Development appraisal and risk 93
£$ ts
(i) Estimated Rental Value (ERV)
Net lertable area 42,065 fe (3,908 m‘) @ £30 per ft2 (£$322.92 per m‘)
(ii) Capitalised @ 7.0% YP in perpetuity
(iii) less purchaser’s costs @ 2.75%
Net Development Value (NDV)
1,261,971
14.29
18,028,162
495,774
17,532,388
(b) Development costs
(c) Building costs
Estimated building cost
Gross area 49,500 ft2 (4,599 m‘) @ £$132 ft2 (£$1,421 rrr’) 6,535,179 6,535,179
(d) Professional fees
Architect @ 5%
Structural engineer @ 2%
Quantity surveyor @ 2%
M & E engineer @ 1.5%
Project manager @ 2%
326,759
130,704
98,028
130,704
130,704
816,897
17,500
6,000
30,000
53,500
(e) Other costs
(iv) Site investigations –– say
(v) Planning fees – say
(vi) Building regulations
(f) Funding fees
Bank‘s legal/professional fees – say
Bank‘s arrangement fee
Developer‘s legal fees – say
60,000
90,000
50,000
200,000
(g) Finance costs
(i) Interest on (c) building costs, (d) professional fees, (e) other costs
and (f) funding fees divided by a half (= £$6.33m/2) over building
period of 12 months @ 8.25% compounded quarterly = (1.0206)’ 323,570
continued ...
94 Development appraisal and risk
Examl!Je 3.3 continued
£$ £$
Resk
(ii) Interest on (c) buildingcosts, (d) professionalfees, (e) other costs
and (f) fundingfees (£6.33m) over void period of 12 months @ 8.25%
compounded quarterly = (1.0206t 647,140 Divi(
970,711 acqu
(h) Lettingand sale costs Resk
Lettingagents @ 15% ERV 189,296 Say

This
547,282
Land
Net total development costs excludingland costs and interest on land
costs 9,123,568 plus,
(i) Developer’s profit Total
@ 20% on net total development costs (£$9,123,568) excluding land
costs and interest on land costs 1,824,714 multi
= (I.
(j) Net Total Development Costs (NTDC) 10,948,282 Total
(k) Residuei.e. NDV less NTDC 6,584,106
plus I
Total
This residue is made up of the followingelements:
Net!
Land price = Less
plus cost of acquisition @2.5% 0.025 Deve
1.025
Deve
multiplied by cost of interest of holdingland for development period
and void (30 months) @ 8.25% compounded quarterly (1.0206)10= 1.226 Note
Total land cost 1.257 reaso
!Il:
multiplied by profit on total land cost @ target rate of 20% 1.2
1.508
The residual land value i.e. the price the developer can affordto pay to
ensure the target rate of profit, is therefore derived as follows:
Development appraisal and risk 95
£$ £$
6,584,106
lily factor (calculated above) to take account of land price,
·n costs, interest and profit as calculated above 1.508
4,366,176
4,365,000
‘fliliS €alculation can be checked as follows:
4,365,000
109,125
4,474,125
1″Ii!l!lltiplied by interest for 30 months @ 8.25% compounded quarterly
“‘” (1.0206)10 = 1.226 1,013,319
5,487,444
plus Net Total Development Cost excluding profit
Total Development Cost (TOC)
9,123,568
14,611,013
Net Development Value, as above
‘Less Total Development Cost (TOC)
17,532,388
14,611,013
2,921,375
Developer’s profit on cost 20.0%
Note: this result confirms that at a land price of £$4,365,000 the target level of profit of 20% can
reasonably be expected to be achieved.
Tabl€
Mo:
%1
p.
ove:
thui
be s
spre
incr
som
duri
desi
cost
Oft,
patt
1
holi
The
ove
1
cost
and
the
cost
1
of (
acer
that
for
con
inte
($£
witl
figu
ind
IS SI
is e:
at tl
rate
I
infl
the
clea
oce
e.g.

o
‘”
,k–free
Discounted cash flow approaches 103
Accordingly, as the expenditure br income for each year occurs at the end of
the year the PV multiplier for each year is calculated to correspond with the year
number (or waiting time) shown in column a for each period of the project. The
year 1 and year 2 PV multipliers are calculated as follows.
