Neil Crosby Pat McAllister Peter Wyatt

www.reading.ac.uk

School of Real Estate and Planning

Henley Business School

Fit for Planning? An Evaluation of the Application of Development Viability Appraisal Models in the

UK Planning System

Neil CrosbyPat McAllisterPeter Wyatt

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Agenda

• What is a development viability assessment?

• Why have development appraisals become important in the UK planning system?

• Will address two questions about their application– To what extent are development appraisal models internally

coherent ? – Is there clear guidance and agreement about assumptions

and approach on how they should be applied in the planning system?


What is development viability appraisal?

• Conventionally, development appraisals are used – To estimate land value (land value at which development feasible?)– To estimate profitability or return (financial surplus generated by

development scheme)– A framework for negotiating between developers, landowners and other

stakeholders in the development process i.e. planning authorities.

• Land Value is the residual surplus after the expected costs of development have been subtracted from expected revenues and an appropriate allowance has been made for a profit/return to the developer.

• This project appraisal method is used rather than indirect comparison because of heterogeneity in sites’ capacities to generate revenues and in the costs of creating those revenues. It is a single time point estimate in a dynamic market through time.


Why have development appraisals become important in the UK planning system?

• Allmendinger (2011) - Four attempts to tax development gains in UK since WW2 - the 1947 Development Charge, the 1967 Betterment Levy, the 1973 Development Gains Tax and the 1976 Development Land Tax.

• Since 1990, current regime is Section 106 agreements which detail payments to Local Authority for the planning permission

• Planning Obligations typically take the form of provision of affordable housing for residential developments over a certain threshold size, as well as payments for infrastructure, amenity and public service provision (Monk et al, 2008).

• Campbell and Henneberry (2005) identify the shift towards putting financial viability at the heart of negotiations for planning gain.

• 2010 implementation of Community Infrastructure Levy (CIL) - a standard charge based approach for offsite infrastructure.


Implications

• There are arguments regarding whether Planning Obligations are a a tax on development value or a mitigation of the effects of a development, but reality is that payments now have to be set in a viability framework.

• Planning obligations have to be economically viable.• The aim according to the Draft RICS Guidance Note is to produce

an “An objective economic viability test of the ability of a development project to meet planning obligations, whilst ensuring an appropriate site value for the landowner and a market risk adjusted return to the developer in delivering that project”

• Implies three major stakeholders in the added value from undertaking the development – landowner, developer, LPA.


Development appraisal

• Two major research questions– Intricacies of DA models– Application to DVA

• Intricacies of the model relate to relate to the type of model (residual or cash flow/discounted cash flow) and the inputs and their application within practice.

• Application to DVA relates to the use of the models to identify the allocation of the gains from development to the developer, landowner and the community.


Model composition and use in practice

• Case studies, appraisal texts, proprietary models suggest:– Basic residual technique used quite regularly to assess

development viability– Cash flow applications also applied quite regularly but issues

include:• Profit put in as a lump sum even though cash flow discounted at the

target rate of return includes “profit”• Target rate identified as the borrowing rate, even though completely

different risk profiles for bank and developer• Finance assumed on 100% of outlay including land value –

hypothetical infinite yields to equity• Some include value and cost change, some do not, little

amendment to target rates/interest rates.

– Little of this accords with finance theory and application and with applications in property investment appraisal.


Applications in the UK Planning System

• To provide a basis for negotiating developers’ planning obligations at the level of the individual site or scheme

• To provide a basis for assessing whether area-wide policies regarding planning obligations or land designation proposed in Core Strategies and Development Property Documents are economically viable.


Application of DA to DVA Residual is the land value regardless who owns it and how much they paid for it.

Theoretically, developer’s return stays relatively static within the cost base and therefore the POs are paid out of the land element.

What uplift over the EUV will persuade the landowner to put the land up for development?


Threshold Land Value

• So a fundamental question is how much of the uplift from the permission goes to a landowner to persuade them to release the land for development.

• Homes and Communities Agency suggests three approaches– Market Value of land based on price signals from land

transactions– Market Value of land expressed as a proportion of gross

development value– Market Value assuming current use plus an incentive


Threshold Land Value

• Market Value of land based on price signals from land transactions– Circular argument – MV under these circumstances includes

the hope of getting the planning permission. It therefore must also include the perception of the POs that will attach to it. But DVA is an assessment of what should be paid if the PP IS granted.

• Market Value of land expressed as a proportion of gross development value– Assumes that there is a relationship between GDV and land

price which there is not. If there were we would not need residual techniques taking into account costs of development in the first place.


Market Value assuming current use plus an incentive

• POs should come from the uplift in value before and after the planning permission, but taking no account of hope value of that permission.

• Basis should therefore start with an assessment of EUV.• But landowner would not bring land with development potential

forward if no gain (because there is still hope value for something)• So needs to be EUV as the bottom line - plus the incentive• Top line is the land value excluding POs but landowner knows that

is unrealistic within the policy framework.• So what is fair to both Community and landowner???????


A few other issues to consider

• Landowner/developer sunk costs in the site. – Will they flow through into existing use land value – no – but will they

flow through into residual land value for the proposed development – yes.

– They should be added to EUV if that used as a framework for negotiating POs.

• Changing residual values through time– Land values notoriously volatile. (London land price volatility 2.5

times London house price volatility 1984-2009)– Viability very sensitive to differential changes in GDV and Costs, i.e.

the latest financial crisis and property crash. But developers get high rates of return purely because they take the risk.

– If POs change through time, LPAs are risk sharing and should consider both the advantages and disadvantages of fixing POs rigidly through a scheme


Conclusions

• Development appraisal is a much less well developed application of appraisal compared to investment appraisal and applications do not accord with developed “finance” theory.

• Preliminary observation is that applications of DA to DVA across different LPAs (both in assessing area wide studies and individual sites) are very variable.

• But there is potentially a framework within the residual value concept for determining planning obligations and payments.

• However, this framework can only set the parameters and the final sharing of development gains needs to be addressed by policy makers.

• Also developed in the paper but not in this discussion, there is a huge mismatch between the individuality of each development site and the homogeneity required by some applications of DVA, especially to area wide modelling of POs