PE Valuation - Residual Method

Question 1

Do the RICS provide relevant guidance on the Residual Method?

Answer 1

Yes, RICS Guidance Note Valuation of Development Property (1st Edition, October 2019)

Question 2

When would you use a Residual Land Valuation (RLV)?

Answer 2

Land or property suitable for re(development)

Question 3

How else could you value development land?

Answer 3

Comparison with sale price of land for comparable development (usually active market, low density development)

Question 4

How does a RLV differ from a Developer Appraisal (DA)?

Answer 4

RLV output is land value, DA output is profit

Question 5

What is the basic process of undertaking a RLV?

Answer 5

Gross Development Value (GDV) - Costs - Developer’s Profit = Land Value

Question 6

What is the basic process of undertaking a DA?

Answer 6

Gross Development Value (GDV) - Costs - Land Value = Developer’s Profit

Question 7

What does a development appraisal show?

Answer 7

Viability or feasibility of a development - you can adjust for the developer’s specific inputs

Question 8

What are some of the key things you should look for when inspecting a development site?

Answer 8

Extent/developable areas
Topography
Flood risk
Previous land uses (including contamination)
Building sizes, height and efficiency
Abnormals, e.g. site conditions, access
Party wall, boundary and right of light issues
Geotechnical conditions
Infrastructure
Occupation & other interests (whether actual or implied by law)
Archaeology
Waste/mineral extraction rights/risks

Question 9

What else needs to be considered when inspecting a development site?

Answer 9

Planning framework
Permitted Development rights
Existing planning use and any consents
Special controls e.g. TPOs, green belt, listed status, conversation area
Environment concerns/biodiversity/ecology

Question 10

How can you assess development potential?

Answer 10

What is the highest alternative land use?
What could you obtain planning for?
What type of space is in demand?
What is the market likely to do over the next few years?
What can be accommodated on the site?
Do you need to acquire adjacent land?

Question 11

What is Gross Development Value (GDV)?

Answer 11

Market Value of the proposed development assessed on the special assumption that the development is complete as at the date of valuation in the market conditions prevailing at that date

Question 12

What is Net Development Value (NDV)?

Answer 12

Reflects transaction costs incurred if the completed development was sold on the date of valuation

Question 13

How do you establish GDV?

Answer 13

Generally using the comparable or investment methods

Question 14

What do development costs include?

Answer 14

Build costs (based on GIA)
Professional fees (c. 10-20%)
Site preparation
S106/CIL
Planning and statutory/regulatory obligtion costs
Sale agent fee (1-2% GDV)
Letting fee (10% initial rent)
Marketing costs
Continency (3-10% construction costs)
Finance costs

Question 15

Where could you source build from?

Answer 15

QS
Client
Contractors
SPONS
BCIS

Question 16

What is included in the development programme?

Answer 16

Pre-construction - site assembly, obtaining vacant possession, planning, design and engineering process, ground investigations and works, building contracts, demolition and site preparation

Post-construction - completion until full letting, sale of re-financing, defects liability period

Principal construction - enabling works, main build (could be phased)

Question 17

What is S106?

Answer 17

Legally binding private contract between a developer (or a number of interest parties) and a local planning authority, operating alongside a statutory planning permission

Question 18

What is the Community Infrastructure Levy (CIL)?

Answer 18

Planning charge to help deliver infrastructure to support the development of an area

Question 19

What is CIL charged on?

Answer 19

Net increase in the gross internal area of development on the site

Question 20

What are finance costs paid on?

Answer 20

Site purchase including purchaser’s costs (straight line basis)

Development costs (S curve)

Holding/void costs (straight line basis)

Question 21

What do holding costs typically include?

Answer 21

Service charge
Interest
Empty rates
Insurance
Security
Cleaning

Question 22

How is developer’s profit typically calculated?

Answer 22

% of GDV
% of total development cost including interest

Question 23

What other criteria might be assessed in terms of performance measurement?

Answer 23

Initial yield on cost
Cash-on-cash (equity yield)
Interest on capital employed
DCF (NPV approach)
Equated yield (IRR appraoch)
Amount of cover
Return on capital employed
Profit erosion

Question 24

Development is inherently risky, how can you assess this risk for a client?

Answer 24

Monte Carlo simulation
Scenario analysis
Sensitivity analysis

Question 25

What are the disadvantages of a RLV?

Answer 25

Needs accurate inputs
Doesn’t take into account timing of cash flows
Sensitive to minor adjustments
Calculations hidden (particularly if using software such as Argus)