Brief on Stamp Duty Land Tax

*Disclaimer – Please Note:  I am NOT an expert in taxation and the information provided below should NOT be taken as definitive advice.  It is for guidance only.  All readers and propospective investors/developers are highly advised to seek professional advice in taxation matters.

Stamp Duty Land Tax (SDLT) was introduced in 2003; and although it is often still known as ‘Stamp Duty’, it is now different from it.

The original Stamp Duty was first introduced in 1694, and was a tax on documents (i.e. documents used in transactions).  Several years ago, Stamp Duty was referred to as a ‘voluntary tax’.  This is because there wasn’t much control over registration for it (it was meant to be compulsory).  Now however, there is no escaping it.

Stamp Duty (as opposed to SDLT) is payable at the point of purchase, on transactions that are evidenced in writing.  When the duty has been paid (this should be within 30 days to avoid penalties), the Stock Transfer Form (in the case of shares) is stamped.  HMRC delegates the determination of the Head Charge to the Stamp Office who states the amount of stamp duty that must be paid.  Stamp Duty Reserve Tax is payable on electronic transactions (such as some company share purchases).

The property equivalent to Stamp Duty is SDLT.  It is paid in the following circumstances:

  • At the point of purchase (on qualifying properties)
  • At the commencement of a long-leasehold occupation
  • At the commencement of commercial tenancy agreements, where the total rent payable before the tenant’s first opportunity to ‘break’ amounts to a sum that qualifies for SDLT.

Current SDLT rates are:

  • For properties up to £125,000, the rate is zero.  No SDLT is payable.
  • For properties from £125,000 to £250,000; the standard rate is 1% of the property value , and for first-time buyers, it is zero.
  • For properties from £250,000 to £500,000; the rates for standard and first-time buyers is 3% of the property value.
  • For properties from £500,000 to £1m, the rates are 4%.
  • For properties over £1m, the rate is 5%.

From late 2014, SDLT on residential property is tapered, like income tax.  This means that if the value is over any of the thresholds, the whole value is not taxed, just the amount that is over the threshold.

So, if a property is bought for £330,000; the amount of SDLT (at current rates) payable is £1,250.00 (1% of £125,000) plus £2,400 (3% of the remaining £80,000) = £3,650.

Prior to this change in the rules, there tended to be an accumulation of property values at just below the threshold values.  For example, there were many properties for sale at around £249,950 but not many at £255,000 (assuming these values are the sale prices).

It must be stressed, that SDLT is paid by the purchaser (although the Coalition Government is understood to be considering plans to transfer the SDLT liability to the vendor).  It must also be paid in a way that is completely separate from the mortgage.  I have heard of first time buyers enquiring whether they can include the SDLT charge in their borrowing from the mortgage company.  This is not permitted!

If a new leasehold property is occupied by a tenant, the rates are:

  • For tenancies that total less than £125,000 for the life of the lease, no SDLT is payable.
  • For tenancies that total more than £125,000 over the life of the lease, 1% of the value that exceeds £125,000 is payable (so if a tenancy will total £130,000 over the total lease term, £50 is payable (1% of £5,000)).

Clearly, the lease term and rent would have to be quite substantial to qualify for this.

On commercial property, slightly different rates apply.

For properties that are not newly built:

  • For purchase values up to £150,000; or annual rent is below £1,000, the rate is zero.
  • On purchase values up to £150,000; or annual rents above £1,000, the rate is 1%.
  • For purchase values between £150,000 and £250,000, the rate is 1%.
  • For purchase values between £250,000 and £500,000, the rate is 3%.
  • For purchase values above £500,000, the rate is 4%.

For commercial properties that are newly built:

  • For tenancies with a term-value of up to £150,000, the rate of SDLT is zero.
  • For tenancies with a term-value of more than £150,000, then 1% of the value that exceeds £150,000 is payable.

Because SDLT is payable on the transfer of an interest in property, liability can arise when a property is transferred into or out of a Partnership.  This is (as I understand it) one of the most challenging areas of property tax but I will attempt to expalin as well as I can…

  • The relationship between partners is important.  If 2 family members form a property investment company, no additional SDLT is due over the usual purchase liability.  So this means that provided SDLT was paid by the family members on acquiring the respective property interests, no additional SDLT should be due when the interests are transferred to the partnership.
  • If an unrelated partner joins (i.e. not a family member) any tranfer of a property interest into the property investment company will attract SDLT.
  • If the individual members of a property investment company decide to go their seperate ways and transfer the interests in properties between them, 2/3rds of each individual’s interest will be liable for SDLT.
  • If an individual purchases a share in a property investment company (for example 25%), then that person is liable for that proportion of the property interest (so 25% of the combined property interest for SDLT would be payable).