.to the
“or the
ltiplier
nt day
ecision

ermine
are set
Example 6.3
If the income and expenditure occurred at the beginning of each year then the
DCFcalculation would need to be revised as set out in the example below. Where
the expenditure in year one is made now, which in a DCF calculation is
represented by the number 1.0000, in other words no discount is made when this
figure is multiplied by the initial expenditure. The cash flow in year 2 then occurs
at the beginning of that period so the PV multiplier is calculated using a
discounting period of one year, which is the total waiting time represented by the
previous period which has just ended.
It 5 per
oject is
a b c

Start of Cashflow rv e year estimate 5.00% Project A -£2,000.00 1.0000 1.0000 –£1,500.00
2 £1,000.00 0.9524 0.9524 £476.19
3 £3,000.00 0.9070 0.9070 £4,535.15
4 £5,000.00 0.8638 0.8638 £5,614.94
5 £10,500.00 0.8227 0.8227 £5,758.92
Total £17,500.00 NPY £14,631.03 NPY £14,885.20
g
roject B
lCF
1,428.57
£453.51
4,319.19
5,347.57
5,484.68
4,176.38
As these examples show, discounting annual cash flows over a period of five years
is useful to ascertain values of short-term projects but it is not particularly helpful
when analysing investment income and costs over a much longer period of say 15
to 20 years. Accordingly, the DCF technique requires adaptation for use in
property investment valuation and analysis in order to accommodate longer time
scales, whereas the business use of the method as shown here is normally for a
relatively short ‘pay-back‘ period only, which could be as little as five or six years,
and often with the terminal value relatively low (scrap value or nil).
for each
ponding
102 Discounted cash flow approaches
reference to British Treasury bond rates if a secure and relatively risk-free
investment is required as a comparator.
Once the discount rate is selected, it is then input in decimal form into the
present value (PV) formula and the FV multiplier is then calculated for the
desired time period over which the cash flow would be received. The PV multiplier
is then applied to the cash flow to adjust the future cash flow into present day
terms. Reference to Example 6.2 shows the use of a simple DCF as a decision
I making tool.
, I

t
Example 6.2
A business decision needs to be made about two projects A and B to determine
which one is best to undertake. The estimated cash flows of each project are set
out below.

3 £3,000.00 £5,000.00
: 4 £5,000.00 £6,500.00

2 £1,000.00 0.9070 £907.03 £500.00 0.9070 £453.51
3 £3,000.00 0.8638 £2,591.51 £5,000.00 0.8638 £4,319.19
4 £5,000.00 0.8227 £4,113.51 £6,500.00 0.8227 £5,347.57
5 £10,500.00 0.7835 £8,227.02 £7,000.00 0.7835 £5,484.68
Total £17,500.00 £17,500.00
NPV £13,934.32 NPV £14,176.38
The DCF figure is derived by calculating the appropriate PV multiplier for each
period and then multiplying it by the estimated cash flow for the corresponding
period. .
Accordingly, as the expend
the year the PV multiplier for
number (or waiting time) sha
year 1 and year 2 PV multipli
1
(1+
. 1
(1 +
Example 6.3
If the income and expendit‘
DCF calculation would neec
the expenditure in year o
represented by the number
figure is multiplied by the ir
at the beginning of that
discounting period of one Y’
previous period which has:

3 £3,000.00
4 £5,000.00
5 £10,500.00
Total £17,500.00
As these examples show,
is useful to ascertain valu
when analysing investme
to 20 years. According]
property investment vah
scales, whereas the bush
relatively short ‘pay–bacl
and often with the term
is
7 The residual method
le
.ir
ty
Where market evidence is available, the investment or comparable methods of
valuation are appropriate. This caveat applies to land as well as to buildings but
unless the land comprises a relatively small, single site for which there might be
some evidence of sales, differences in the size, shape and potential suggest that it
is unlikely that a comparable transaction would be forthcoming.
Where it is required to provide a valuation of undeveloped land or value land
with obsolescent buildings incapable of producing an economic rent but which
are suitable for redevelopment, the residual method may be used. The current
rent, where the existing property is let, is unlikely to be a guide to value; similarly,
it is equally unlikely that a similar site or group of buildings have been sold
recently that would provide even a rough indication of what the land and
buildings are worth.
In these circumstances, the valuer tends to mimic the market; that is, the
possibilities of developing or redeveloping the site are explored to determine
whether a viable use can be found for the site which would offer a means to value
it. Generally, the approach would be to calculate the difference between the final
value of the redeveloped site and the cost of carrying out the development work,
sufficient to give the developer a satisfactory return that takes account of the risks
inherent in such an undertaking.
