The article you are about to read is without doubt the holy-grail for best-practice land valuation, and the principles described here would be used by housing developers, banks and surveyors when assessing the valuation of UK land for development.
We are always happy to help with the valuation of your land should you require further assistance, and we do this free of charge and without any obligation. Please click here to submit your land details for a free valuation estimate.
There is so much poor information available on the Internet regarding this topic, usually from unscrupulous websites who will grossly under-value your land, so we decided to share with you the correct way to value land which is eligable for development.
The article you are about to read is without doubt the holy-grail for best-practice land valuation, and the principles described here would be used by housing developers, banks and surveyors when assessing the valuation of UK land for development.
The UK Land Sales team is a small group of successful property developers, surveyors and estate agents with many years experience of land acquisition and development. We are always happy to help with the valuation of your land should you require further assistance, and we do this free of charge and without any obligation. Please click here to submit your land details for a free valuation estimate.
This article discusses the approach to the valuation of land where the proposed development, or redevelopment, is to be carried out by removing all, or substantially all, of the existing buildings and constructing new buildings. For clarity this form of development will be referred to throughout as 'development land'. This article does not apply to re-development based on a major refurbishment of existing buildings, with limited demolition. Even if the land has no existing buildings, the principles in this article will still apply.
There are two approaches to the valuation of development land:
In practice it is likely that a valuation would utilise both approaches, and the degree to which either, or both will be relevant depends upon the nature of the development being considered, and the complexity of the issues.
Valuation by comparison is essentially objective, in that it is based on an analysis of the price achieved for broadly similar developments. The residual method, in contrast, relies on an approach that is a combination of comparison and cost and it requires the valuer to make a number of assumptions - any of which can affect the outcome, in varying degrees.
To reflect the approach to this type of valuation this article has been divided into the following sections:
In order that the valuer is able to judge the certainty of the outcome of the valuation, and the processes involved, it is essential to have an awareness of the characteristics of the existing site and an adequate knowledge of each of the development components. The level of detail which is appropriate, when assessing development potential, will vary according to the purpose of the valuation. Judgement is required as to what is appropriate in each case.
The level of information available for a residual valuation will be determined by the stage at which the valuation is being prepared. For example a valuation in advance of an acquisition will be based on less certain estimates than if the land has been held whilst planning has been progressed, or the valuation is at a date where the redevelopment has commenced. It may therefore be necessary to review the valuation as more detailed information becomes available.
Physical inspection of the site, and related enquiries, will reveal site specific information. Such information, either positive or negative, could include the following matters, which are not intended to be exhaustive or to apply to every case:
The planning regimes in England, Wales, Scotland and Northern Ireland have differing legislative and regulatory controls. The extent of the enquiries that will be necessary and appropriate will vary in each case but the following matters may need investigation.
Where the current permission(s) is not considered to be the optimum permission for which there is a reasonable prospect, having regard to the applicable planning regime, it will be necessary to form a view as to what permission is likely to be obtained and the associated planning agreements that would be required to obtain that consent. This will include consideration of published planning policies recognising that they heavily influence future additions to the supply of particular types of building. Consideration will also need to be given to emerging consultative planning policies, including national or regional guidance that may be taken into account when deciding planning applications and, in the longer term, may influence the supply of competing space or otherwise affect the value of the completed scheme.
An accurate assessment of the form and extent of physical development that can be accommodated on the site is essential, having regard to the site characteristics, the characteristics of the surrounding area, and the likelihood of obtaining permission. In more complex cases it is recommended that this assessment is undertaken in consultation with appointed project consultants, such as architects and quantity surveyors, environmental and planning consultants.
Matters that may be considered include:
Although the valuation is required of the actual site there may be a possibility of increasing the development potential by acquisition of, or merger with, adjacent land. Conversely it may be necessary to acquire adjacent land, or rights over adjacent land, before the proposed development could take place. The likelihood of resolving such matters and whether such acquisitions should be reflected in the valuation will require discussion with the owner.
The valuer will need to liaise closely with both the appropriate planning authorities and the owner to ensure that the appraisal reflects fully the various aspects of the proposed development.
In considering the development potential it is necessary to establish the potential demand for the optimum alternative forms of development that may be possible. Clearly it would not be appropriate to consider building a high specification office block in an area where there is no, or limited, demand for such a property. Matters to be considered could include, but not exclusively:
Valuation by comparison is only reliable if evidence of sales can be found and analysed on a common unit basis, such as, site area, developable area or habitable room. Although comparable sales can be analysed in unit terms there are many other factors that will determine the price paid and unit comparison may not, in a particular case, be the most significant. Even where reliable information is not available the comparison method can provide a useful check of a valuation prepared using the residual method.
Typically, comparison may be appropriate where there is an active market and a relatively straightforward low density form of development is proposed, (for example, if the land is greenfield within a rural economy where infrastructure costs are consistent and not excessive, or small residential developments, and small industrial estates), and it is likely that the density, form and unit cost of development will be similar. Less frequently, it may be possible to compare larger sites for housing developments on this basis.