For further information on SDLT, a visit to the HMRC website is recommended – http://www.hmrc.gov.uk/sdlt/intro/rates-thresholds.htm

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The Effect of Contamination on Development Land Value

Developing a property on contaminated land is not as ridiculous as it first seems.  Contaminated land is a massive problem for developers because:

  1. The sheer amount of contaminated sites across the UK.  There are an estimated 50,000 – 100,000 potentially contaminated sites in the UK which in total, which cover around 1% of the UK landmass.
  2. Very large companies and government agencies such as Shell, Esso, British Gas and the MoD regularly dispose of large amounts of land which will be regarded as contaminated.  In some circumstances, the very fact that certain activities have been carried out on a plot, automatically labels the area ‘contaminated’.
  3. The owner of an area of land where contamination is found to have originated from is often liable for the clean-up costs.
  4. Successive UK governments have encouraged development on brownfield sites in preference to greenfield.   This makes developers consider purchasing contaminated sites more readily.
  5. Contamination has a very large effect on property/land value.

But, to completely disregard contaminated land as ‘undevelopable’ would be to intentionally miss out on many opportunities.

Contaminated Land @ The Property Speculator

© Copyright Evelyn Simak and licensed for reuse under this Creative Commons Licence

The contamination will have the effect of reducing the value of the land or property because of:

  1. The original cause of the contamination.  I.e. what the substance was/is that resulted in the contamination.
  2. The general response to the scope of the contamination, both by the potential purchaser and the Local Authority.
  3. The amount of work required to establish the level of contamination and what has to be done to remedy it.
  4. The resulting effect on the eventual sale or letting value of the property.

Roughly, costs involved in a contaminated site can be categorised into Direct and Indirect.  Direct costs include the funding of remedial work, and penalties for not following exactly what the local council require and in the case of a commercial investment property, a void period – where the occupants must be moved out in order to carry out the work.  The indirect cost is tricky to quantify; it is associated with the effects and public perception of contamination.  A desirable area can quickly become not-so-desirable when the public discover that contamination has occurred.   This perception can be a very individual view among prospective purchasers or tenants.  This is known as Stigma.

The actual calculation involved in establishing a basic development value on a contaminated site is really not too different from a standard Residual Appraisal.  The formula for which is:

Value of land = GDV – (Build Costs + Required Profit)

To add the contamination component into the equation produces:

Value of Land = GDV – (Cost of Land Remediation + Build Costs + Required Profit)

However, this might serve to over simplify things a bit too much.  This does not take the element of Stigma into consideration.

Stigma, when used in the context of contaminated land can be defined as:

“the blighting effect on property value caused by perceived risk and uncertainty in the effectiveness of contamination remediation”.

To put it another way, it is the difference in value between a remediated contaminated site and a comparable “clean” site with no history of contamination.

These uncertainties are based on intangible factors such as:

  1. Scepticism over the effectiveness of land remediation.
  2. The risk of inadequacy of the remediation process.
  3. The risk of changes in legislation or remediation standards leading to further work.
  4. The difficulty in obtaining finance.
  5. A general fear of the unknown.

It might be argued that this general reluctance to use previously contaminated land is justified.  Many people believe the term ‘remediation’ is simply another term for clean-up.  It isn’t.  The term ‘remediation’ simply means that the level of contamination on the site has been reduced to a level below that specified by the Environmental Agency.  The term ‘Caveat Emptor’ (‘let the buyer beware) springs to mind here.

Clearly, because the influence of Stigma is difficult to quantify, it’s also difficult to measure.  What can be done, is analyse the behaviour of experts in this field:

During the summer of 1998, a four-page mail questionnaire was sent to a targeted, preselected group of 208 Property appraisers in the United States and Canada. The target group consisted of 192 appraisers in the United States and 16 in Canada.

Of the participants, nearly 60% (49) reduced rental income to account for on-site contamination. However, some comments indicated that a noticeable number of respondents found no impact on the rental income of contaminated properties that were used for commercial, retail, or industrial purposes. Several additional comments indicated that some respondents also used increased operating expenses when valuing a contaminated property.

