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RICS APC Commercial Real Estate S1 2024 > Optional - Development Appraisals (L2) > Flashcards

Optional - Development Appraisals (L2) Flashcards

1
Q

What basis of measurement are BCIS Cost Estimations provided against?

A

For commercial property they are provided in £/m² on a Gross Internal Area (GIA) basis. And for residential property they are provided on a GEA basis.

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2
Q

Have you Actually been onto the BCIS? How Does it Work?

A

Yes:
1. Average prices split into deciles
2. Location Factor
3. Contract Sum Factor

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3
Q

What is a section 75 agreement?

A

Section 75 of the 1997 Town and Country Planning Act (Scotland). It requires developers to provide a certain amount of affordable housing as part of their development or make a financial contribution to provide infrastructure.

The agreement may restrict use of the land and/ or regulate activities on the land being developed. The agreement may also oblige the land owner to make a financial contribution to the Council which must be used for the purposes that are outlined in the section 75 agreement.

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4
Q

Level 1

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

A

A development appraisal is a series of calculations to establish the viability/profitability of a proposed development based upon client inputs

Development Appraisal: GDV – Total Development Costs - Residual Site Value = Profit

A residual is a valuation of a site to find the market value of the site based on market inputs.

Residual: GDV – Total Development Costs - Profit = Site Value

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5
Q

Level 1

What assumptions does a residual appraisal use?

A

Market

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6
Q

Level 1

What assumptions does a development appraisal use?

A

Client specific and market.

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7
Q

How do you choose a finance rate?

A

Based on current market assumptions. If known, should be based on specific rate at which client can lend.

If not, usually reflects LIBOR plus a premium or BoE plus premium. LIBOR to be replaced by SONIA (Sterling Overnight Index Average) in 2021.

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8
Q

Level 1

Is 100% finance rate realistic?

A

No, but it’s the market normal/standardised practice and used in an appraisal to reflect the opportunity cost of capital.

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9
Q

Level 1

What is GDV and how is it calculated?

A

This is a market value of the proposed completed development scheme, assuming present values and current market conditions.

The comparable method is used to establish market rent, which is capitalised at an All Risks Yield. Also incentives such as a rent free, letting void should be assumed if appropriate.

Purchaser’s costs should be deducted.

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10
Q

Level 1

What is included in your Total Development Costs?

A
  1. Site preparation (demolition, landfill tax, remediation works)
  2. Build costs
  3. Planning costs (including s.106 and CIL if applicable)
  4. Professional Fees
  5. Finance Costs
  6. Contingency
  7. Marketing Costs
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11
Q

Level 1

What is included in professional fees?

A

Usually 10% - 15%. Includes architects, structural engineers, QS, CDM etc.

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12
Q

Level 1

What is included in marketing costs?

A

Brochure/advertising.

EPC.

Usually around 1-2% of GDV.

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13
Q

Level 1

What is a usual Developer’s Profit assumption?

A

Usually 15-20% of profit on cost.

Profit on GDV is generally for used for residential, however Profit on Cost is also used.

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14
Q

Level 1

Can you explain the concept of development finance.

A
  1. Finance for borrowing money to purchase the land is calculated on a straight line basis over the length of the development period.
  2. Calculation of finance required for the construction period is to assume the total cost of construction (including fees) over half of time period using the S curve which means that that the assumption of halve the interest that would be borrowed for all of the construction period.
  3. The S Curve reflects the incidence of costs being drawn down
  4. Assumes 100% debt finance
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15
Q

Level 1

What is VAT payable on?

A

All professional fees.

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16
Q

Level 1

What is profit erosion?

A

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.

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17
Q

Level 1

What are the limitations of development appraisals?

A
  1. Importance of accurate information and inputs.
  2. It does not consider the timing of cashflows.
  3. Very sensitive to minor adjustments.
  4. Implicit assumptions hidden and not explicit (unlike in a DCF).
  5. Always cross check with comparable land values if possible.
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18
Q

Level 1

What are the forms of sensitivity analysis?

A

Simple sensitivity – analysis of key variables (eg. Ield, GDV, build costs).

