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Development Appraisal L2 EP APC Residential 2022 > *Development Appraisals > Flashcards

*Development Appraisals Flashcards

1
Q

Define Development Property?

A

Interest where redevelopment is required to obtain highest and best use or where improvements are being contemplated or are in progress at valuation date.

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2
Q

Define Development?

A

Defined by Town & Country Planning Act 1990:

“the carrying out of building, engineering, mining or other operation in, on, over or under land, or the making of any material change in the use of any building or other land”.

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3
Q

When would you use a Development Appraisal?

A

I would use a development appraisal when I needed to calculate the profit of a client’s proposed development, or offer advice on a proposed development.

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4
Q

Outline the differences between a residual valuation and a development appraisal?

A

Residual = finding residual land value, based on market assumptions.

Appraisal = assessing the profitability of a scheme and are based on client assumptions and market assumptions.

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5
Q

How is residual land value calculated?

A

GDV - (build costs & profit) = Residual Land Value

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6
Q

What are some of the main costs included in a residual?

A

Build Cost
Professional fees
Statutory costs
Marketing costs
Legal costs
Purchasers costs
Agents fees
Contingency

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7
Q

What are the professional fees?

A

Architect (usually highest proportion of fees)
Quantity Surveyor
Structural engineer
Mechanical/electrical engineer
Project manager
C.D. Manager

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8
Q

What are the main components of a residual valuation?

A

GDV
Build Cost
Professional fees
Statutory costs
Marketing costs
Legal costs
Purchasers costs
Agents fees
Contingency
Profit
Residual Land Value
Timescales
Sensitivity analysis

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9
Q

What is profit erosion?

A

The period within which the profit from the development is eroded after completion due to holding charges (i.e. interest charges, building insurance, security and utility charges).

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10
Q

What is IRR?

A

Internal rate of return is a time weighted measure of return.

Internal rate of return is the annual rate of growth an investment is expected to generate.

The higher the IRR the better. Reduce timescales to improve.

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11
Q

What is an S-curve?

A

The S-curve is the pattern of cash flow which I assume the construction costs follow within my Argus Residual Appraisal.

It represents the assumption of how costs are spread across the construction period, with the majority expected during the middle of the construction period.

The purpose is to reflect when monies will be spent.

The interest is expected to follow the same pattern across this period.

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12
Q

What are the limitations to the residual method?

A
  1. The use of assumptions and not real costs.
  2. Assumes 100% debt finance which isn’t realistic.
  3. Small changed to inputs can have a large impact on profit/residual land value.

As per the RICS guidance note: Valuation of Development Property 2019 - you should cross check with the comparable method.

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13
Q

What is the basis of measurement used for the calculation of build costs and where would you find an up to date estimate of such costs?

A

GIA
BCIS (Build Cost Information Service)
Consult a building surveyor

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14
Q

What is a sensitivity analysis?

A

It’s a risk analysis technique, used to presented potential outcomes in changes to key variables.

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15
Q

What are the three forms of sensitivity analysis?

A
  1. Simple sensitivity analysis of key variables i.e. GDV and construction costs.
  2. Scenario analysis - changes scenarios for the development content i.e. changing the phasing of the scheme of its design.
  3. Monte Carlo Simulation - using probability theory, using software such as ‘Crystal Ball’.
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16
Q

What inputs would you vary in a simple sensitivity analysis?

A

i.e. upwards and downwards changes in construction costs and sales rates.

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17
Q

What outputs would you expect to show in a sensitivity analysis?

A
  1. Effect on land value
  2. Effect on profit amount
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18
Q

How would you reflect planning requirements within your valuation?

A

I would enter any S.106 or CIL costs under ‘statutory’ within my valuation. I would also time the cash flow in accordance with the requirements within the CIL liability notice and the S.106 agreement.

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19
Q

What interest rate do you typically use?

A

Typically within my development valuations I assume the project will be 100% debt financed and generate a general market facing finance rate (to allow for comparison purposes and not accounting for developer specific discounts).

Typically I apply 6.5% which includes the Bank of England base rate (0.1%) cost of borrowing and arrangement fees.

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20
Q

Why have you used profit on cost?

A

Reflective of the risks associated with the development and a market facing input I would typical expect given the requirements of developers on similar development projects.

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21
Q

When would you increase contingency?

A

Typically where the development is speculative and in the early stages of planning and therefore higher risk.

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22
Q

Why did you include 10% contingency in your case study appraisal?

A

This was included within the Building Surveyor’s costings.

Understood that it was due to the current difficulty at the time obtaining building materials and the delays in obtaining them.