While 73% of respondents reported that they occasionally made a separate deduction for stigma, only 26% indicate that they did so as often as 75% of the time. The uncertainties and risks associated with cash flows from a contaminated property are most frequently reflected in decreased estimates of value via sales comparison analysis (73%), followed by an increased capitalization rate (66%) or an increased yield, or discount, rate (61%).

All but one of the respondents said they would not ignore anticipated or forecast remediation costs in valuing contaminated properties. Some 60% indicated that they would deduct the present worth of total remediation costs estimated by environmental experts.

Although it seems to stand to reason that properties built on previously contaminated land are negatively affected, the degree of this effect is not necessarily substantial.  In the last decade or two, technology and methods have improved a great deal to make remediation techniques much more effective. I have personally dealt with previously contaminated land where a client intended to build a new, high-profile office block.  The value of the site was scarcely different to a comparable site with no history of contamination.

To quote a case study, results from a study of the market sales data of post-remediated vacant residential land along the Swan River, in Perth, Western Australia, from 1992-1998 can be looked at. The intention of the study was to establish the amount of “stigma” arising from a site’s contamination history.  The effects of this were measured on residential property values of remediated property. The results showed that while a site’s contamination history impacts negatively on property prices, the price decreases were offset by the positive influence on price from additional amenities provided in the area where the case study was carried out.

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The Growth in Investment of Online Estate Agencies

Over the past few months the world of estate agents has seen a rise in the investments being made in online estate agencies.  With some big names entering the arena, we wonder if we will see a long-term change in the industry…

We only have to go back to December 2013 to see the first significant investment made in an online estate agency when James Caan of Dragon’s Den fame made an investment in one of the country’s biggest online agents, Emoov.  As well as his money, Caan also became the face of the company.

Prior to Caan’s investment, Sarah Beeny of a similar celebrity status announced the online expansion of her sales portal, Tepilo.

On top of both of those, and more recently, the online market saw the biggest name enter the fray.  Sir Stelios Haji-Ioannou of Easyjet fame announced that he will be joining the competition with his own online estate agency, Easyproperty.

Recent reports also suggest that two more online agents are set to make waves in the digital market places.  Both EstatesDirect and PurpleBricks have received significant backing from investors.

DatingDirect, who sold out to Match.com for £30m in 2007 are putting money into EstatesDirect, whilst famous High Street store Poundland are investing in PurpleBricks.

Perhaps now is the time to sit up and begin to take notice of where the world of estate agents is heading.

So are these online estate agents, with their big financial and business backings going to change the face of the industry forever?

At the recent My Home Move Brick + Click event in Solihull, an interesting panel debate between three well-known estate agents took place.

Jon Cooke from YourMove, in favour of traditional estate agents argued that they would not be affected by their online counter parts, saying they still offered better value for money despite charging “extortionate” agency fees when negotiating a sale.

Miles Shipside from RightMove showed results of a survey from their large database of users that revealed some interesting data.

According to Miles, these are the top decisions that influenced a seller’s decision:

  1. Agent’s reputation
  2. Quality of response to my enquiries
  3. Presence of property portals
  4. Low fees
  5. Recommendations (friends + family)

With ‘low fees’ ranking as the fourth most important factor, notably behind an agent’s reputation, online estate agencies will have their work cut out for them.

Adam Day from one of the first online estate agents; Hatched; was keen to defend and promote technology that gives his company, and companies like his, an advantage over traditional agents who aren’t taking the digital world as seriously.

Mr Day was quoted as saying:

We know how traditional estate agents work and have adapted their systems with technology to give the customer a better experience.

The co-founder of Hatched was also confident that more people will move towards the online sphere when selling their property with the perceived value of the seller working in their favour and traditional estate agents’ dismissiveness of the digital world.

So will the more established brands like Hatched, HouseNetwork or HouseSimple prevail in the long run?  Or will they lose a significant part of the market share with heavy investment from the competition?

Financial backing certainly has its advantages, but it is by no means a guarantee for success.  When it comes to choosing an estate agency, we have previously mentioned the agent’s reputation.  On top of this, an agent’s experience and knowledge will also plays a vital role.  Three things money cannot buy.

For an example of this we should go back to 2008 when WOWProperty became the very first online estate agency to receive significant investment.  They have over £1.75m in their kitty, but little more than a year later the company had all but disappeared.

