1 The role of viability in decision making Anthony Lee

2 Agenda  Why viability is now so important in planning decisions  Basic principles  How does a developer use an appraisal  What is included in an appraisal  The main appraisal tools  Validating an appraisal and how appraisals can be distorted  Future proofing Section 106 agreements  What will be different under CIL?  Appeal decisions and viability  Discussion

Why viability has become so important  Pre-2008 – assumption that values would keep going up  Developers and banks were getting lazy – taking a view on viability  Viability and deliverability of schemes is under pressure  Sales values have fallen  Selling houses has become more difficult (choice; mortgages)  Potential planning obligations pot has got smaller  Development finance more difficult to secure  Grant funding for affordable housing drastically reduced  Landowners have not yet adjusted to new market reality  Moving away from negotiated S106 to fixed CIL – viability impact

4 The purpose of a financial appraisal to a developer Prior to site purchase How much should I pay for site?  Density & No of units  How much will scheme cost?  What profit do I require?  How much do I need to borrow?  How much will it cost to borrow?  What will I receive for flats?  How much is left to pay for the land?  Submitting bids  Weighing competing options After site purchase Is development on track?  Land cost  Scheme cost  Finance costs  Predicted receipts from sales  What is my outturn profit?  Speculative purchase vs  Purchase with planning

5 Why are planners interested in scheme finances?

6  Potential for land value capture  Securing affordable housing without public subsidy  Enables RSLs to purchase stock from developer at a discount Paying to mitigate the harm of the development  Funding for or direct provision of community infrastructure

Viability in planning: the basics Value uplift ‘created’ by grant of Planning Permission

8 What information does an appraisal generate? Affordable Private RESIDUAL LAND VALUE

A basic residual appraisal

Establishing a site’s benchmark land value  A positive residual value is good, but is it enough for landowners?  Factors to consider in establishing benchmark land values (1) previously developed land:  What is the land worth in its current use?  Is there demand for the current use?  Are rents low?  Is tenant financially stable and likely to stay  Rent and yield approach  Floorspace: Say 10,000 sq ft  Rent: £5 per sq ft  Yield: 10% (equates to 10 times the rental income)  Capital value: Rent x floorspace x yield = £500,000  Add premium/landowner return – say 10% = £550,000

Benchmark land values  Factors to consider in establishing benchmark land values (2) greenfield sites:  Low value in current use (agricultural value c. £20k per ha)  Farmers unlikely to sell for development at this level  ‘Life changing sum’  Yard-stick of 15 to 20 times current use value  Suggests value of £300k to £400k per ha  BUT this is not a definitive minimum threshold land value!

14 How scheme viability is determined Residual land value with given level and mix of affordable housing and other planning obligations Scheme is viable

15 How scheme viability is determined Residual land value with given level and mix of affordable housing and other planning obligations Scheme is unviable Falling sales values

16 Appraisal models  Three Dragons Toolkit  Static model with fixed development period  Simple to use  Contains ‘benchmark’ values  Free to LPAs (everyone else pays £150 per annum)  HCA ‘Economic Appraisal Tool’ and ‘Development Appraisal Tool’  User can define development period and timings  Cashflow backed  No benchmarks – relies wholly on user inputs  Free to download from HCA website  Circle Developer  ‘Gold standard’ valuation model  Used by valuers for secured lending valuations  Full cashflow  No benchmarks  Not user friendly – lots of training required  Expensive licence-based access

17 What is an appropriate land value?  Purchase price  Transparent and measurable (normally publicly available)  Was it an appropriate purchase price at the time?  Did it anticipate future growth in sales values?  Competition for land – only those who ‘took a view’ bought sites  Value of alternative uses is also clearly a consideration  Current use value  Acts as a ‘fallback’ position if developer fails to achieve consent  Incentive to the landowner for bringing the site forward  EUV at time of site purchase? Or now?

18 Validating an appraisal  Working with advisors to validate appraisal  Sales values – comparable evidence  Commercial rents / yields – comparable evidence  Profit level – profit on what? Before or after finance?  Is profit rate assumed a proper reflection of risk?  Is finance rate reflective of type of developer and risk of scheme?  Professional fees – reflective of complexities of scheme?  Current use value – realistic assumptions on rents, yields etc  Affordable housing value – RSL offer / valuation – optimum value?  Sensitivity testing – what ifs?  Sales values + / - %  Build costs + / - %  Grant / no grant….

19 How an appraisal might be distorted  Falsely inflated Current use value  Inconsistency in assumptions used for EUV and scheme  Alternative use value with no prospects of securing planning  Sales values below realistically achievable level  Comparables not truly comparable (quality, location, height etc)  Relying on Three Dragons Toolkit affordable values  Build costs too high / over-generous contingencies  Double counting (eg fees in build cost plan and in appraisal)  Development timescales too long or skewed  Flows of income not properly reflected (esp Affordable Hsg)  A combination of the above  Small differences in appraisal variables have big impact

20 Negotiating a ‘deal’  Appraisal result is rarely ‘the’ answer  Always scope for movement on both sides  Needs to be attractive to bank (and investor) to fund  Developer needs to see a reasonable prospect of a profit  Where might the development be in the future?  Helping both sides to ‘take a view’  Flexible S106 agreements are helping

21 Flexible application of policy “Clark urges councils to re-negotiate unviable S106 agreements” 23 March 2010 Is this the answer to shortfalls of affordable housing? How can LPAs respond?