Determining whether land has a redevelopment or development value is
related to whether a satisfactory planning consent can be obtained for the
proposed scheme. Essential to the considerations is the understanding that not
only must planning requirements be met, but the scheme must also generate
interest and demand for it to sell either as an investment or for owner occupation
upon completion. Apart from any novel ideas regarding what might be suitable
and profitable, there will be general views as to the type of development suitable
for the site and the immediate area.
One of the considerations is that a sizeable site may be developed in many
different ways and for different uses, subject always to planning consent. Where
the site is large enough to allow for internal access roads and some mixed use, a
tentative layout is central to the investigations necessary to make a bid for the
site.
IS,
1e
114 The residual method
Factors affecting value
As indicated above, many factors could influence any proposals for development
and consequently the value of the land. These include:
• the area, shape and contours of the site
• the existing road frontage and ease of access, including any apparent problems
• the location of the site and its suitability and accessibility for the use or uses
proposed
• the proportion of the site that may be developed in relation to the total site
area. Any proposals would have to take into account service ducts, main
sewers, easements, overhead power cables and physical features such as
slopes, flood plains and the nature of the subsoil
• the geology and soil and its effect on additional costs of foundations and
substructures
• any planning considerations such as the likelihood of restrictions on hours of
business, height of buildings, community infrastructure levy, highway
improvements, building materials to be used and similar considerations
• statutory and other protection of the existing buildings. In England and
Wales buildings may be listed as being of architectural or historic importance
or they may be susceptible to listing. Any such designation may affect the
layout and external appearance of any new buildings.
This list is illustrative, not exhaustive, but it indicates the types of problem and
the probable delays associated with each item. It also indicates the requirement
for painstaking enquiries and preparation to avoid likely problems.
The basic approach
In essence, the method is a cost-based approach which is then related to a final
value to test the viability of any development proposal. The procedure for
determining site value is illustrated in Figure 7.1; alternatively, where the cost of
the land is known, the procedure is shown in Figure 7.2.
VALUE ON COMPLETION OF DEVELOPMENT
less
COSTS AND DEVELOPER‘S PROFIT
leaves
SURPLUS FOR SITE PURCHASE
Figure 7.1 Residual valuation: basic approach to calculation of site value
CONSTI
Figure 7.2 Residual vs
Criticisms
The approach is ru
manipulated to sue
overreaction, partie
development or ree
similarly interested
likely to fail when e
of value is likely to
For a developer to b
completion and co
attempting to assest
Where the criti:
theoretical exercise
and the value will I
The bidding mar
In the normal situat
developers, investc
purposes of redeve
deductive process,
the completed proj
difference betweer
carrying out the sel
, make on the basis e
lower bids reflectn
borrowing, or the e
method has the att
because the inputi
developer or btddei
developers are con:
,
lent
ems
uses
site
lain
I as
md
s of
Nay
md
nce
the
md
ent
nal
for
of
The residual method 115
VALUE ON COMPLETION
less
CONSTRUCTION COSTS AND SITE PURCHASE COSTS
leaves
BALANCE FOR DEVELOPER‘S PROFIT
Figure 7.2 Residual valuation: basic approach to calculation of developer’s profit
Criticisms
The approach is not without its critics. It is claimed that the inputs can be
manipulated to such an extent that any result can be achieved. This is an
overreaction, particularly when the purpose is to acquire land and/or buildings for
development or redevelopment in the light of competition from other parties
similarly interested. Too Iowan offer on the part of the potential purchaser is
likely to fail when other bids are received, whilst an owner with an inflated view
of value is likely to experience a dearth of interest and a failure to find a buyer.
For a developer to be interested, there must be a reasonable prospect of a profit on
completion and compensation for taking on specific risks, particularly that of
attempting to assess the future market.
Where the criticism may be justified is where the assessment of value is a
theoretical exercise to establish a value for acquisition where there is one buyer
and the value will not be tested in the market.
