Development Appraisals

Question 1

What are the basic elements of a development appraisal?

Answer 1

Gross development value minus total costs including a fixed land value equals developers profit.

Question 2

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

Answer 2

The calculation contains the same elements, but in a development appraisal the outcome is profit whilst in a residual appraisal it is the land value. Development appraisals reflect client-specific assumptions, whereas for residual appraisals I use market assumptions.

Question 3

How did you appraise X development site?

Answer 3

I was instructed to provide current market value for the site, so I produced a residual site valuation. I calculated the Gross Development Value, from which I took away the costs associated with the development, in order to produce a residual land value.

Question 4

What do the costs include?

Answer 4

Costs associated with development include build costs, professional fees, marketing fees and the developer’s profit.

Question 5

What are professional fees made up of?

Answer 5

Architect – 5%, Structural engineer – 1.5%, Quantity surveyor – 1%, Project manager – 2%, M&E engineer – 1.5%, CDM principal design and contractor – 0.5%. Planning consultant and assumption for additional fees assoc. with obtaining planning (e.g. Heritage consultant etc).

Question 6

How did you get your build costs?

Answer 6

My client supplied the build costs, which had been prepared by their cost consultant. These were prepared independently by a qualified Quantity Surveyor, and I checked them with a colleague in Building Consultancy who agreed that they were reasonable. I therefore adopted these in my appraisal.

Question 7

How else could you get build costs?

Answer 7

I could use BCIS, which provides average build costs for different types of property based on samples of tender documents. These can be filtered for the region and development type.

Question 8

Are there any problems with BCIS?

Answer 8

In London BCIS is not very applicable as it is very heterogeneous and doesn’t take into account site specific constraints and circumstances. For example, large basements, piling, party walls and restricted access. BCIS also doesn’t include contingency, externals and abnormal costs.

Question 9

How did you arrive at your GDV?

Answer 9

I used the comparable method of valuation to come to an opinion of value for the proposed units. I produced a unit by unit pricing schedule with reference to the proposed plans and area schedule. In order to value the affordable housing element I talked to my colleagues in the affordable housing team, who use a discounted cashflow model to value the affordable housing.

Question 10

What are purchasers costs?

Answer 10

I included purchasers costs of 6.8% on the commercial element. This is made up of stamp duty at 5%, legal and agency fees at 1.5%, plus VAT.

Question 11

Why 4.99% stamp duty?

Answer 11

The stamp duty payable relates to the existing use of the property. Commercial SDLT has 0% up to £150k. 2% between £250k and 5% over £250k.

Question 12

How would you appraise a large development?

Answer 12

I would use phasing to cashflow the build and revenue of the development.

Question 13

How do you decide what finance rate to use?

Answer 13

I discuss finance with my colleagues within the capital advisors team to see what banks are currently lending at (LIBOR plus premium). This represents a blended rate for different types of finance including senior debt and mezzanine finance. It also includes entry and exit fees.

Question 14

What amount of development is usually equity funded?

Answer 14

The higher amount of equity funding the greater the risk to the developer. Current lending restrictions mean that loan to value ratio is in the region of 50-60%, reducing the amount of senior debt. However, developers can then seek mezzanine funding over this level.

Question 15

What impact would it have if your client said they had mezzanine funding?

Answer 15

Mezzanine funding is usually lent at a higher interest rate so I would increase the finance rate in my appraisal.

Question 16

How do Banks set their interest rates?

Answer 16

With reference to the Bank of England base rate and Libor, which is the London inter-bank lending rate. They will then apply a premium to this.

Question 17

What Loan to Value ratio would you expect?

Answer 17

Loan to value ratios have been reduced following the financial crisis. The LTV would differ depending on the lender and the borrower, however I would expect a maximum of approximately 65%.

Question 18

What are the main methods of financing a development?

Answer 18

1. Senior debt – partial funding from banks
2. Mezzanine finance – stretch finance using a secondary source to reduce equity input
3. Equity finance – profit share with an equity partner
4. Joint venture – reduce risk, deliver scheme with a partner through an SPV
5. Forward fund – secures funding for project delivery and asset is usually transferred to funder at completion

Question 19

Why would you use PoC rather than Profit on GDV?