Also due to the fact that it was a smaller scheme, so 10% on this scheme does not actually translate to much, in comparison to a larger scheme.

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23
Q

What is the likely level of contingency in a development appraisal?

A

Usually 5% to reflect and average level of risk and to provide a buffer for any unknown costs.

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24
Q

What abnormal costs can occur in a development?

A
  1. Ground Contamination.
  2. Ground retention needed.
  3. Piled foundations being required.
  4. Allowances for flooding.
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25
Q

What is the likely level of finance cost in a development appraisal?

A

Typically, I apply 6.5% which includes the Bank of England base rate (0.1%) cost of borrowing and arrangement fees.

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26
Q

What is the likely level of professional fees in a development appraisal?

A

8-10% depending on the stage of the project.

VAT is always payable on professional fees.

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27
Q

What is the likely level of required profit in a development appraisal?

A

20% on cost.

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28
Q

How would profit vary on a scheme of 100 units and a scheme of 1 unit?

A

Might expect a higher profit given the higher risk of increased numbers of units.

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29
Q

How is BCIS information obtained?

A

The BCIS obtains its data from tender cost analysis

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30
Q

What does BCIS information exclude?

A

VAT
Contingencies
Fees
External works and facilitating works.

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31
Q

What are some of the weaknesses of BCIS information?

A
  • Often taken from public sector development which has a reduced specification.
  • Need to account for exclusions within the data.
  • Offers guidance but specific costs of a project can vary.
  • larger housebuilders tend not to submit data, so costs are inflated.
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32
Q

What are the three ways you could calculate the finance rate?

A
  1. Bank of England base rate + premium
  2. Might be provided in client’s loan terms
  3. The LIBOR rate (London Inter Bank Offer Rate) + premium (variable lending rate between banks for a three month borrowing term)

n.b. LIBOR is being replaced with SONIA (Sterling Overnight Index Average) rate by the end of 2021.

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33
Q

What are the main reasons a developer needs finance for?

A
  1. Site purchase
  2. Construction costs & associated costs
  3. Holding costs to cover voids until site is disposed
34
Q

What are the two main methods of funding?

A
  1. Debt finance - taking a loan
  2. Equity finance - selling shares, JV or own money
35
Q

What is the Loan to Value ratio?

A

A ratio expressing the value of the loan in proportion to the value of the property.

Typically LTVs are 60% of value.

36
Q

What are the forms of finance available?

A
  1. Senior debt - first level of borrowing
  2. Mezzanine - additional money required over the LTV
37
Q

If BCIS was limited, how would you deal with this?

A

Rebase to the county instead of LPA.
Consult senior colleagues and a building surveyor

38
Q

What is new build premium?

A

Due to being brand new and never lived in

Apply 10 - 15%

39
Q

How do Land Registry record new build prices?

A

They report on the NET SALES PRICE - as developers will often add incentives such as free kitchen appliances to the sales.

Developers need to complete a disclosure of incentives form to Land Registry.

40
Q

What is a typical IRR for a small development site?

A

30% roughly.

The larger the site, the lower the IRR as far away from getting the money and being in a positive position.

41
Q

What do builders offer purchasers?

A

New build typically have a warrantee of 10 years.

42
Q

What is an NHBC warrantee?

A

NHBC is the UK’s leading independent standard-setting body and provider of warranty and insurance for new homes.

Offers:

  • First 2 years = defects insurance period i..e any faulty products
  • Years 3- 10 = structural insurance period
43
Q

What does the finance rate include? Why 6.5%?

A
  1. Base rate of 0.1%
  2. Entry fees
  3. Exit fees
  4. Risk - what the bank what to get in return for lending.
44
Q

What is a viability assessment?

A

Assess whether the new use is more valuable than the existing use

Residual land value is compared to the benchmark

45
Q

Why can some people borrower at a lower rate?

A

If they have finance agreements with banks.

If the development is lower risk, they may be offered a lower interest rate.

46
Q

When is CIL paid?

A

Typically at the commencement of development.

47
Q

How do you calculate the finance for borrowing for the site purchase?

A

On a straight line basis, using compound interest over the length of the development period.

48
Q

How do you calculate the finance for borrowing for the construction?

A

Assume total construction costs (including fees) over half of the time period, using an S-curve calculation

49
Q

How do you calculate the finance for borrowing for the holding costs?

A

On a straight line basis, using compound interest from completion of construction until disposal.

50
Q

What is the formula for Development Appraisals?

A

GDV - Costs - Land Value = Developer’s Profit

51
Q

What is a S106 obligation?

