Level 2 - Development Appraisals Flashcards
T1. Tell me about a development appraisal which you have been involved with and how you undertook the work?
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T2. Do you calculate your costs for a development appraisal on a GIA basis or GEA basis?
I calculate them on a GIA basis. Residential dwellings are measured on a GIA basis
T3. How do you work out your contingency rate?
Typically a contingency rate would be between 5-10% of the construction costs but this would depend on the level of risk of the development.
T4. What is contingency?
A future event or circumstance that cannot be predicted with certainty, i.e. additional construction
T5. How would you calculate the Gross Development Value of a new residential development?
The GDV of a new development can be obtained gaining evidence of recent sales transactions within the near vicinity, and also be obtained from market evidence.
T6. How would you reflect planning requirements in your development appraisal?
If I was undertaking a residential appraisal I would take into account an appropriate level of s.106 and s.278 costs, that I would find out about from the relevant planning authority, and this would be deducted from the GDV after accounting for construction costs, and a contingency.
T7. How do you estimate the total construction cost for a scheme?
In order to assess the construction cost of a scheme, I would look to use the BCIS, to ascertain what cost levels are on nearby schemes in the area. I would check this level against what local Quantity surveyors felt was an appropriate level of costs to account for.
T8. Where would you typically get your finance rate for a development appraisal from?
Firstly check with your client as they may have a specific loan facility and be able to borrow money at a certain rate, I would then use that.
I would also look at comparable scheme to see what finance rate had been used. However the best way of working out the best level of finance achievable for the scheme would be to talk to the developer, and find out what finance arrangements he has been able to find on recent projects, and compare the market conditions then with the current market.
A typical market finance rate would be 6%.
Interest should also be calculated to cover the time period from the purchase of the land, the construction of the building and any projected letting / sale void upon completion of construction.
T9. If I was Joe Bloggs carrying out a development, would the finance rate be higher or lower than more regular finance users?
It would be higher
T10. Outline the main focus of development finance used by developers?
Debt and Equity funding
Debt funding is lending money from a bank or other financial institution.
Equity funding is selling shares in a company, JV’s or using your own money.
T11. What is a typical LTV ratio?
Crest Nicholson was self funded. However talking to colleagues at other organisations typically 50% - 60%. It used to go up towards 70% but lenders are now more risk adverse.
T12. When do you need most of your costs for a development? What is an S -Curve?
Typically developers do not need access to all the capital at once due to the S Curve nature of costs within a development scheme, that allow for costs to start at a low level, and rise through the construction process.
The interest on the finance will normally be on a rolled up, compound interest basis, that will provide for the full amount of financing needed throughout the development.
As not all of the money will not need to be drawn down on at once the interest rate payable will start low and will increase with the more borrowing. During site preliminaries there aren’t many outgoing costs and therefore your borrowing will be low. As time progresses into the construction phase your costs will increase particularly when the frame of your building is being put up etc. This may mean that the increase in borrowing is quite steep. Once your development is near complete and it is just the marketing your costs of finance will the tail off until you have sold your development and paid off your loan.
You would typically look at it that you would only need to pay full interest for half of the proposed development, as interest payments will be very low and the start and then will be high in the second half. It in theory evens itself out!
T13. You mention that you carried out a development appraisal of a development site in Wokingham (West Court) Talk me through this?
REVIEW ASAP, INCORPORATE.
I recently purchased a site in Shoreham, which had outline consent for 106 residential units. I was instructed to lead the planning application for the reserved matters application.
The scheme had been costed and I reviewed the likely GDV for the scheme. I looked at recent comparable residential sales around the area.
• Site – 5.41 gross acres
- GDV (Rent * Yield)
- Less purchasers costs = NDV (these are the costs a purchaser will need to pay when buying the site from you!)
- Subtract Site Costs – They already owned the site – price £5,000,000.
- Subtract Total costs – planning, S106, professional fees including structural engineers, CDM contractor, M&E consultants 10% - 15% - c. £150 psf
- Demolition - £1,500,000.
- Subtract Contingency – 5% of total construction costs.
- Subtract Marketing costs - £740,000
- Less Finance Costs – 6%. I confirmed the finance costs with my line manager.
- Profit on GDV of 26%
T14. Outline the differences between a residual valuation and a development appraisal.
A development appraisal will typically give you the profitability of a proposed development and a residual valuation will give you the value of the land.
A residual will give you the Market Value and therefore you would need to use market led costs, either from the BCIS website or if your client has a tendered scheme where they have gone to the market to actively obtained costs.
A residual is based on the valuer’s inputs and is for a practical purpose.
A development appraisal will be on costs provided by your client. You are able to play around with the costs to achieve your desired profit levels.
Development appraisal is usually based on the clients inputs. Give you a calculation of worth.
Residual Valuation is a valuation of a property holding, it is a specific calculation to establish the residual value of a development site, by estimating the GDV of a proposed scheme, deducting the total proposed development costs to arrive at a MV of the development site.