Scenario analysis – timing and costs

Monte Carlo simulation – using probability theory.

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19
Q

Level 1

What does a cashflow look like?

A

Timeline of income and costs over a set period of time.

Shows the timings of assumptions made.

Cost of finance.

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20
Q

Level 1

What does a planning permission contain? What are typical conditions included?

A

When planning permission was granted.

Conditions of approval.

Reference.

Description of development.

Location of development.

Date of application.

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21
Q

Level 1

What is the difference between debt, mezzanine and equity finance? What is the capital stack?

A
  • Debt finance – lending money from a bank or other funding institution
  • Equity finance – selling shares in a company or JV partnership or own money used.
  • Mezz funding – additional funding from another source for the additional monies required.
  • Senior funding – first loan.

The capital stack refers to the layers of capital that go into purchasing and operating a commercial real estate investment.

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22
Q

Level 1

What do you need planning permission for?

A

Anything that constitutes development under the 1997 Town and Country Planning Act (Scotland)

  1. Demolition
  2. Rebuilding
  3. Structural alterations
  4. Amalgamations
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23
Q

Level 1

What don’t you need planning permission for?

A

Maintenance/interior alterations – although mezzanines over a certain size now require planning permission.

Permitted development.

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24
Q

Level 1

In a development appraisal, give some examples where risk might be reflected?

A
  1. Contingency
  2. Yield (all risks) on ERV
  3. Profit on cost (if exceptionally large development)
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25
Q

Level 1

How long does planning permission last for?

A

Usually 3 years.

Outline applications normally last 3 years with development taking place within 2 years of the approval being granted.

You can apply for an extension

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26
Q

Level 1

What does a cashflow look like?

A

Timeline of income and costs over a set period of time. Shows the timings of assumptions made and the cost of finance.

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27
Q

Level 1

Explain the concept of finance costs.

A

Most development projects are funded from interest-paying borrowings which are highly sensitive to timescales.

Interest arises on land acquisition and development costs.

The rate of interest reflects levels in the market for the type of scheme involved. It is either paid when due or deferred (rolled up) throughout the projected programme.

Conventionally, the interest is compounded either quarterly or annually (market practice).

Delay, added complications, or shifts in the money markets can all have an important impact on finance costs.

Viability appraisals generally assume that projects are fully funded by borrowing money.

This is often referred to as 100% gearing. Even where the funder has provided only part of the finance debt and the developer has used his own funds for the balance (equity), the appraisal should reflect the total cost of the funding.

28
Q

Level 1

What is IRR?

A

Internal rate of return.

A measure of profitability.

The discount rate required to make the net present value of all future cash flows equal to zero.

The % interest earned on each £1 invested.

29
Q

Level 1

What guidance did the RICS release on valuing development property?

A

RICS GN Valuation of development property, 2020

30
Q

Level 1

How is development property defined in RICS Valuation of development property, 2020?

A

Development Property is 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

31
Q

Level 1

According to RICS Valuation of development property, 2020, 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

32
Q

Level 1

What does RICS Valuation of development property, 2020 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)

33
Q

Level 1

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

34
Q

Level 1

What does RICS Valuation of development property, 2020 recommend should be done to account for risk in the valuation process?

A
  • Sensitivity 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
35
Q

Level 1

How should you value land that is in the course of development according to RICS Valuation of development property, 2020?

A
  • Value of the land + costs already spent at the valuation date

and/or

  • Completed development value - costs remaining to be spent at the valuation date
36
Q

Level 1

How should the output of the valuation be reported according to RICS Valuation of development property, 2020?

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)

37
Q

Level 1

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

A

GDV is subject to more variation

38
Q

Level 1

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

A

Planning permission

39
Q

Level 1

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)

40
Q

Level 1

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)
41
Q

Level 1

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

42
Q

Level 1

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
43
Q

Level 1

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
44
Q

Level 1

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
45
Q

Level 2

What was the build cost rate of your scheme and how did you measure it?

A

Architects drawings provided GIA for the scheme, inflated by 10% to reflect likely GEA.