WOWProperty attempted to build history from thin air whilst consumers opted for more established businesses; those that had invested time forging bonds of trusts with their clients.

The modern era of online estate agents has been quietly building for a number of years now and the recent investment suggests it’s almost certainly going to grow.

Barrie Smith attended the MyHomeMove Conference in 2014. An expert in making offline businesses successful in the online space, he was intrigued by the huge investments in online estate agencies, and the current debate around the merits of the online vs offline property sales business models.

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Is the tide turning for London’s Eastern Fringe?

After ‘location, location, location’ the phrase ‘the ripple effect’ is probably one of the most heard when it comes to making that crucial decision, where you should base yourself. And this decision is no less important for the commercial occupier than it is for the residential purchaser.

In London, however, it’s complicated. Given London’s sprawling nature and its ‘city-of-villages’ structure, those ripples overlap; some are stronger, some weaker. Tenants may want to be a stone’s throw from a transport hub or a buzzing street, but wherever that stone lands, its ripples will be felt further out. Not all tenants are brave enough to see where this takes them, but given the rise of rent in the capital and the scarcity of office space, it may be worth prospective tenants looking where others have not yet discovered.

So, where might this be?

The cheapest area is the Eastern Fringe side of the city as well as the area from the east of the City towards the Docklands. At the moment, at the highest end of the market in the eastern fringe, tenants can expect to pay around £25 per square foot – a fraction of the sums in other, more popular, areas of the London.

The reason behind the cheaper rent is simply because there is currently more supply than demand. The problem with the supply is that the quality isn’t great (yet). The problem with the demand is that there isn’t much (yet). The fact is, at present, many of the buildings are tired and not what tenants want in terms of facilities, appearance, or fit-for-purpose-ness, hence the lack of demand.

While the transport links are there, and will continue to improve with Crossrail in 2018, the area isn’t necessarily where clients want to find themselves. Of course, some tenants may be able to work around this, particularly if all their business is conducted online, for example, where meeting face-to-face with clients is a rarity.

Alternatively, the fast-rising number of serviced office buildings that offer meeting spaces in the more popular districts of London means that the one-off hire of a meeting room could be a solution for a business owner who doesn’t want their clients to see their cheap but not-so-cheerful premises.

The lack of demand at present may be a result of caution on the part of the tenant winning out over the need to save money on rent. Businesses considering a move to this area may face challenges in recruiting or retaining staff, as the amenities and social spaces are in short supply compared to other areas of the city.

The Above Factors Will Start Fading in Significance

Many of the buildings are undergoing development as landlords see the potential to attract more and better-quality tenants, resulting in improved longer-term rents. Aldgate will be the location of a new development, another step towards an improvement in the area, one that began with targeted regeneration plans in 2007. Goodman’s Fields, the site of an RBS cheque-clearing centre, will be a mixed-use seven-acre development of offices, apartments, retail and restaurants, the first phase of which is due to be completed next year.

Prospective tenants may need to be canny in assessing the best time to jump into the Eastern Fringe and beyond. Too soon, or to the wrong kind of property, and business may be affected: too late and rents might already have started to increase. Some tenants may in fact be ‘pushed’ rather than ‘pulled’ to this area when their leases elsewhere – originally negotiated in cheaper times – come up for renewal or review and the resulting rent increases, meaning that staying put is not an affordable option.

 The rise of other, formerly neglected, districts can offer much to the Eastern Fringe area in terms of inspiration and what can be achieved. Redevelopments and refurbishments have, over the last few years become more imaginative, to reflect the needs and wants of the TMT (technology, media, telecoms) sector and those who work within it. Old buildings are not necessarily seen as restrictive and untouchable, but quirky.

Refurbishments can also incorporate the technological installations that businesses of all sizes require now as standard, although such retro-fitting does not come without challenges – or cost. In addition, without a guaranteed tenant lined up, a landlord may be reluctant to invest this much. There is an element of risk that will need to be assessed and taken by both landlords and tenants before great changes in the scene here are achieved. In contrast, the new developments planned for these areas will offer the blank-canvas option for tenants who want to be based somewhere clean, new and bright – and reasonable.

