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Development appraisals Flashcards

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1
Q

What is the difference between a development appraisal and a residual valuation?

A
  • Development appraisal: establish the viability/profitability of a proposed development using a client’s inputs
  • Residual valuation: establish the market value of a site using market inputs
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2
Q

What is the methodology for calculating residual site value (5 steps)?

A 
Gross development value (GDV) 
- Total development costs (TDC) 
= Gross site value
- purchasers' costs 
= Residual site value
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3
Q

What costs would you allow for as part of total development costs (8)?

A
  • Site preparation
  • Planning costs
  • Building costs
  • Professional fees + VAT
  • Contingency
  • Marketing costs & fees
  • Finance costs
  • Developers profit
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4
Q

What would be included in your estimate for site preparation costs (7 potentially) and how would you estimate them?

A
  • Demolition, remediation works, landfill tax, site clearance, levelling, fencing and provision of services.
  • Obtain a contractor’s estime for these works
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5
Q

What would be included in your estimate for planning costs (5 always, 2 potentially)?

A
  • Section 106 payments under the Town and Country Planning Act 1990
  • Community Infrastructure Levy (CIL) charged by most Local Planning Authorities
  • Section 278 payments for highway works
  • Planning application and building regulation fees
  • Costs of planning consultants
  • Cost of any specialist reports required by the LPA (e.g. Environmental Assessment)
  • Required percentage of affordable housing for a new residential development in the form of social, intermediate and key worker housing
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6
Q

What is the calculation for estimating building costs and what 5 sources of information could you use?

A

Gross internal floor area multiplied by cost per square metre (to estimate total cost of building works)

  • Client information
  • Spons Building Costs book
  • Quantity Surveyor estimate / bill of quantities / cost estimate
  • Building Surveyor estimate
  • RICS Building Cost Information Service (BCIS)
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7
Q

What basis are the costs on BCIS usually expressed? Where does RICS obtain the information from?

A
  • Usually based on a GIA basis

* Obtain monthly updates from Quantity Surveyors / Building Surveyors and recent contract prices / tenders agreed

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8
Q

What would be included in your estimate for professional fees (5 potentially, which is largest proportion) and how would you estimate them (typical % range based off figure, why varies)?

A
  • Architects (largest proportion), M&E consultants, project managers, structural engineers, quantity surveyors
  • Typically 10-15% (plus VAT) of total construction costs
  • Can vary them depending on the complexity of the project e.g. lower architects fees required for an industrial warehouse than a high-rise residential building
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9
Q

What would you typically estimate for contingency costs (typical % range, dependent on what)?

A

5-10% of total construction costs (depending on the level of risk and likely movements in building costs)

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10
Q

What should you source for your marketing budget, and would be included in your estimate - fixed costs (2, 1 for resi) and fees (2, think agency types, % range based off what figures)?

A 
Marketing budget (use evidence/quotes):
• Cost of an EPC
• Sales fee: 1-2% of GDV
• Letting fee: 10-15% of Market Rent
• National House Building Council (NHBC) warranty for residential schemes
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11
Q

In your residual financial calculation, what LTV is assumed, what is the typical development finance rate range, and what are the usual reference rates to calculate the interest rate applied (3 possibilities)?

A

 Loan-to-value assumed: typically 100% on valuation versus actual scheme specifics
 Typical development finance rates say 5-7%

 Choice of interest rate can include:
• LIBOR (London Inter Bank Offer Rate which is the variable lending rate between banks for a three-month borrowing term) plus the premium to reflect interest rate which is available.
• Bank of England Base rate plus premium
• Rate at which the client can borrow money. (A swap rate agreed with the developer’s bank.)

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12
Q

What are the 3 elements for residual finance i.e. ‘the developer needs to borrow money for the…’ (think 3 phases), and how are they calculated?
+
How is interest calculated/on what basis/over what period for each?

A
  1. Finance for borrowing the money to purchase the land (site purchase + purchaser’s costs): calculated on a straight-line basis over the length of the development period. Rolled up method of calculation is used (compound interest).
  2. The finance required for the construction period = assume total construction costs (including fees) over half of time period using a ‘S’ curve calculation (=50% of actual time)
  3. Holding costs to cover voids until the disposal of the scheme (empty rates, service charges and interest changes) – compound interest on a straight-line basis
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13
Q

What holding over costs need to be accounted for after the development is completed (3), until the disposal of the scheme?

A

Empty rates, service charges and interest charges

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14
Q

What financing arrangement does the development appraisal process assume?

A

100% debt finance

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15
Q

What does the S curve principle assume for total construction costs, and what is it therefore reflecting?

