Development Appraisals

Question 1

What is a development appraisal?

Answer 1

A development appraisal is a tool to financially assess the viability of a development scheme.

Question 2

What can you assess with a development appraisal?

Answer 2

1. The residual site value
2. Assess the profitability of a scheme and its sensitivity to changing inputs

Question 3

What is a residual valuation?

Answer 3

It is a form of development appraisal. It can calculate the valuation of a property to find the market value at the date of the valuation for a specific purpose.

Question 4

What is the methodology of a development appraisal?

Answer 4

It is the Gross Development Value (GDV) of a completed scheme take away the total development costs.

Question 5

What is GDV?

Answer 5

GDV is the Gross Development Value of a completed scheme. It includes the market value of the completed scheme at date of valuation. Use comparable method to calculate rents and yields. All risks yield is used. An allowance of rent free periods, tenant incentives or marketing void can be made. Usually deduct purchasers costs for commercial property valuations.

Question 6

What might be included in total development costs (TDC)?

Answer 6

Site preparation e.g demolition, remedial works, site clearance.
Planning costs e.g Community infrastructure Levy, planning consultants, Section 106 payments.
Building costs
Professional Fees (10-15%+VAT)
Contingency (5-10%) depending on risk
Marketing costs and sale/letting fees (sale 1-2% GDV Letting 10% of rent)
Finance costs
Developers Profit

Question 7

What is a Section 106 Payment?

Answer 7

A legal agreement for planning obligations e.g affordable housing, infrastructure costs to gain a planning consent.

Question 8

What are sources of building costs?

Answer 8

I usually use BCIS
Can also use client information
Quantity or building surveyor estimates
SPONS Architect and Builders Price Book.
I’ll often sense check costs with other recent similar project my colleagues or I have been involved in.

Question 9

How much is usually charged for professional fees?

Answer 9

10-15% plus VAT of total construction costs.
Includes architects, engineers, project managers etc

Question 10

What are the 3 elements if finance that a developer needs to borrow money for?

Answer 10

1. Site purchase - Compound interest
2. Total construction and associated costs - S Curve calculation
3. Holding costs (empty rates, service charges and interest charges) until disposal - Compound interest

Question 11

How is finance calculated?

Answer 11

Assume 100% debt financing
Financing to purchase land is calculated on a straight line basis over development period.
Finance for construction costs are calculated using S curve calculation
On going holding costs are calculated on a straight line basis from completion until disposal

Question 12

What is the straight line basis of interest?

Answer 12

Compound interest, using the rolled up method of calculation. Interest is recalculated over period as more money is loaned.

Question 13

What is S Curve calculation?

Answer 13

It is used to calculate the finance required for construction period. To calculate it you assume the total construction costs over half of the construction period. It reflects when the monies tend to be drawn down.

Question 14

How do you calculate developers profit?

Answer 14

Usually its a percentage of GDV or total construction costs. 15-20% depending on the risk (higher for high risk projects)
GDV more likely used for residential.
Percentage has increased in recent years (COVID) given riskier market conditions.

Question 15

What are current units costs like and where would you find these out?

Question 16

What are the two main methods of development finance?

Answer 16

Debt Finance - borrowing from a bank
Equity Finance - Selling shares or using own money

Question 17

What is loan to value ratio?

Answer 17

Percentage of the property value that a borrower will finance. Usually 60% but in difficult market, lenders may use 60% loan to cost. (60% of the property value will be loaned, the rest self financed)

Question 18

What are alternative methods for financing?

Answer 18

Joint venture - 2 or more parties
Forward sales - pre selling the completed scheme to investor or developer

Question 19

What is overage?

Answer 19

An arrangement made for the sharing any extra receipts received above and beyond originally expected as agreed in a pre agreed formula

Question 20

When is VAT Payable

Answer 20

On all professional fees

Question 21

What is the profit erosion period?

Answer 21

The length of time it will take for the development profit to be eroded by holding costs and it becomes loss making due to interest charges.

Question 22

What are limitations of residual valuations?

Answer 22

Relies on accurate information and inputs
Sensitive to minor adjustments
Does not consider timing of cash flows

Question 23

What are three forms of sensitivity analysis?

Answer 23

Simple analysis of key variables like yield, GDV, Build costs, finance rate
Scenario analysis - changes in timings or design
Monte Carlo simulation - probability theory using software.

Question 24

What is included in the Guidance Note Valuation of Development Property 2019?

Answer 24

Assumptions must be clearly identified in report
Advises to not avoid reliance on single method of valuation and cross referencing where possible.
Discounted Cash Flow technique might be best for complex or lengthy schemes. Residual otherwise best.
Valuation should be given as a single figure except when there is potential for significant variation (different options/design)

Question 25

What is development property?

Answer 25

Interests where redevelopment is required to achieve the highest and best use or where improvements are contemplated or in progress. Includes: Construction of buildings Redevelopment Improvements Land allocated for development or higher value use.

Question 26

When is stamp duty payable?

Answer 26

Up to £125k 0% £250k 2% £925k 5% £1.5m 10% £1.5m+ 12%

Question 27

Are you aware of any other sensitivity analysis?

Answer 27

Simple - changing inputs, GDV, costs etc Scenario - changing market conditions, timings Monte Carlo Simulation - using software for probability theory

Question 28

What professional fees do you use?

Answer 28

Usually around 10% but can vary depending on the scheme/developer.

Question 29

Does a development appraisal assess value?

Answer 29

No, a development appraisal assesses viability of a scheme, usually focused on the profitability of the scheme, accounting for all the costs and risks. A residual valuation establishes the value of the land, based on the GDV minus all costs and developer profit. The residual value is the value of the land.

Question 30

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

Answer 30

Development appraisal is to look at the viability of a specific scheme, usually based on the profit. A residual valuation is concerned with the value of the property, accounting for developer costs and profit.

Question 31

What is senior debt?

Answer 31

First level of borrowing that takes precedence over secondary/mezzanine funding

Question 32

What is mezzanine funding?

Answer 32

Additional funding for additional monies required over normal loan to value lending.

Question 33

For Levenshulme Cricket Club what did you review when you tested the proposed bids with your own appraisal?

Answer 33

I used my own comps to calculate GDV as well as build costs from a combination of BCIS, recent similar schemes and quantity surveyor guidance. I then compared their residual values to mine. This allowed me to scrutinise their bids and when required seek clarification for the figures they used. E.g comp and build cost evidence.

Question 34

What is the importance of sensitivity analysis?

Answer 34

Appraisals, particularly residual valuations can be very sensitive to slight changes in the input, particularly build costs. Build costs and GDV can vary quickly, particularly when a project can take a couple of years to complete. Therefor sensitivity analysis is important to make the client aware of the potential variances and how these might effect its viability and the level of risk involved in the project.