In comparing sites the following factors, which are not exclusive, may be relevant:
Generally, high density or complex developments, urban sites and existing buildings with development potential, will not easily lend themselves to valuation by comparison. The differences from site to site (for example in terms of development potential or construction cost) will be sufficient to make the analysis of transactions problematical. The higher the number of variables and adjustments for assumptions the less useful the comparison. Comparison is rarely appropriate where construction has begun.
Where the comparative method is used it is assumed that the valuer will use standard valuation techniques, which may incorporate some of the elements of a residual valuation.
Where the nature of the development is such that there are no, or limited, transactions to use for the comparative method, the residual method provides an alternative valuation approach. However, even limited analysis of comparable sales can provide a useful check as to the reasonableness of a residual valuation.
A residual valuation requires the input of a large amount of data, which are rarely absolute or precise, coupled with making a large number of assumptions. Small changes in any of the inputs can cumulatively lead to a large change in the residual value. Some of these inputs can be assessed with reasonable objectivity, but others present great difficulty. For example, the profit margin, or return required, varies dependent upon whether the owner is a developer, a contractor, an owner occupier, an investor, or lender, as well as with the passage of time and the risks associated with the development.
Having established the development potential a residual valuation can be expressed as a simple equation:
(value of completed development) - (development costs + developers profit) = land value
Each element of this equation is discussed in the following paragraphs.
The value to be adopted is the Market Value of the proposed development assessed on the special assumption that the development is complete. In some instances another special assumption may be that the completed development is let and income producing rather than available for sale or letting. After making allowances for transaction costs this is widely referred to as the Gross development value (GDV).
The finance costs, notional or actual, are included in the residual value calculation and therefore there is no need to adjust the GDV to reflect these.
Where there is no existing planning permission for the project it will be necessary to allow for the costs of obtaining that permission. Where the development may be contentious, allowances should be made for the potential additional costs, including delays caused by appeals and/or inquiries, (these will include fees and additional holding costs and may extend to creating models, lobbying etc). This heading would not normally include any deferment of the scheme as a whole due to the contentious nature of the development as such matters would properly be reflected in the final assessment of the land value, (see below).
The impact of legally binding agreements linked with the grant of planning permission has to be considered. The obligations usually, but not always, are deliverable on-site but, for instance, in the provision of local, or wider, highways provision, could be elsewhere. The requirements might be for a cash payment, the provision of community facilities, affordable housing or providing enhanced public transport.
There are various matters relating to statutory and regulatory obligations that may have to be considered. Such matters, which could incur significant costs, could include:
These will include agents fees, legal costs and Stamp Duty Land Tax. For investment property, as yields are quoted net of purchaser's costs, the incidence of SDLT on the onsale should be reflected. The deduction of these costs from GDV will establish the Net Development Value.
It will be necessary to consider the costs to be incurred before the main construction activity can proceed. These will include:
If appropriate, it will be necessary to estimate the costs incurred in securing vacant possession, acquiring necessary interests in the subject site or adjacent property, extinguishing easements or removing restrictive covenants, rights of light compensation etc. The allowances should be realistic, recognising the fact that the other parties will expect to share in the development value generated.
The letting out of advertising space on hoardings or the securing of short term tenancies (for example, surface car parking) can help to offset finance costs before and during the development phase.
A reasonably accurate estimation of the building costs, at the valuation date, of the development is a major component in a residual valuation. In other than the most straightforward schemes it is recommended that the costs be estimated with the assistance of an appropriately qualified expert. Detailed costings are conventionally based on the Gross Internal Area (GIA) (see the RICS Code of Measuring Practice) and are usually recorded on this basis in reference books. Care will need to be taken to check that calculations provided by other professionals are on the basis of GIA.
A residual valuation is very sensitive to variations in the estimated costs and the accuracy with which costs can be assessed may vary greatly according to the specific site characteristics or the requirement, or plan, to retain specific structures, any unusual building specifications and the extent to which a new building will have to reflect relevant sustainability policies. Therefore, the use of reference books, and websites, including the BCIS website, are considered to be only guides and undue reliance on them can compromise the accuracy of the valuation.
The procurement route is also a key consideration in determining the build cost. The various routes impose differing responsibilities on the parties which will affect the build cost and which it will be appropriate to include. Reference is often made to a fixed price contract. It should be recognised that whilst this does allow for inflation it is only fixed to the extent of the works outlined in the contract. A contractor can amend the pricing if any variations to the specification are made, or unforeseen events occur.
It is essential that the valuer understands which route has been, or is likely to be, chosen. The suitability for the particular development and the implications of that choice on the relevant elements of the residual calculation may require recourse to other surveying disciplines.