A
  • The usual assumption is to halve the interest that would be borrowed for all of the construction period i.e. assumes that total constructions costs + fees are paid over half the time period
  • Reflects when monies tend to be drawn down - lower levels of expenditure at the beginning and end of projects
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16
Q

What is the typical % range for developers profit, on what 2 potential bases, and what % range would this be for consented or non-consented sites?

A

15-20% of total construction costs or GDV (GDV more frequently used as a base for residential use)

Consented sites will typically have a profit on cost of 15-20%. Non-consented sites will have 20-25%, depending on how it complies to local policies and whether they’d had a positive pre-application

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17
Q

How is the main influence/what does developers profit depend on, when may it be lower, and what is the current trend?

A
  • Depends on the level of risk
  • If scheme is low-risk (or pre-let / sold) a lower return may be required
  • Current riskier market conditions means the percentage of profit required has risen
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18
Q

How should you verify the output of a development appraisal?

A

Cross check site value with comparable site sales if possible

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19
Q

When conducting a residual site valuation, what date should the inputs be taken from?

A

Taken at the date of valuation

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20
Q

What are the two main methods of development finance?

A
  1. Debt finance: lending money from a bank or other funding institution
  2. Equity finance: selling shares in a company, JV partnership, own money used, forward purchase from an investor or occupier
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21
Q

What is a typical loan to value (LTV) ratio, and how is interest typically calculated over the course of a project?

A

c. 60%

Interest is calculated on a rolled-up basis – i.e. added to the loan as the project proceeds

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22
Q

What are the 3 (potential) capital stacks (debt) used in development financing, and what is the riskiest/least risky/because of what arrangements?

A
  • Senior debt: takes precedence over other sources of funding. If the borrower defaults, the lender can take ownership of the property
  • Mezzanine finance: will sit below the senior debt in terms of priority. Typically has a higher rate of return than senior debt but lower than equity
  • Equity: riskiest and most profitable portion of the capital stack. Riskiest as the other tranches of capital will be repaid before the equity holders
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23
Q

When would you use mezzanine financing?

Study These Flashcards
A

Funding for additional monies required over the normal LTV lending

24
Q

What are swaps and how are they used?

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A

Form of derivative hedging for interest rates. Swap rate will be the market rate for a fixed rate, fixed term loan

