Viability and development economics 5 th and 6 th June

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

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)

Shinfield - Competitive Return “I am not convinced that a land value that equates to the EUV/CUV would provide any incentive to the landowner to sell the site…There would be no incentive to sell the land…I do not consider that the appellants would be a willing vendor…the Council’s valuation witness...stated that a landowner should be content to receive what the land is worth, that is to say the site value…If a site is not willingly delivered, development will not take place. The appellants, rightly in my opinion, say that this would not represent a competitive return.”

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 S106 Etc. Fees Design Engineer Sales Etc. Profit Landowner Developers Builders Land Existing / Alternative Use Value + premium (TLV/EUV+) Policies/CIL CIL, affordable housing, CfSH, open space etc.

Overview of the HDH simple viability model

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.

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)

Rents, Yield and Capital Value Yield = Rent / Value x 100 (%) Years Purchase (YP) = 1/Yield Value = Rent x YP Factors influencing yields for commercial property: covenant (how strong is the tenant - Will they pay their rent on time and stay solvent?), location, the building itself, upward only rent reviews in the lease etc.

Rent to Value Table 5.1 Capitalised typical rents £/m 2 Rent£/m2YieldCapitalised Rent £/m2 Large industrial417.0%586 Small industrial487.0%686 Distribution506.0%833 Large office936.5%1,431 Small office1007.0%1,429 Large retail - Convenience1305.0%2,600 Large retail - Other1207.0%1,714 Small Retail1057.0%1,500 Leicester Shops2367.0%3,371 Other Shops %1,364 Hotels 6.5%2,150 Student Halls 6.5%2,225 Leisure758.0%938

Yield Exercise