Answer 19

Costs tend to be more certain and stable than GDV in London.

Question 20

Are there any other methods of measuring return?

Answer 20

IRR – which stands for the internal rate of return.

Question 21

What does the IRR measure and when would you use it?

Answer 21

It is essentially an annualised return on an investment and is used to compare investment or development opportunities which have different timescales to determine which will be the most profitable (discount rate required to reach a Net Present Value of zero). Based on the principle that money is worth more today then it is in the future

Question 22

What IRR would you expect?

Answer 22

If a scheme was completely equity funded then circa 10%. If there was a high level of debt funding then 17-20%.

Question 23

How would you calculate IRR?

Answer 23

Essentially I would find the discount rate which resulted in a net present value of zero. I could do this through linear interpolation, creating two cashflows and applying a different discount rate to each - one that resulted in a positive net present value and one that resulted in a negative net present value

Question 24

How do you come to your demolition costs?

Answer 24

I would advise the client to have a demolition survey carried out, however if this was not appropriate I would seek advice from a colleague in building surveying. In my experience demolition costs tend to range between £3-5 psf.

Question 25

How would your approach to an appraisal vary on a PD scheme?

Answer 25

I would strongly advise my client to appoint a QS to prepare a cost plan as the build costs for PD schemes can be very variable depending on the condition of the building and how well it lends itself to conversion.

Question 26

Are there any problems with using Argus Developer software?

Answer 26

Argus developer is useful as it is a very quick method of running a development appraisal. However, it does make certain assumptions which cannot be controlled.

Question 27

What types of sensitivity analysis are there?

Answer 27

1. Sensitivity analysis
2. Scenario analysis
3. Monte Carlo

Question 28

Is it realistic to not include reservation fees and deposits within your cashflow before PC if you’re assuming off plan sales?

Answer 28

Yes as in most circumstances the deposit will be paid to the developer’s solicitor and held by them until completion. The only circumstance where the deposit is paid to the developer is when they are registered with NHBC as NHBC insure the deposit in the event the developer becomes insolvent and does not complete.

Question 29

What is NHBC?

Answer 29

NHBC stands for the National House Building Council. They offer warranties on new homes, which are required by most mortgage lenders. Developers who sell properties with NHBC warranties must adhere to the NHBC standards of construction, and the site will be inspected at key stages to check compliance. For the first 2 years the developer will be liable for fixing any defects, and for the next 8 years the NHBC will fix defects for structural and weather proofing parts

Question 30

What is contained within the RICS valuation paper no 12 valuation of development land 2008

Answer 30

outlines the following: how to assess development potential, valuing using the comparable method, residual method, assessing the land value and reporting the valuation

Question 31

What does BCIS stand for and what does it look like

Answer 31

The Building Cost Information Service
it has news on the home page and the contents down the left hand side where the analyses section can be found to determine the build cost categories.

Question 32

How would you promote the site within the local plan?

Answer 32

There are two key elements to land promotion:

Submit evidence to the council showing why the development you are proposing is actually needed.

Demonstrate why your site is suitable for the type of development that is needed.

Question 33

What is outlined within RICS GN Financial Viability in Planning 2012

Answer 33

Describes key features of development viability and why they are used in planning
Development Management
How to assess viability
Good overview of competency

Question 34

how else could you assess development land?

Answer 34

Cash flows - setting out the year on year expenditure to show the scheme profit.

Question 35

What impact did Housing and Planning Act 2016 and Neighborhood Planning Act 2017 have on the CPO process?

Answer 35

Aimed at speeding up CPO
Giving longer notice to occupiers
acquiring authority makes CPO
SoS is required to publish timetables
CPO can be exercised by GVD (General vesting Declaration) or Notice to treat.

Question 36

What is outlined in the RICS Professional Standards and Guidance - Valuation of Development Property, 2019?

Answer 36

Supplements IVS (410)
When valuing development land, assumptions & special assumptions must be clearly stated.
Assumption = Optimum development
Use both residual & comparable method to cross-check
Use risk analysis - sensitivity & scenario analysis
Reporting the valuation - uncertainty, report significant variation.