Resolving viability issues (1) Reduce S106 Affordable Private

Affordable Private Resolving viability issues (2) Reduce affordable

Resolving viability issues (3) Reduce land value Affordable Private

25 In return, LPAs should share the upside  Flexible application of policy requirements  Deferred obligations / Contingent obligations  Single phase and multi-phase schemes  Trigger points  What is the shelf life of a review?  Caps and collars  Catch-up clauses  Cascades  Fountains

26 What will be different when CIL is in place?  CIL Regulations April 2010 (as amended)  Differential rates permitted (by area; type of development)  Balance between maximising revenue and financial viability  Affordable housing relief  Exemption on proven viability grounds if providing equivalent S106  To be paid in instalments  Intended to operate as fixed charge  Implication is that Affordable Housing will have to flex  Applies to net additional floorspace – what is ‘occupied’?  Certainty for developers on amounts payable when bidding  LPAs may find themselves in same ‘balancing’ role as now

The RICS viability guidance and decision making  Current convention: compares scheme value to current use value of site (plus an appropriate margin)  RICS GN suggests “Market Value”  Issues:  Market value arrived at through comparables  Potential overpayments/hope value  How comparable are the other sites that the MV is based upon?  May leave little scope to secure affordable housing  Potential circular argument if basing MV on residual approach  RICS argue their approach recognises the market  Current Use Value approach will frustrate delivery  But Planning system seeks to influence the market – see Mayoral CIL examiner’s report

RICS Guidance Note on viability  So is it helpful in its current form?  Yes – for developers – Market Value benchmark  Yes – for valuers – hours of debate on “Market Value”  No – for LPAs – fails as a practical manual  No – for Inspectors – no ranges of guidance on inputs  Assumes land values cannot fall and planning must compensate  Does it enhance deliverability of schemes?  No – lower planning obligations but higher land payments  Departs from conventional approach to viability testing  Resistance to housing schemes from communities  Less local approvals and more appeals

29 Planning Inspectorate’s perspective on viability Guidance emerging from appeal decisions  Flanders Way, Godalming (Waverley Borough Council)  Nether Street (LB Brent)  Jericho Canalside (Oxford City Council)  Lesney Toy Factory (LB Hackney)  Croydon Road (LB Croydon)  Commercial Road (LB Tower Hamlets)  Ram Brewery (LB Wandsworth)  Goldhawk Road Industrial Estate (LBHF)

30 Planning Inspectorate’s perspective on viability Guidance on viability appraisals and ‘cascades’ Flanders Way  Appraisals to be undertaken at time of application  Cannot delay determination until market improves  Review mechanisms not proven to be robust Nether Street  Council and Appellant could not agree Aff Hsg percentage  However, a review mechanism was agreed  Inspector rejected review mechanism (and dismissed appeal)  Circular 05/2005 – UUs only when requirements known  Review offered no certainty that Aff Hsg would be provided

31 Planning Inspectorate’s perspective on viability Guidance on appraisal benchmark (i.e. EUV or Purchase Price) Jericho Canalside  Accepts purchase price as benchmark for appraisal  Price paid was considered to reflect ‘market value’ for land  No evidence that land could have been purchased for less Lesney Toy Factory  Using price paid will affect Aff Hsg delivery if price is too high  Comparable deals not accepted as justification of price paid  Council argued that EUV should be used as benchmark  Inspector agreed; price paid must reflect Aff Hsg requirements

32 Planning Inspectorate’s perspective on viability Zero affordable housing 154 – 160 Croydon Road  Inspector indicates that Policy 3A.10 can include 0% aff hsg  Residual value of site with 35% aff hsg exceeded EUV  No basis therefore for Council’s requirement for 35% 516 – 520 Commercial Road  Appellant’s approach to site purchase reflective of “bubble”  Scheme unviable with or without affordable housing  Removing aff hsg would simply make the loss slightly lower  Aff hsg secured through condition (no undertaking provided)

33 Is there a ‘minimum’ acceptable AH provision? Ram Brewery, Wandsworth (November 2009)  An 11% total provision of affordable housing falls far short of even the lowest level of policy aim…. It is therefore clear that the affordable housing provision that is proposed as part of the 2 schemes does not comply with the aims of LDF Policy IS5 or those of the London Plan. Goldhawk Road, Hammersmith (October 2010)  whilst clearly more [than 6%] affordable housing would be of more benefit, the issue, as set out in the relevant policies, is whether the proposed level of provision is the maximum reasonable amount. I consider the applicant has provided robust evidence to demonstrate that the scheme as proposed would provide this. Planning Inspectorate’s perspective on viability

34 ‘Housing land supply’ approach High Wycombe (May 2009)  Appellant argued that Council would not have a five year land supply if affordable housing required on every site  Inspector thought there was a healthy land supply (historically)  Therefore no urgent need for the appeal site to come forward Banbury Park, Waltham Forest (October 2010)  Viability agreed between parties – scheme currently unviable  Strategic site – too important to allow with only 20% affordable  Council’s own borough-wide study - 20% was maximum viable  Approach adopted in inquiry would destroy land supply Planning Inspectorate’s perspective on viability

35 Conclusions  Needs for affordable housing can never be fully satisfied  Land value capture is not limitless  Schemes create one ‘pot’ of value – how is it shared  Short term capacity to meet all requirements could be limited  Flexible approach will be key to delivery  But – it is not the role of Planning to bail out developers!

36 The role of viability in decision making