In all cases the inclusion of a contingency allowance to cater for the unexpected is essential. The quantum which is usually reflected as a percentage of the building contract sum is dependent upon the nature of the development, the procurement method and the perceived accuracy of the information obtained.
The incidence of fees and expenses will vary significantly according to the size and complexity of the development. The following items may need consideration:
Interest is incurred and either paid when due, or deferred (rolled up), throughout the projected programme during the pre-contract, contract and post-contract stages. An allowance is made to reflect the opportunity cost of the monies even if the developer is funding the project internally on the assumption that the completed fully let and income producing development will be sold, or long-term finance will be obtained on its transfer to the developer's investment portfolio. This allowance is also included where the development is to be owner occupied.
It is usual for interest to be treated as a development cost up to the assumed letting date of the last unit, unless a forward sale agreement dictates otherwise. In the case of residential developments the sales of individual units may occur at various stages during the development and appropriate assumptions will have to be made regarding cash flow, both inward and outward. The rate of interest adopted will reflect the levels adopted by the market for the type of scheme involved.
The approximate timings for the pre-construction, principal construction and post construction periods have to be determined. The valuer is recommended to liaise with the owner, such professionals as might be appointed, or colleagues with relevant experience, to assess an appropriate, realistic time frame for each of the phases.
Conventionally the chosen interest rate will be compounded, either quarterly or annually in line with the current market practice.
In applying interest two approaches are commonly used:
The attendant costs (excluding interest) in holding the completed building up to the assumed date of the final letting or sale, including such items as insurance, security, cleaning and fuel. A proportion of the service charge on partially let properties may have to be included together with any potential liability for empty rates.
In some areas and on some properties, special allowances, or grants, may be available to the developer. These may relate to the cost of remediation of contaminated land, promotion of job creation, or assistance to ensure that a scheme proceeds. The availability of such funds would require discussion with the relevant government office and the possibility of their availability being changed, or withdrawn at short notice, is to be recognised.
Capital allowances might be available on the cost of plant and equipment and certain buildings. They are available as an expense of the business being carried on by the property owner, whether that is as an owner occupier or an investor. They are not available to developers, unless the property is to be retained as an investment.
The worth of capital allowances is not assessable by way of a formula being dependent on the particular circumstances of the property owner. They are not usually explicitly included in development appraisals, but their potential availability may be reflected in the price offered by certain owners.
The decision as to the inclusion of VAT is best resolved by discussion with the owner but, in the absence of explicit instructions, the Valuer may have regard to current practice in respect of the election to tax for the type and location of property concerned. In more complex developments it may be necessary to explicitly include the incidence of both payments and recoveries of VAT. Any assumptions made are to be stated in the report.
The nature of the development, and the prevailing practice in the market for the sector, will help to determine the selection of the profit margin, or rate of return and the percentage to be adopted will vary for each case.
It is usual to assume that the developer will seek either a capital profit expressed as a percentage of the total development cost (including interest) or of GDV. The former approach is more common. The latter derives from the traditional financing of commercial developments where the completed property is sold to a long-term investor. Although the valuer has to exercise judgement on the figure to be incorporated, it may be helpful to obtain the owner's views.
It is also common practice for development companies who retain completed schemes in their investment portfolios to judge the success of a scheme in terms of the enhancement of the balance sheet (net asset value (NAV)) rather than the profit and loss account (income).
There are, however, other criteria that are sometimes adopted. These include:
The appropriate level of profit to be assumed in the appraisal cannot be specified in this Paper, as market requirements will vary from project to project and from time to time. Evidence may be deduced (with difficulty) by analysing transactions, but it is better obtained from the valuer's knowledge of the market or of developers' requirements.
In any event, it must be recognised that the appropriate profit to be expected from a particular development will be influenced by a number of factors which might lead to the departure from the market 'norm'. High amongst these will be the certainty of the information available to the valuer, and the general risk profile (for example, whether the interest rate is fixed, whether the scheme is pre-let or pre-sold) but the scale of development, the amount of financial exposure and the timescale will also be relevant.
Where a comparative approach has been followed the land value will have been determined at an early stage. However the valuer may wish to check the result against a simplified residual appraisal, or consider if any of the factors explicit within a residual valuation,( such as specific planning or site characteristics), have not been appropriately reflected in any adjustments that the valuer has made to the comparables.
Where a residual approach has been followed the valuer draws together the various elements and, having established the completed value, by deduction of the various costs, will determine the residual land value.
The residual value is not necessarily the same as the value of the land as it has to be considered in the context of the valuation as a whole. The following matters may have an impact on the residual value and need to be addressed before the final conclusion is reached:
The aim of this artilce is to assist the valuer in the more complex cases by providing a framework within which a consistent approach to the valuation of development land is adopted. It does not advise the valuer how to undertake this type of valuation - that is a matter of professional expertise - but, by following the principles, the valuer may have confidence that all the factors relevant to this type of valuation have been considered.
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