The bidding market for development land
In the normal situation, the property development market is composed ofbuilders,
developers, investors, speculators and others wishing to purchase land for the
purposes of redevelopment. They normally arrive at the value of the site by a
deductive process and their principal concern is to decide whether the value of
the completed project justifies all the costs of completing the development. The
difference between the value of the completed development and the costs of
carrying out the scheme represents the maximum bid the developer can afford to
make on the basis of the inputs used. Different developers may arrive at higher or
lower bids reflecting levels of efficiency, costs of overheads, the firm’s cost of
borrowing, or the desire to purchase a particular piece of land. Thus the residual
method has the attributes of a ‘calculation of worth’ rather than of market value,
because the inputs into the valuation are often highly specific to a particular
developer or bidder. The matter of worth versus market value is important. When
developers are considering a bid, they need two points of reference: worth, which
116 The residual method
is a calculation showing what they can afford to pay, and market value, which is
what they will have to pay to secure the site from other competing bidders.
The unique calculations made by each interested party will result in a range of
possible bids. The greater a developer‘s efficiency the higher the residue, or
resulting value, although not all of the efficiency savings will necessarily be used
to purchase the site. A developer should be able to make the winning bid without
sacrificing the whole of the increment attributable to the company’s greater
efficiency and will consider the likely bids of competitor others together with the
benefits of purchasing the site. Except in auction situations, it is possible to make
an initial offer to establish interest and possibly obtain feedback from the vendor
before negotiations begin.
For example, a developer may have calculated a residual value of, say, £1
million for an office development site but would be ill-advised to make an offer
until the market price was known. If the site was then placed on the market at
£850,000 the developer would be in an advantageous bidding position and may
also obtain it for less through the negotiating process. Conversely, had the asking
price been fixed at £1.1 million, a purchase at this price would eat into the
developer’s profits based on the calculations made. Worth and value therefore set
the parameters within which to bid, and where worth is lower than market value
the developer may decide to withdraw from the transaction altogether.
If the deal is abandoned it would be wrong to conclude that time had been
wasted. On the contrary, the exercise has indicated to the prospective developer
that the particular site should be avoided unless there is a realistic prospect of
either reducing costs or intensifying development to increase the value of the
completed project. If negotiations remain open with the vendor then the
developer may eventually secure the site at the higher price but with a more
profitable scheme in the end. This is an example of the way in which development
proposals are shaped and refined.
The process of valuation
Having collected as much information as possible about the site, locality and
costs, the valuer will make use of it in determining the residual value of the site.
However, it should be highlighted that the available information may be used to
produce results other than site value. For example, the land may already be in the
ownership of the developer or its price may already be fixed, in which case the
developer may wish to determine the available spend for construction works or
may calculate the minimum value of the completed development to justify the
payment of a certain land price.
The main constituents of the development process are shown in Figure 7.3,
whilst a typical allocation of costs is illustrated in Figure 7.4.
Preliminaries
Appoint professional team
Finalize plans
Invite tenders
Arrange finance
(long/short term)
OR
Find buyer
Figure 7.3 The main comp
Figure 7.4 Allocation of rna
Value on completion
The first step is to estim:
capital value. of the con
commercial property the
and multiplied by the ren
tum is multiplied by the y
been identified through t
involves the investment
I
The residua! method 117
Construction
Post-construction
Preliminaries
APpoint professional team
Define building
programme
Finalize lettings (access to
tenants for fitting out)
Finalizeplans Site preparation Organize OR sale
Invite tenders Take up long-term finance
Construction work
Make all payments due in
respect of development
Arrange finance
(long/short term)
OR
Find buyer
Advertise press and
onsite
The main componentsof the developmentprocess
he
ire
-nt
nd
rte.
lto
the
the
Figure 7.4 Allocation of main development costs
; or
the Value on completion
The first step is to estimate the gross development value (ODY), which is the
capital value of the completed development. If the development involves a
commercial property then the floor area of the proposed building is calculated
and multiplied by the rent per square metre to find the total rental value. This in
tum is multiplied by the years’ purchase in perpetuity at an all-risks yield that has
been identified through the analysis of the market. This part of the assessment
involves the investment method and is normally straightforward, involving a
7.3,
il
, ”
118 The residual method
market rent (or rack rent) capitalized in perpetuity for a freehold valuation or, if
leasehold, for the length of the ground lease available (or more typically 125
years). Where the interest is leasehold, the frequency and nature of rent reviews
if any, of the head leasehold interest will be relevant to the yield, as will the effec~
of any unusual provisions in the lease that fetter the developer’s ability to manage
and operate the development in the best way. This is because it is assumed that
the development will be sold on completion and, accordingly, the estimated costs
of transfer are deducted from the final valuation.
If the proposed scheme involves residential development then the value on
completion is calculated by estimating the sale price of each house or apartment.