A

Under the Town and Country Planning Act 1990, Section 106 payments are planning obligations that are negotiated between the LA and the developer, in order to make the scheme acceptable in planning terms (legal agreement btw developer and LA planning dept)

52
Q

What are the main differences between S106 and CIL?

A

CIL is:

  • for all infrastructure necessary to support the development
  • can’t be used to secure affordable housing
  • tariff-based charging system that covers the whole area, and is based on the increase in net floor area
  • viability is tested at district-wide level at the evidence gathering stage, then charges are mandatory

S106 is:

  • only justifiable if necessary to make the development acceptable in planning terms
  • must be reasonable and in relation to scale of dev.
  • can be used to secure affordable housing
  • site-specific charge
  • by negotiation
  • viability testing is undertaken on a case by case basis
53
Q

What are the main methods of development finance?

A
  1. Debt finance (lending from bank/funding institution)
  2. Equity finance (capital outlay - usually JV partnerships/forward sales)
54
Q

What is mezzanine funding?

A

Additional funding for additional monies required over the normal LTV lending

55
Q

How is interest calculated?

A

On a rolled-up basis. i.e. added to the loan as the project proceeds

56
Q

What is an overage agreement?

A

An arrangement made where any additional profit (above the expected return) is shared between the vendor/landowner and developer, in a pre-arranged apportionment.

57
Q

What is massing analysis?

A

This is testing changes in site density and building heights, incorporating matters such as rights of light etc.

58
Q

What are the different parts of the development process?

A
  1. SITE PREP/ PRE CONSTRUCTION
    - Demolition
    - Site clearance
    - Remediation works
    - Landfill tax
    - Provision of services
    - Levelling
    - Fencing
  2. PLANNING
    - Planning consultant fees
    - Planning apps
    - Building regs
    - Environmental impact assessment
    - CIL/s106/s278
  3. CONSTRUCTION
    - Build costs
    - Professional fees (10-15%)
    - Contingency (5-10%)
  4. POST CONSTRUCTION
    - Marketing costs and fees
    - EPC
    - Sale fee (1-2% of GDV)
    - Letting fee (10-15% of MR)
    - Holding costs
59
Q

What are the different brackets for stamp duty?

A

0 - £150,000 = 0%
£150,001 - £250,000 = 2%
£250,001 + = 5%

60
Q

What are you looking for specifically on inspection of a development site?

A
  • location (proximity to town centre/road network)
  • infrastructure
  • topography / site levelling
  • signs of contamination
  • any abnormals (site access/conditions)
  • infrastructure
  • archaeological interests
  • flood risk
  • surrounding uses
61
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
62
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
63
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)
64
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
65
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

66
Q

What financing arrangement does the development appraisal process assume?

A

100% debt finance

67
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
68
Q

What is the profit erosion period/what is it measuring?

A

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

69
Q

How is development property defined in RICS Valuation of development property, 2019?

A

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

70
Q

According to RICS Valuation of development property, 2019, what should Market Value for a development property assume?

A

Optimum development i.e. the development which yields the highest value, taking into account the prospective economic and planning conditions

71
Q

What does RICS Valuation of development property, 2019 state about the use of multiple valuation approaches?

A

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)

72
Q

What method does the RICS Valuation of development property state should be used for complex and/or lengthy development schemes?

A

Discounted cash flow (DCF) technique. Simple residual method can be used in other cases

73
Q

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?

A
  • 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
74
Q

How should the output of the valuation be reported according to RICS Valuation of development property, 2019, and except for in what circumstances?

A

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)

75
Q

Why is profit on cost a more reliable method of measuring developers profit than profit on GDV?

A

GDV is subject to more variation

76
Q

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)?

A
  • 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
77
Q

What do developers consider the greatest risk when undertaking a development?

A

Planning permission

78
Q

How did you use special assumptions in your residual valuation approach?

A

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

79
Q

Name the three types of listed building

A

Grade 1
Grade 2
Grade 2*

80
Q

When do you need listed building consent

A

Any alteration or extension which will impact the character or interest of a listed building

81
Q

On what basis is the finance rate calculated on?

A

It is a blended rate encompassing the lending market and risk at the time. Exit costs and lending fee are reflected in the rate

82
Q

What are the recent changes to the use classes

A

Class E

Shops, offices, gyms, restaurants, residential industrials

Class C

Dwelling houses, hotels and guest rooms

Sui Generis

Cinemas, pubs, takeaway food

Class B

Industrial and storage and distribution

Development Appraisal L2 EP APC Residential 2022 (2 decks)

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