This valuation assumes a number of key variables and is undertaken at a particular point in time, using current costs and values.
It can be used to establish the site value or profitability of a proposed development scheme.
Development Appraisal
Is a calculation (or series of) to establish the viability of a proposed development.
It does not produce a Market Value but provides guidance as to whether the proposed development is commercially viable.
It can establish the land value and / or the likely profit to be generated by the proposed development
This can be in the form of a traditional residual valuation approach or using a DCF method of valuation.
T15. 15. Have you carried out a residual valuation?
- Yes I assisted with a residual valuation of a site in Chertsey.
- They submitted a planning application for a proposal of 130 units.
- Comp evidence to find out the GDV.
- I took off costs which I obtained from the quantity surveyors. £65.00 psf sq ft build costs.
- I used a finance rate of 6.00% which was approved by the client.
- Took off profit on GDV of 25%.
- Site value of £1.21m per acre.
T16. 16. How do you calculate the finance costs for a residual valuation?
Site purchase – straight line over entire period
Total Construction Costs & associated – S curve ½ interest rate
Holding – until disposal (empty rates, service charge & interest charges)
T17. What factors affect the sensitivity of an appraisal? How can you deal with these sensitivities? And what is a sensitivity analysis?
Development Appraisals are sensitive to many factors, particularly to the variables that are put into the appraisal, such as construction costs, rates of interest, the yield and the rent.
A sensitivity analysis will show you how the outcome changes when the inputs are varied slightly.
Will provide different scenarios to the client.
T18. What software does your practice use for development appraisals? Do you like this software? What are its limitations?
I don’t undertake Development Appraisals at Hadron Consulting. Crest Nicholson used Excel Spreadhseets to undertake development appraisals, which whilst being a useful tool, the key assumptions and calculations remain hidden, and therefore the user is reliant on the information being put in being correct. I do like the software now, as I am aware of how to use it, and am practised at it.
T19. Tell me about an instruction which you have dealt in respect of undertaking a form of sensitivity analysis. What are the main forms of sensitivity analyses?
I undertook a development appraisal of a development proposal for a site in Sayers Common. I ran various sensitivity analyses, changing the GDV and potential costs.
There are 3 forms of sensitivity analysis which can be used to consider the accuracy of the valuation;
1) Simple Sensitivity Analysis – a series of sensitivity analysis should be run to consider the impact of changes of fixed amounts to the key variables, such as construction costs, rates of interest and the GDV.
2) Scenario Analysis – the valuer can consider what might happen to the key variables in a scheme under differing economic conditions, such as changes in interest rates or rental growth rates on a pessimistic and optimistic basis. This technique can be enhanced by adopting probability linked scenario analysis, by adopting the assessment of probabilities to the variables.
3) Simulation – Crystal Ball / Monte Carlo. Require the probable value for each variable to be identified, for probability to be assumed to each and then for random numbers to be generated in order for the value to be used in the calculation to be selected.
T20. What are the main weaknesses of the residual method of valuation?
There are 4 main areas of weakness;
1) Development appraisals / residual valuations are unstable and extremely sensitive to minor adjustments.
2) The method does not take into account the timing of cash flows (unlike the DCF approach). It is growth IMPLICIT rather than growth explicit.
3) High quality of information for the inputs is essential
4) IMPLICIT assumptions remain hidden
5) Always cross check with comparable sites if possible.
T21. Why are purchaser’s costs deducted from an appraisal and when are they deducted?
Purchasers costs are deduced from the GDV as a purchaser would need to pay these when buying the finished product. This will give you the NDV.
Costs will need to be put in place if you wanted to buy the land. Agents costs, legal costs and Stamp Duty on buying the land.
1.5% costs will need to be taken off at the end as these are costs to the Developer when he needs to sell the site. 1.5% of the NDV.
T22. How do you reflect potential contamination costs in the valuation of a brown field site?
I would reflect potential contamination in a brownfield site by either talking to an expert in this field and getting an estimate for the costs of remediation, otherwise the additional costs of remediation could be reflected in the contingency level put on the construction costs. It may also be appropriate in some case to reflect the additional risk associated with the remediation within the ARY.
You may put in a cost obtained from a specialist into you appraisal for remediation.
T23. What are the advantages of using a DCF calculation for the valuation of a development site rather than a residual valuation?
- Allows for the valuer to input any changes in costs or values over the project.
- It shows the timing of peak cash outlays
- Shows outstanding debt at any given point
- Accounts or phasing over the build period that must be reflected in the land value
- Allows for sensitivity analysis to examine the effect of input changes on the outputs.
- Allows for off plan sales to be factored in.
T24. 24. What is a s.106 agreement? How do you have regard to it in your valuation of a development site?
- S.106 contribution could include the funding of the construction of a new local school or community centre, other infrastructure or the provision of social housing.
- It should be incorporated into the Total Building Cost or if in a cash flow paid at the commencement of construction.