The estimated sale prices will vary depending on the range of accommodation
proposed. Typically one would expect different sale prices for houses with four,
three or two bedrooms and similarly distinct prices for apartments of different
sizes. In addition, the estimated sale prices should also reflect other distinctive
features such as the size of any garage or the number of car parking spaces provided
with each property. Analysis of the residential market in the locality should
provide sufficient comparable evidence for the valuer to make a reasonable
estimate of the property values upon completion. Once this data is collected then
the GDV for a residential scheme is calculated by adding together all the
estimated sale prices of each residential unit. In the United Kingdom it is usually
assumed that the majority of properties in a private development scheme would
be sold to separate owner-occupiers with, sometimes, a small proportion allocated
for sale to a not-for-profit housing association or equivalent.
Mixed scheme developments may involve a combination of different types of
commercial property or may involve a combination of commercial and residential
property. In the case of the latter, the GDV is calculated using a combination of
the investment method and the comparative methods outlined above.
Development costs
When estimating development costs, the initial exercise is likely to consist of a
broad estimation of the main costs and a view as to whether the completed value
of the development is likely to be sufficient to justify further investigation.
The main constituents of development costs are discussed below.
Building costs
The valuer should allow a sufficient sum for building costs and contingencies,
especially since these have a ‘knock-on’ effect on other costs (for example, fees
and finance). Too generous an allowance, on the other hand, may make the
residual amount uncompetitive and result in failure to purchase the site. At this
stage a good deal of information, expertise and experience is called for.
Details of building costs will eventually be determined when a contract is
signed with the appointed contractor. Meanwhile, information will be gathered
from a range of available sources. The developer might provide figures based on
its own cost experienc
of price information;
price subscription serv
Surveyors (RICS). Ar
is given in Appendix
The proposed deve
total letting space. I
standards laid down il
The calculations sl
clearance and prepar
environment, costs IT
prerequisite of planni
of a quantity surveyo
expertise to advise at
Professional fees ano
Professional fees cha
account for 12-15 pe
of the building. Chari
and building regulati
Site acquisition, tl
will involve fees, eh
contribution to the p
for prospective tenan
of short-term finance
developer is registen
recoverable. Charitu
regard to VAT, and
Contingencies
An allowance in the
is made to cover th
where significant are
Short–term finance
Short–term finance i
for professional sen
architect. The moni
Three distinct elem(
building costs, profe
period following co
refinanced) .
!
The residual method 119
[rs own cost experience. Price books such as Span’s or Laxton’s give a wide range
of price information; the Building Cost Information Service (BCIS) provides a
price subscription service under the auspices of the Royal Institution of Chartered
Surveyors (RICS). An edited extract from RICS BuildingCost Information Service
is given in Appendix A.
The proposed development will be measured, typically off plan, to reflect the
total letting space. It is important for the measurements to conform to the
standards laid down in the RICS Code of Measuring Practice (CMP) (2007a).
The calculations should also include associated items such as demolition, site
clearance and preparation where relevant. With an ever-growing emphasis on
environment, costs may include the remediation of ground contamination as a
prerequisite of planning permission. The valuer may be able to obtain the advice
of a quantity surveyor; alternatively, the development team may have sufficient
expertise to advise at this stage.
m it is usually
.cherne would.:
tion allocated
Professional fees and charges
Professional fees charged by architects, quantity surveyors and engineers might
account for 12-15 per cent of the construction cost depending on the complexity
of the building. Charges are levied by the local authority for planning applications
and building regulation approval.
Site acquisition, the development itself and any sale of the completed scheme
will involve fees, charges and expenses. The developer may agree to make a
contribution to the professional fees of other parties (for example, as an incentive
for prospective tenants) and will be responsible for any arrangement fee in respect
of short-term finance. Stamp duty land tax (SDLT) will be payable. Where the
developer is registered for VAT the amount paid can be ignored, as it will be
recoverable. Charities and certain other groups are in a different position with
regard to VAT, and it may be necessary to provide for all or some of the charges.
erent types of
nd residential
rrnbination of
rve.
o consist of a
npleted value
igation.
Contingencies
An allowance in the region of 5 per cent of the combined building costs and fees
is made to cover the cost of unexpected items. The allowance may be higher
where significant areas of cost have not been resolved in the early stages.
ontingencies,
example, fees
lay make the
e site. At this
for.
a contract is
II be gathered
ures based on
Short-term finance
Short-term finance is required to provide working capital to acquire the site, pay
for professional services and meet interim and final certificates issued by the
architect. The money is borrowed and interest paid for the period of the loan.