Used BCIS to determine median newbuild resi at £118 per sq ft

46
Q

Level 2

What was your developer’s profit percentage and why?

A

15% on GDV: relatively low-risk given popular residential area
15% - 20% is typical

47
Q

Level 2

What was your professional fees percentage and why?

A

10%: architect had already been engaged to determine scheme
10% - 15% is typical

48
Q

Level 2

What did you assume VAT on?

A

professional fees, marketing/sales fees, legal fees

49
Q

Level 2

What were you marketing and legal fee percentages?

A

1% on sales and 0.5% on legals which is standard in commercial world

50
Q

Level 2

What contingency percentage did you incorporate and why?

A

5% on build costs - scheme unlikely to change as planning permission had already been sought
5% - 10% is typical depending on risk to build costs

51
Q

Level 2

Did you assume anything for siteworks?

A

Yes, £500,000 for access roads to each plot and services

52
Q

Level 2

What was the land cost?

A

We were aware that there was a provisional land price on the table for £1.5m. This equated to £150,000 per acre which was cross checked with land comps and was reasonable

53
Q

Level 2

What were your finance costs?

A

£1.2m. Calculated as 9.00% of total build costs on a straight line basis assuming 100% finance needed

54
Q

Level 2

What was the duration of your project assumed to be

A

2 years

55
Q

Level 2

How did you arrive at 9.00% for your cost of finance?

A

At the time, base rate was 5.00% and finance colleague advised 4.00% over base was market rate for such finance deals.

56
Q

Level 2

What was your total GDV and what did this work out on a £ per sq ft basis?

A

£15m averaging out at £270 per sq ft.

57
Q

Level 2

Can you summarise the calculation?

A

GDV: £15m (270 psf)
Build Costs: £6.7m (120 psf)
Dev Profit: 15%
Prof Fees: 10%
Sales: 1%
Legal: 0.5%
Contingency: 5%
Siteworks: £500k
Land: £1.5m agreed with land owner
LBTT: £65k

58
Q

Level 2

How is LBTT calculated

A

0-150k: 0%
150k-250k: 1%
250k+: 5%

59
Q

Level 1

What is a sensitivity analysis?

A

It’s a tool used to test how responsive certain inputs are to minor adjustments and how they affect the overall viability of a development project.

60
Q

Level 1

Can you talk me through RICS Valuation of Development Property (2020)?

A
  • To supplement the Red Book where there is an interest in the redevelopment or property or the development of land.
    • Market comparison approach (i.e. land sales)
  • Residual approach (i.e. dev appraisal)
  • Good to not just rely on one
  • Input based so establishing facts is really important
  • How to value land partially developed
  • How you should adapt mandatory aspects of a report to satisfy Red Book mandatory compliance
61
Q

Level 2

What was the land previously?

A

Farmland adjacent to boundary of the hotel that we were valuing that had planning permission already granted. Landowner didn’t want to complete the works and was looking to sell. Hotel owner in talks to buy the land for £1.5m

62
Q

Level 2

25 detached units of what?

A

Detached residential dwellings

63
Q

Level 2

What evidence did you collect for your GDV and where?

A
  • Second hand sales comparables of most affluent suburban street in Scotland next door to proposed development
  • Asking prices and registered sales of new housing development at Dargavel Village close-by - a 4,000 home masterplan
64
Q

Level 2

What is an S-curve

A

Visual representation of the flow of development costs throughout the lifecycle of a project. High initial costs to purchase land, then low which gradually increases as build costs ramp up, then low again as the sale proceeds of first plots pays for the build costs of the next phase.

65
Q

Level 2

What is an Internal Rate of Return

A

Used in a DCF appraisal, all future cash flows are discounted back to a Net Present Value of zero to give an estimate of the developer’s profit.

The internal rate of return (IRR) is the annual rate of growth that an investment is expected to generate.

66
Q

Level One

What is an abnormal cost and what is an example of one?

A

A cost that you usually wouldn’t expect, for example, unusual ground conditions requiring deeper foundations.

RICS APC Commercial Real Estate S1 2024 (20 decks)

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