Residual Method Flashcards
What is a development appraisal used as a tool for?
To financially assess the viability of a development scheme.
A development appraisal can be used to establish a ________ ________ ________.
Residual site value.
Why is a development appraisal particularly useful?
To assess profitability and sensitivity to changing inputs.
A development appraisal can _____ or ______ a site value.
Assume or calculate.
A valuation is one of the possible _____ of a development appraisal.
Outputs
A development appraisal provides guidance add to the _____ of the proposed development.
Viability.
What is the most common purpose of a residual site valuation?
A specific valuation of a property holding to find the site value.
A residual site valuation provides a valuation for a particular ____ on the date of the valuation.
Purpose.
A residual site valuation is a form of ______ _______.
Development appraisal.
What two methods can the residual valuation be based upon?
Simple residual valuation
DCF
Can both residual and DCF be used as a Red Book valuation?
Yes
The Red Book guidance and exemptions relate to PURPOSE not methodology.
How is a site value worked out using the residual method?
GDV
Less Development Cost
Less Profit
= Site Value
How is GDV calculated?
- At the date of valuation
- Use plans and take check measurements
- Assume present values and market conditions
- Comparable method to establish rents and yields.
- ARY used
- Allow rent-free period/tenant’s incentives/void is appropriate.
- Deduct purchaser’s costs for commercial property valuations.
What costs are involved in site preparation?
Demolition
Remediation
Landfill tax
Services
Clearance
Levelling
Fencing
What does the Town & Country Planning Act 1990 Section 106 payment cover?
It is a legal agreement for planning obligations to gain planning consent (e.g. affordable housing, new school, infrastructure costs).
What is affordable housing?
For those whose incomes are insufficient to allow them to buy or rent a home on the open market.
Social or intermediate (rented by a registered social landlord or shared ownership).
Where is the percentage of affordable housing requirement for a new development set out?
Local Authority planning policy.
What does Section 278 cover?
Payments for Highway works.
What other planning costs should be factored in?
Planning application fees
Building regulations
Planning consultant
Environmental impact assessment
Other specialist reports required
What sources can be used to estimate build costs?
Client information
SPONS
QS/BS Estimate
BCIS - is usually based on GIA basis (BCIS obtains monthly updates from QS/BS sources and recent tenders agreed)/
What is the usual percentage of total construction costs for professional fees?
10-15%
What professional fees are included?
Architect
Structural Engineer
CDM Principal Designer
What level of contingency is usually appropriate?
5-10% of total construction costs
What marketing cost is usually appropriate?
1-2% GDV sale
10% initial annual rent
EPCs
NHBC residential warranty schemes
What developer’s profit is usually used?
15-25% of GDV or total construction cost
When may a lower return be required?
If a scheme is low risk e.g. already sold or pre-let
What happens to the percentage of profit required in risky market conditions?
Goes up
How is the finance interest rate chosen?
LIBOR (variable lending rate between banks plus premium)
Bank of England Base Rate plus premium
Rate at which client can borrow money
Swap rate agreed with developer’s bank
ALSO ARRANGEMENT FEE
What are the three elements for finance?
- Site purchase (and costs) - compound interest on a straight line basis.
- Construction - s curve interest taking half costs over length of build programme.
- Holding costs to cover voids until disposal - compound interest on straight line basis.
What is the principle of there S curve when calculating finance required for the construction period?
It reflects the incidence of costs when monies are drawn down.
Payment of construction costs adopts the profile of an S curve over the length of the project.
Halve the interest that would be borrowed for all the construction period.
What are the two main methods of development funding?
- Debt finance - from bank/other institution.
2. Equity finance - selling shares in company or joint venture partnership, or own money used.
What is the current LTV?
50-60% due to current lending restrictions
How is interest calculated within development finance?
On a rolled up basis (compound).
Added to loan as project proceeds.
What is the first level of debt borrowing and takes precedence over any mezzanine/secondary funding?
Senior debt
What can be used to obtain additional funding over the normal LTV?
Mezzanine funding from another source.
What is a forward sale?
Where a completed scheme is pre-sold to wither an investor or occupier to fund the development.
What is the arrangement made for sharing of any extra receipts over and above the original expected profits?
Overage (also known as claw back).
What is the term used to describe the length of time it would take for the development profit to be eroded by holding charges following completion?
Profit erosion period.
What are the limitations of the residual methodology in relation to financial modelling?
- Requires accurate information.
- Does not take into account timing of cash flows.
- Very sensitive to minor adjustments.
- Implicit assumptions hidden (not explicit like DCF).
ALWAYS CROSS CHECK WITH A COMPARABLE SITE VALUATION IF POSSIBLE.
What is required for key variables such as GDV, build costs and finance rate to show a range of values?
Sensitivity analysis
What are the three forms of sensitivity analysis?
- Simple sensitivity analysis of key variables.
- Scenario analysis - development content/timing/costs such as phasing scheme or modifying design.
- Monte Carlo simulation - probability theory using software such as Crystal Ball.
What RICS VIP is relevant to development appraisals?
VIP No. 12 - The Valuation of Development Land
What does VIP 12 cover?
The entire process:
- Establishing the facts
- Assessing the development potential
- Valuation by comparison method/residual method
- Assessment of MV of proposed development on completion.
- Assessing development costs.
- Assessing site value.
- Reporting the valuation
What does VIP 12 state should be included when reporting?
- Comment on costs and contract procurement.
- Viability of proposed project.
- Assumptions and sensitivity in the residual calculation.
- Implications of contract/cost over runs.
- A reflect of market conditions at the time of valuation.
