What is the latest RICS guidance on development?
RICS Guidance Note – Valuation of development property, 2019
- IVS 410 – for secured lending purposes, you should always adopt both a residual and comparable approach
What is the difference between a development appraisals and a residual valuation?
· Development – assesses the viability or profitability of a development
· Residual – used to calculate the land value, i.e. the amount that could be paid for property/land based on a specific development at a given profit level
How do you calculate GDV?
Sales values x no. of units
assessed based on market comparables using an appropriate valuation method, e.g. comparable method for a residential dwelling or the investment method for an office or shop which is to be let out. “
When would you use profit on cost and profit on GDV?
· Profit on cost – for higher risk developments, such as those by small housebuilder
· Profit on GDV – used by big house builders as less risk - used by larger housebuilders
* MV of completed development
* MR/ARY
* Value at current date
* Purchasers costs deducted
DA Process
- Calculate GDV
- Less:
o Site price
o Planning
o Construction Costs
o Prof fees
o Marketing and agents costs
o Finance
o Purchasers costs - = Developers profit (on cost/GDV)
Development Costs
- Site value (if known)
- Site Prep – Demolition/remedial etc – Case specific £150-200
- Planning costs – S106/CIL/affordable housing/cost to progress planning from outline to Reserved Matters
- Building costs – (BCIS/Building Surveyors/Quantity surveyor)
- Prof fees – 10-15% of total construction costs (architects fees – 4%) – prof fees will come down if big resi scheme.
- Legal fees
- Contingency – 5%-10% of total construction costs
- Marketing costs
- Agents fees – 1% for sale-10% for letting
- Developers profit (possibly) – 15-20% on cost/GDV – risk based
- Finance – 7-8% - based on market at the time
o 5-6% is a blended rate made up of debt and equity (60/40 split)
o Debt = not cheap at the moment base rate 5.25% + premium from bank so 9% / Equity = more expensive @ 7-8%.
o Also includes the costs of arranging debt financing – e.g. arrangement fees, monitoring fees and exit fees
Development Finance
Client may have specific loan facility, comparable scheme
Types:
* Equity (selling shares or a JV) / debt (bank or financial institution) – 50% LTV for developments
* Senior debt finance (first level of debt – takes precedent over mezzanine funding)
o Interest on mezz funding would be higher (riskier)
* Mezzanine funding (additional funding over normal LTV – private equity)
* Junior
4 ways to calculate development finance rate:
* Bank of England Base rate + premium – 0.75%
* 6 month LIBOR + premium – 1.94%
* 10 year gilt + premium - 0.711%
* Client specific borrowing rate (might have agreement with bank)
- General finance rates at 2023 9%
Profit erosion
length of time it would take for your profit to entirely erode due to holding charges following completion (i.e. interest payments or empty rates).
Overage
Arrangement made for sharing any extra receipts received over and above profits expected in pre-agreed formula.
Sensitivity Analysis
- Simple – key variables – GDV, build costs, finance
- Scenario – timing, costs, phasing
- Monte Carlo Simulation – probability theory
S Curve / Finance
- Interest on finance is rolled up, compound basis, interest starts low and then builds up – OCC – opportunity cost of capital
3 elements for finance:
1. Site purchase – compound rolled up – straight line
2. Total construction costs – S-curve – adopts full costs over half time period
3. Holding costs – cover voids – straight line
Finance for borrowing money to purchase land – calculated on a straight line basis over length of development period. Rolled up method, meaning interest builds up and up and you pay it off in one lump sum at the end. S curve adopts profile of payment of construction fees
Performance Metrics
- IRR
o Used by large housebuilders – typically target 15-16% - NPV
o In order to hit an NPV of zero, your IRR needs to have been met (i.e. you will have had to have hit your required rate of return). Therefore anything above zero is surplus profit.
Choice of Profit on Cost vs Profit on GDV
- Commercial – commercial developer’s risk often lies in the construction. They typically pre-let buildings which takes the risk out of the GDV element.
- Resi – resi developer’s risk often lies in the sale of their houses (how many can they sell, how much for etc). Their costs don’t vary dramatically because it is all done in-house.
Affordable Housing
- AH is purchased by Local Authorities or Registered Providers
- Different types:
o Shared Ownership – where someone purchases a % of the property value and then pays rent on the rest
o Intermediate Tenure – homes for sale or to rent at a discount to market value
o Social Rent – bottom of the rung.
o Affordable Rent – rent that is capped at 80% of MR
When might the developers profit be lower than normal?
When the scheme is very small and not many houses are being built or when a high percentage of the properties on the site are affordable housing units and they therefore do not have the uncertainty of them.
What is the typical amount for developers profit?
Between 15 and 25% of GDV or total construction cost, depending on the risk of the development. GDV more frequently used as a base for residential use. Percentage of profit required has risen recently given the riskier market conditions.
How much would you deduct for fees?
10-15% plus VAT of total construction costs for architects, M&E consultants, project managers, structural engineers. A lower % would be appropriate for a large project.
How much would you deduct for contingency fees?
Say 5-10% of total construction costs depending on the level of risk and likely movements in building costs.
What do you consider when calculating the build costs?
Site preparation, demolition, remedial works, landfill tax, provision of services, site clearance, levelling, fencing. Obtain contractor’s estimates for these.
- Planning costs, S.106 payments, CIL, planning policy e.g. level of affordable housing, S.278 payments for highway works, planning application fees, building reg fees, planning consultant, environmental impact assessment.
- Building costs, estimate total cost of building works using Spons, QS estimate, BS estimate, BCIS (based on a GIA basis, updated monthly from QS/BS sources and recent contract prices/tenders agreed).
107) How much would you deduct for marketing costs and fees?
I would use evidence/quotes. Cost of an EPC, NHBC warranty. Normal sale fee around 1-2% of GDV. Normal letting fee around 10% of initial annual rent.
What might the developer need to borrow the money for?
- Site purchase (compound interest on a straight line basis)
- Total construction costs (calculation based on a S-Curve taking half of the costs over the length of the build programme)
- Holding costs to cover voids until disposal of the scheme, empty rates, interest charges (compound interest on a straight line basis).
What are the two main methods of funding?
- Debt finance (borrowing money from a bank or another funding institution)
- Equity finance (selling shares in a company or joint venture partnership or own money used).
Assume 100% debt finance.
What are the limitations of the residual method?
- Importance of accurate information and inputs
- Does not take into account the timing of cash flows
- Very sensitive to minor adjustments
- Implicit assumptions hidden and not explicit (unlike a DCF)
Is VAT payable on Prof fees
Yes
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