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RICS APC > Development appraisals > Flashcards

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

RICS APC (20 decks)

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