cost of any specialist reports required by the LPA (e.g. Environmental Assessment)

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6
Q

How would you estimate the building costs?

A

• Client information
• Spons Building Costs book
• Quantity Surveyor estimate / bill of quantities / cost estimate
• Building Surveyor estimate
• RICS Building Cost Information Service (BCIS)

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7
Q

What basis are the cost on BCIS usually expressed? Where does RICS obtain the information from?

A

• Usually based on a GIA basis
• Obtain monthly updates from Quantity Surveyors / Building Surveyors and recent contract prices / tenders agreed

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8
Q

What would be included in your estimate for professional fees and how would you estimate them?

A

• Architects, M&E consultants, project managers, structural engineers, quantity surveyors
• Typically 10-15% (plus VAT) of total construction costs
• Can vary them depending on the complexity of the project e.g. lower architects fees required for an industrial warehouse than a high-rise residential building

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9
Q

What would you typically estimate for contingency costs?

A

5-10% of total construction costs (depending on the level of risk and likely movements in building costs)

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10
Q

What would be included in your estimate for marketing costs and fees and how would you estimate them?

A

Marketing budget (use evidence/quotes):
• Cost of an EPC
• Sales fee: 1-2% GDV
• Letting fee: 10-15% of initial annual rent
• National House Building Council (NHBC) warranty for residential schemes

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11
Q

How would you estimate the interest rate?

A

• LIBOR + premium
• Bank of England Base rate + premium
• Rate at which the client can borrow money

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12
Q

What THREE elements does the developer need to borrow money to finance? What basis would they be represented?

A
  1. Site purchase + purchaser’s costs: compound interest (straight-line basis)
  2. Total construction costs + fees: based on an s-curve taking hold of the costs over the length of the build programme
  3. Holding over costs to cover voids until the disposal of the scheme: compound interest (straight-line basis)
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13
Q

What holding over costs need to be accounted for after the development is completed, until the disposal of the scheme?

A

Empty rates, service charges and interest charges

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14
Q

What capital stack does the development appraisal process assume?

A

100% debt finance

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15
Q

Explain the concept of the s-curve and why it is applicable.

A

• Assumes that total constructions costs + fees are paid over half the time period
• Reflects when monies tend to be drawn down - lower levels of expenditure at the beginning and end of projects

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16
Q

What would you typically estimate for developers profit?

A

15-20% of total construction costs or GDV (GDV more frequently used as a base for residential use)

Consented sites will typically have a profit on cost of 15-20%. Non-consented sites will have 20-25%, depending on how it complies to local policies and whether they’d had a positive pre-application

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17
Q

What will influence the level of profit required by a developer?

A

• Depends on the level of risk
• If scheme is low-risk (or pre-let / sold) a lower return may be required
• Current riskier market conditions means the percentage of profit required has risen

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18
Q

How should you verify the output of a development appraisal?

A

Cross check site value with comparable site sales if possible

19
Q

When conducting a residual site valuation, what date should the inputs be taken from?

A

Taken at the date of valuation

20
Q

What are the two main methods of development finance?

A
  1. Debt finance: lending money from a bank or other funding institution
  2. Equity finance: selling shares in a company, JV partnership, own money used, forward purchase from an investor or occupier
21
Q

What is a typical loan to value (LTV) ratio?

A

c. 60%

22
Q

What are the typical components of a capital stack for development financing?

A

• Senior debt: takes precedence over other sources of funding. If the borrower defaults, the lender can take ownership of the property

• Mezzanine finance: will sit below the senior debt in terms of priority. Typically has a higher rate of return than senior debt but lower than equity

• Equity: riskiest and most profitable portion of the capital stack. Riskiest as the other tranches of capital will be repaid before the equity holders

23
Q

When would you use mezzanine financing?

A

Funding for additional monies required over the normal LTV lending

24
Q

What are swaps and how are they used?

A

Form of derivative hedging for interest rates. Swap rate will be the market rate for a fixed rate, fixed term loan

25
Q

What is overage?

A

Arrangement for the sharing of any extra receipts received over and above the profits originally expected, as dictated by a pre-agreed formula

Usually shared between vendor/landowner and developer in a pre-arrangement apportionment

26
Q

What is the profit erosion period?

A

Length of time it takes for the development profit to be completely eroded, due to empty rates, service charges and interest costs, following the completion of the scheme

27
Q

What are the limitations of the residual valuation methodology?

A

• Dependent on accurate information and inputs
• Does not consider timing of cash inflows
• Very sensitive to minor adjustments
• Implicit assumptions hidden and not explicit
• Assumes 100% debt finance

28
Q

What variables would you typically conduct a sensitivity analysis on?

A

• GDV
• Build costs
• Finance rate

29
Q

What are the THREE forms of sensitivity analysis?

A
  1. Simple sensitivity analysis - of key variables e.g. yield, GDV, build costs and finance rate
  2. Scenario analysis - changing scenarios for the development content/timing/costs such as phasing the scheme or modifying the design
  3. Monte carlo simulation - using probability theory with software such as Crystal ball
30
Q

What guidance did the RICS release on valuing development property?

A

RICS Valuation of development property, 2019

31
Q

How is development property defined in RICS Valuation of development property, 2019?

A

Interests where redevelopment is required to achieve the highest and best use or where improvements are either being contemplated or are in progress at the valuation date

32
Q

According to RICS Valuation of development property, 2019, what should Market Value for a development property assume?

A

Optimum development i.e. the development which yields the highest value, taking into account the perspective economic and planning conditions

33
Q

What does RICS Valuation of development property, 2019 state about the use of multiple valuation approaches?

A

Best practice avoids reliance on a single approach or method of assessing the value of development property

Output should always be cross-checked using another method (market comparison approach, residual method)

34
Q

What method does the RICS Valuation of development property state should be used for complex and/or lengthy development schemes?

A

Discounted cash flow (DCF) technique. Simple residual method can be used in other cases

35
Q

What does RICS Valuation of development property, 2019 recommend should be done to account for risk in the valuation process?

A

• Risk analysis should be used to show changes to the inputs which might affect the valuation
• Risk and return levels and assumptions should be explicitly stated in the valuation report

36
Q

How should you value land that is in the course of development according to RICS Valuation of development property, 2019?

A

• Value of the land + costs expended at the valuation date

and/or

• Completed development value - costs remaining to be expended at the valuation date

37
Q

How should the output of the valuation be reported according to RICS Valuation of development property, 2019?

A

Reported as a single figure, except where there is potential for significant variation (e.g. if there is uncertainty around the valuation the different options identified should be report)

38
Q

Why is profit on cost a more reliable method of measuring developers profit than profit on GDV?

A

GDV is subject to more variation

39
Q

What financing rate would you typically assume when running a residual valuation?

A

Depends on the risks associated with the site. Typically this would be around 5.5% but are likely to increase to 6% or more given the current uncertainties in the debt market

40
Q

If you were to conduct a residual valuation now, how would you approach it differently in light of the current circumstances?

A

• Increase your contingency to reflect uncertainties in material costs
• Increase the timescales to reflect that it would take longer for you to get on site.
• Increase finance costs as cost of debt has increased

41
Q

What is GDV?

A

Gross development value (GDV) is the estimated contract price or Market Value of the completed development. States gross as it is prior to any marketing fees being deducted

42
Q

What do developers consider the greatest risk when undertaking a development?

A

Planning permission

43
Q

How did you use special assumptions in your residual valuation approach?

A

GDV was the aggregate market value of the proposed development, assessed on the special assumption that the development is complete on the date of valuation in the market prevailing conditions