Session 2: The role of viability in plan-making and development management

A Development Viability Appraisal Income Costs Cash flow

Key Inputs - GDV Gross development value (GDV) The income from the development Sale of product Subsidy and grant. Expressed as £/m 2 Set by the market and largely beyond the control of LPA or developer

Key Inputs - Cost of development –Construction Costs (BCIS) –Site Costs –LPA ‘discretionary’ costs e.g. CfSH, Affordable Housing, CIL, s106 etc. –Abnormal Costs e.g. Flood defences, Grouting, Demolition, Contamination etc. –Fees i.e. Architects, Planning, Engineers –Finance i.e. Interest, Fees, Legal and valuation –Sales i.e. Agents, Advertising –Contingency and Profit

Key Inputs - Profit To reflect risk Reward Cost of Capital On GDV or on Cost?

Profit On GDV or on Cost? Two schemes, A and B, each with a GDV £1,000,000 A has a development cost of £750,000 B a lesser cost of say £500,000 All being equal in the schemes the developer stands to lose £750,000 in scheme A, but only £500,000 in B. A is therefore more risky, it follows that the developer will wish (and need) a higher return. By calculating profit (at 20%) on costs, the developer’s return in scheme A would be £150,000 and in scheme B would be £100,000 and so reflect the risk – whereas if calculated on GDV the profits would be £200,000 in both.

Profit On GDV or on Cost? Not trying to recreate a particular model. In fact risk and profit are more complicated. Profit Return on Capital Loan to value (LtV) of funding Contingency fund Development risk Bankers security / risk / confidence A pragmatic approach

Phasing and Developer’s Return Why are developers obsessed with build rates and phasing? Return on Capital employed…

Return on capital employed (ROCE) A measure of the level of profit relative to level of capital required to deliver a project. Developments of large flatted blocks on previously used land in urban areas with high cash requirements will demand significantly higher levels of profit to achieve an acceptable ROCE than developments of a more standard, less cash intensive nature on virgin ground.

Effect of phasing

Dead Romans found in foundations….

English Heritage get involved…

How much equity at risk and what is the return on that?

Internal Rate of Return – IRR The rate of interest (expressed as a percentage) at which all future cash flows (positive and negative) must be discounted in order that the net present value of those cash flows, including the initial investment, should be equal to zero. It is found by trial and error by applying present values at different rates of interest in turn to the net cash flow. It is sometimes called the discounted cash flow rate of return. In development financial viability appraisals the IRR is commonly, although not always, calculated on a without- finance basis as a total project IRR. (RICS Guidance)

Net developable area versus gross site area In all but the smallest redevelopment schemes, the net developable area (i.e. income generating land) is significantly smaller than the gross area that is required to support the development, given the need to provide open space, infrastructure etc. The net area can account for less than 50%, and sometimes as little as 30% on larger sites, of the site to be acquired (i.e. the size of the site with planning permission). Failure to take account of this difference can result in flawed assumptions and inaccurate viability studies. Gross area Net developable area

Strategic infrastructure and utility costs Cost indices (such as the BCIS) rarely provide data on the costs associated with providing serviced housing parcels, i.e. strategic infrastructure costs which are typically in the order of £17,000 - £23,000 per plot for larger scale schemes.

Key Inputs – Land Value The worth of the site Alternative use value When assessed – before planning starts Hope value Competitive Return (Relates back to the ‘big question’) A life changing event? – Not what they paid!

Harman v RICS Harman: We recommend that the Threshold Land Value is based on a premium over current use values and credible alternative use values. RICS: Threshold land value. A term developed by the Homes and Communities Agency (HCA) being essentially a land value at or above that which it is assumed a landowner would be prepared to sell. It is not a recognised valuation definition or approach.

Harman v RICS “It is somewhat misleading to describe this approach (EUV plus a margin) as totally arbitrary. The market value approach on the other hand, while offering certainty on the price paid for a development site, suffers from being based on prices agreed in an historic policy context…I don’t believe that the EUV approach can be accurately described as fundamentally flawed or that this examination should be adjourned to allow work based on the market approach to be done.” Report to The Mayor of London” Keith Holland BA (Hons) DipTP MRTPI ARICS (Jan 2012)

A Pragmatic Viability Test EUV Plus a premium – reality checked against market value. Will EUV Plus provide competitive returns? Land owner’s have expectations (life changing?) Will land come forward? PAS SUPPORT THIS APPROACH

Gross Development Value All income from a Scheme Construction Site Remediation Abnormals Etc. Fees Design Engineer Sales Etc. Profit Developers Builders Land Existing / Alternative Use Value + premium (TLV/EUV+ ) Policies/CI L CIL, affordable housing, CfSH, open space etc.

Using the model in practice The model used on this course is a basic residual method based on a residential scheme. In practice you will be faced with more complex scenarios such as: Mixed use schemes incorporating commercial - therefore you’ll need to grasp what a ‘yield’ is. Alternative or more complex viability models e.g. Internal Rate of Return (IRR) based models Valuation is a 3 year degree on its own, but you need to be able to interrogate the evidence provided to you.