Three distinct elements require finance: the land acquisition; the construction (the
building costs, professional fees and incidental expenses) and the void period (the
period following completion of construction until the development is sold or
refinanced).
I ‘I’I’ I
li I;
120 The residual method
Figure 7.5 Interest incurred during the stages of development – shown shaded
Land acquisition
Borrowing for the land purchase will be a constant part of the total finance
package to cover the site purchase, fees and associated preliminary costs. This is
shown diagrammatically in Figure 7.5. Where there is a void period, the land
element together with the construction costs need to be financed for an uncertain
period beyond physical completion of the works.
Construction
Borrowing for the construction phase requires progressive access to the total loan
negotiated to enable payments to be made as costs are incurred. Where it is
possible to predict the rate and timing of expenditure, a more sophisticated cash
flow approach can be adopted. Otherwise, an accepted ‘rule of thumb’ is to
calculate the total interest on the build costs and to assume that, on average, half
that amount will be borrowed over the period. This allows for the fact that not all
of the loan will be drawn down at once but at intervals. This approximation
provides a quick estimate of interest payments where the detailed construction
and project plan are not available.
Void period
In the case of a commercial property development, once it is completed the
premises are available for occupation. However, there is no certainty that a
tenant or tenants will have been found by this stage so it is prudent to allow a
void period by the end of which the building will be occupied. Many commercial
developments are speculative, built in the belief that tenants can be found for the
space created. Where possible, the developer will agree sale terms with an
institution or other investor to take effect once the development is complete and
fully let.
£ Marketing the deve
but it is unlikely that
occupation. Until thi:
required to cover all
charges.
Where short–term f
similar lender to meei
property development
1).egotiated may also ré
development cost, th.
track record and fina
developer’s‘ best bid f(
valuation even if a de
of its own funds. This
in the valuation and
effectively paying twi
event that there is sti
anxious to secure an
expected return on i
item.
Where an investm
development, it may
Advertising and ma
Advertising and mal
high and not enti
anticipated, it may
increase the budg
advertisements in r
site boards, show b
and other publicity
also provides a flexil
and a budget shoul
queries and expressi
proposed campaign
as a percentage of
considerable experi
– Agency fees
In the case of a cc
units in the camp
entity. Where joir
Agency fees also a
ce
is
:ld
in
an
is
sh
to
alf
111
m
m
le
a
a
al
m
id
The residual method 121
Marketing the development will take place before construction is completed,
but it is unlikely that all the space will be let by the time that it is ready for
occupation. Until this point is reached, short-term finance will continue to be
required to cover all the costs of land purchase, construction fees and other
charges.
Where short-term finance is required it is usually arranged through a bank or
similar lender to meet the developer‘s need to borrow funds. The perception of
property development is that of a higher-risk activity. However, the interest rate
negotiated may also reflect the size of the loan, the proportion it bears to the total
development cost, the existence of a pre-letting or forward sale, and indeed the
track record and financial reliability of the developer concerned. In assessing a
developer‘s best bid for the land, finance costs should be included in the residual
valuation even if a developer is acquiring the land and financing construction out
of its own funds. This ensures that the opportunity cost of that money is reflected
in the valuation and avoids the calculation of a bid price where the developer is
effectively paying twice for the land and thus bidding away potential profit. In the
event that there is strong competition for a site that the developer is particularly
anxious to secure and develop, the firm may choose to forgo some or all of the
expected return on internal funding by adjusting the amount included for this
item.
Where an investment fund is sufficiently interested in acquiring the completed
development, it may be the institution that also provides the short-term finance.
Advertising and marketing
Advertising and marketing are crucial to the development. Publicity costs can be
high and not entirely predictable; where lettings are not taking place as
anticipated, it may be necessary to re-launch the marketing campaign and
increase the budget by a significant amount. Expenditure may include
advertisements in newspapers and magazines, radio and television advertising,
site boards, show buildings or suites, on-site negotiators, printing of brochures
and other publicity material, press releases and general launch costs. The Internet
also provides a flexible and effective advertising medium offering extensive cover,
and a budget should be allocated for the monitoring of, and response to, online
queries and expressions of interest. The allowance is best estimated by costing the
proposed campaign and adding a margin; it is inappropriate to calculate the cost
as a percentage of the capital or rental value unless the developer has had
considerable experience with the particular type of development.