25
What is overage (also known as Clawback), and what 2 parties usually share it?
Arrangement for the sharing of any extra receipts received over and above the profits originally expected, as dictated by a pre-agreed formula Usually shared between vendor/landowner and developer in a pre-arrangement apportionment
26
What is the profit erosion period/what is it measuring?
Length of time it takes for the development profit to be completely eroded, due to empty rates, service charges and interest costs, following the completion of the scheme
27
What are the limitations of the residual valuation methodology (5)?
* Dependent on accurate information and inputs * Does not consider timing of cash inflows * Very sensitive to minor adjustments * Implicit assumptions hidden and not explicit * Assumes 100% debt finance
28
What variables would you typically conduct a sensitivity analysis on (3)?
* GDV * Build costs * Finance rate
29
What are the THREE forms of sensitivity analysis?
1. Simple sensitivity analysis - of key variables e.g. yield, GDV, build costs and finance rate 2. Scenario analysis - changing scenarios for the development content/timing/costs such as phasing the scheme or modifying the design 3. Monte carlo simulation - using probability theory with software such as Crystal ball
30
What guidance did the RICS release on valuing development property?
RICS Valuation of development property, 2019
31
How is development property defined in RICS Valuation of development property, 2019?
Interests where redevelopment is required to achieve the highest and best use or where improvements are either being contemplated or are in progress at the valuation date
32
According to RICS Valuation of development property, 2019, what should Market Value for a development property assume?
Optimum development i.e. the development which yields the highest value, taking into account the prospective economic and planning conditions
33
What does RICS Valuation of development property, 2019 state about the use of multiple valuation approaches?
Best practice avoids reliance on a single approach or method of assessing the value of development property Output should always be cross-checked using another method (market comparison approach, residual method)
34
What method does the RICS Valuation of development property state should be used for complex and/or lengthy development schemes?
Discounted cash flow (DCF) technique. Simple residual method can be used in other cases
35
Why does RICS Valuation of development property, 2019 recommend that risk analysis should be used/to show what, and what should be explicitly stated in the valuation report?
* Risk analysis should be used to show changes to the inputs which might affect the valuation * Risk and return levels and assumptions should be explicitly stated in the valuation report
36
How should you value land that is in the course of development according to RICS Valuation of development property, 2019 (and/or)?
• Value of the land + costs expended at the valuation date and/or • Completed development value - costs remaining to be expended at the valuation date
37
How should the output of the valuation be reported according to RICS Valuation of development property, 2019, and except for in what circumstances?
Reported as a single figure, except where there is potential for significant variation (e.g. if there is uncertainty around the valuation the different options identified should be report)
38
Why is profit on cost a more reliable method of measuring developers profit than profit on GDV?
GDV is subject to more variation
39
What financing rate would you typically assume when running a residual valuation (dependent on what, and what is the current trend)?
Depends on the risks associated with the site. Typically this would be around 5.5% but are likely to increase to 6% or more given the current uncertainties in the debt market
40
If you were to conduct a residual valuation now, how would you approach it differently in light of the current circumstances (increase what 3 things)?
* Increase your contingency to reflect uncertainties in material costs * Increase the timescales to reflect that it would take longer for you to get on site. * Increase finance costs as cost of debt has increased
41
What is GDV, what method/yield is usually used to calculate, what costs are typically deducted, and why is it gross?
o Market value of completed proposed development at today’s date / date of valuation o Comparative method of valuation used to establish rent and yield o All Risks Yield used o An allowance of a rent-free period or tenant’s incentives and marketing void can be assumed if appropriate o Purchaser’s costs are usually deducted for commercial property valuations States gross as it is prior to any marketing fees being deducted
42
What do developers consider the greatest risk when undertaking a development?
Planning permission
43
How did you use special assumptions in your residual valuation approach?
GDV was the aggregate market value of the proposed development, assessed on the special assumption that the development is complete on the date of valuation in the market prevailing conditions
44
What are S106 agreements, at what point must they be agreed, what tests/how must Local Authorities justify the items required, what 2 actions can the LA request of a developer, and what are 3 typical examples?
Planning obligations set out in legally binding agreement enforceable by the LPA, site specific impact related only. Agreement must be made prior to granting planning consent. They relate to community gain, and LPA can only request items on a case-by-case basis that meet the 3 legal tests of necessity - direct relationship to development, fair and reasonably related in scale and kind of development. LPA can request either specific works or financial contribution towards LPA. Examples include (cost) contribution to school construction, community facility or open space.
45
What are the differences between CIL and S.106 planning obligations in terms of scope and setting charging levels, and why were CILs introduced?
Scope - CILs cover all infrastructure necessary to support development of the area (and cannot be used to secure affordable housing) and S106 covers only items justifiable if they are necessary, directly related to the development and reasonably related in scale and kind to the development in accordance with 3 legal tests. Setting charging levels - CILs are calculated on a tariff basis (floor area) and S.106s are by negotiation. Aim of CILs is to reduce the considerable negotiations required to complete a S106 agreement, and standardise and speed up the planning approach with viability testing.
46
What are typical examples (3) of what the proceeds of CIL and S106s can be used to contribute towards?
Roads and transport facilities Flood defences and open spaces Schools/educational facilities, medical and sporting facilities.
47
When/for what is the residual method used?
• The Residual method is used to value land and properties with o development, redevelopment and refurbishment potential o when it is not possible to value by comparison
48
How do you establish site value (broadest calc), and what cross check should you undertake?
o Deduct the total development costs from the GDV to establish the site value having allowed for normal purchasers costs o Cross check the site value with a valuation of comparable site values if possible
49
What is VAT payable on in a residual valuation?
Remember VAT is payable on all professional fees
50
What 2 ways can developer's profit be calculated, and what are the % ranges for each?
Can be calculated by either a percentage of total cost (22% to 25%) or a percentage of gross development value (15% to 17%)
51
What is Gross Residual Value?
At the end of the development period and discounted at the cost of finance.
52
What are the final acquisition costs for a residual?
Comprise 1% agent’s fees, 0.75% solicitor’s and other fees and, stamp duty land tax (which in this case is 3%). If the site value is “x” Gross Acquisition Costs - 0.0475x = x Gross Acquisition Costs = 1.0475x x = Gross Acquisition Costs / 1.0475
53
What documents form part of a planning application?
Application document, certificate of land ownerships, planning application fee, drawings/plans, D&A statement if major development. Then potentially phase 2 environmental, listed building consent etc.
54
What timescales can affect an appraisal?
``` Length of build period. Holding costs (letting time erases profitability). ```
55
What are the limitations of argus? What are the limitations of excel?
argus is difficult to model different types of finance. Excel cashflow and finance is difficult and excel is more sensitive.
56
What are the limitations of BCIS?
Based on cost averages so problem if limited number of other schemes. Based on historical data so may be out of date Doesn’t account for nuances of development site
57
Why use profit on cost instead of profit on GDV?
PoC is based on Build costs which are set in earlier time. Unknown market fluctuations for GDV.
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