Agency fees
In the case of a commercial property agency fees are incurred in the letting of
units in the completed development and the investment sale of the tenanted
entity. Where joint agents are appointed, the total costs are likely to be higher.
Agency fees also arise upon the sale of residential properties to owner-occupiers
I’
–II !I,
~ . I
, ”
122 The residual method
or investors. The sale of a residential property to an investor does not normally
carry the expectation that the agent wil! find a tenant for the purchaser ahead of ‘
sale.
Fees wil! usually be expressed as a percentage of the estimated rental value used
in the ODY. Investment sale fees represent the purchaser’s prospective costs of
acquisition, to include an agent, solicitor and stamp duty, with investment sale
fees amounting to some 6 per cent of the! sale price. The purchaser deducts the
sale fees from the ODV to arrive at the net price to be paid.
Other costs
Other costs may be incurred in compensating outgoing tenants or in winning the
consent of occupiers of adjoining property (for example, infringements of rights
of light or allowing a crane to traverse the air space). In England and Wales all
letting and sales transactions will be liable to SDLT.
Developer’s profit
The developer‘s profit and risk will be shown as a cost of the development process.
The amount charged may be a percentage of the net capital value of the completed
development or a percentage of the total costs involved, the allowance typically
ranging from 10-25 per cent.
The level of profit and risk will be judged on the complexity of the proposal,
the volatility of the outcome, the prestige of association with the particular
development and the extent to which the profitability may be assured (possibly in
part by a prearranged sale to a fund or investor).
Land value
The gross amount available for land purchase is found by deducting the gross
development costs from the net development value.
The remaining figure, the surplus, includes not only the cost of the site, but
also fees, SDL T and finance charges in acquiring the site and holding it until the
development is fully let and income-producing and thus capable of disposal in the
investment market.
The net amount after deduction of costs is not a value in the strict sense,
merely an indication of the maximum bid the particular developer can afford to
offer for the site if the required returns are to be achieved on the basis of the
information available.
The following example demonstrates the whole process in relati:on to a
proposed office development. The accompanying commentary gives a step-bystep explanation of the valuation.
Example 7.1
A developer wishes to acquir
permission has been grantee
internal floor area (GIA) of
arranged over three floors sen
provided for 20 vehicles. The
region of £150 per square mel
cent and the completed dt
Construction costs are estirr
period of 12 months. It is e:
within three months of comp
Advise the company as to ;
allowing for profit of 15 per c
Estimation of site value
Estimated rental value 1,200 sq.rn
Years’ purchase in perpetuity @ 6%
Gross development value
Deduct costs of sale @ 5%
Net proceeds of sale
Gross development costs
Gross area 1,500 sq.m @ £:
Surface car parking
Contingencies @ 5%
Professional fees@ 15%
Short-term finance @ 9% f(
On construction costs (aver:
On fees (average 75%)
On total cost + finance over
period (3 months)
Agency fees
Fees @ 10% of rents
Marketing campaign
Total costs of development
Developer‘s risk and profit
15% of GDY after costs
Surplus available for land p
Present value £1 for 1.25 ye,
Gross site value
Deduct site acquisition cost1
Maximum available for site
The residual method 123
Example 7.1
A developer wishes to acquire a site in a provincial city where outline planning
permission has been granted for the erection of an office block with a gross
internal floor area (GlA) of 1,500 square metres. The accommodation will be
arranged over three floors served by two passenger lifts and surface parking will be
provided for 20 vehicles. There is a steady demand for office suites at rents in the
region of £150 per square metre. Short–term finance is available at a cost of 9 per
cent and the completed development should show a yield of 6 per cent.
Construction costs are estimated at £1,000 per square metre with a building
period of 12 months. It is expected that the whole of the space should be let
within three months of completion of building works.
Advise the company as to the maximum price it can afford to pay for the land,
allowing for profit of 15 per cent of the development value.
Estimation of site value
£ £ Note
Estimated rental value 1,200 sq.m @ £150 per sq.m £180,000 a
Years‘ purchase in perpetuity @ 6% 16.6667 b
3.
d
Gross development value
£3,000,006 e
Deduct costs of sale @ 5%
£150,000 d
Y Net proceeds of sale
£2,850,006 e
1, Gross development costs
rr
Gross area 1,500 sq.m @ £1,000 per sq.m £1,500,000 }
n