Serviced Offices: The Way Forward

Serviced offices may be key to increasing the profile of this area and reducing vacancy rates. This sector has seen a meteoric rise not only in London but also across the UK and globally. The flexibility of these furnished, staffed, plugged-in and dressed-up office spaces is what attracts tenant businesses of all shapes and sizes, from the one-man start-up to the multinational. Tenants can try out a few square feet of space, a building, or a location and if it doesn’t work out they can move out just as easily as they moved in.

The lack of long-term commitment needed when signing up to a serviced office means less financial risk for many tenants. Since these buildings by their nature house a number of different tenants, there is also a ready-made commercial community available, which may not be the case if one’s office is sandwiched between a takeaway and newsagents for the next five years. Also, because rent prices in the Eastern Fringe are the lowest in the capital, the serviced office model should be able to offer excellent value for money, as well as sweeteners such as rent-free periods, to tenants who are prepared to take the plunge and start creating their own ripples.

Eugene O’Sullivan, is Director at Morgan Pryce – experts in London office search, negotiation and project management and act exclusively for tenants. For commercial property and offices to rent in Mayfair, Soho, Southwark and beyond, talk to Eugene today.

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10 Common Planning Permission Pitfalls and how to avoid them

Much of what people know about planning permission comes from the media such as the programme Grand Designs, the experience of friends and family, or from objecting or would-be-objecting to a neighbour’s plans.

Of the process – and the cost – many actually know very little, and the wealth of information available on the internet can be a little daunting. It’s hard to know where to start, let alone where you’ll end up and what you’ll go through to get there.

Businesses have more to consider than residential owners, when what you do in a building is as monitored as the physical changes you make.

Without specialist knowledge and with an excess of enthusiasm, it’s easy to make mistakes in the planning process.

Here we introduce some of the common pitfalls when dealing with planning permissions.

1. Do you need planning permission?

First of all, consider whether you actually need planning permission at all. Most areas (conservation areas excluded) benefit from a ‘Permitted Development Order’ (PDO), which means that changes of a certain size or height, or distance from neighbours, do not require planning permission. The rules can be found on the planning portal website but it’s important to look at them carefully and perhaps consult a professional.

If a property has already been extended this might prevent further changes under a PDO. Recent legislation also means that in many areas properties used as offices can be converted to residential under a PDO – although discussion with the council may still be required.

2. Avoid the DIY trap

Do-it-yourself has its place, but the rule to remember is to stay within your skillset. Often it amounts to a false economy to have a go yourself. Consider a tiled wall that slopes, or a door that won’t close. This is no less true when applying for planning permission, which involves certain stipulations, as well as local considerations, technical requirements and possibly specialist knowledge.

‘Having a go’ at the application may be cheaper in the short term, but it may result in a failed application, or with conditions attached that compromise your plans. There are professionals who can assist, for example:

Designers.

These will not only maximise the potential use of space but will be working with planning considerations in mind.

Architects.

As above, but they will also be able to draw up the necessary plans, especially where the works involve structural changes.

Planning consultant.

A planning consultant, particularly a local one, will be familiar with the developments that have been granted permission in the vicinity – and more importantly, the ones that haven’t. They will also be able to help you address areas of your application that might elicit objections from the council, local bodies such as Highways, or neighbours, in order to resolve any issues before they are raised. Planning consultants can also be useful if you have to appeal a decision.

In fact, if you use the above services, you probably don’t need to worry about most of these points.

3. Can you really afford the investment?

There is no point in successfully obtaining planning permission for works that ultimately will prove too expensive to carry out properly. It’s difficult to budget for building works when you’re not an expert in that area.

One option is to obtain a builder’s estimate. It’s not a quote for works, but should give you an idea of how much is involved. Then add 20%. Contingency is always required for items not taken into account and latent problems that only become apparent when the diggers start digging. Also, of course, take into account any ancillary fees, such as professionals’ fees, consents planning and building regulation fees.

4. Adhere to the rules and instructions

Planning permission and the process of obtaining it has evolved over many years. Councils may have different considerations, requirements and restrictions, and a chat with one of the planning officers will always be useful. The forms accompanying the application will need to be filled in properly, accurately and comprehensively.

Every application, from a two-storey extension to a full housing development, will need:

• A location plan – obtainable from, for example, the Land Registry or from the deeds • The existing and proposed site layout • Existing floor plans and elevations and corresponding proposed ones • Proposed sections • External details such as doors, windows, drainage, roof tiles, render.

Faults and incomplete details may lead to a rejected or failed application, or extensive to-ing and fro-ing which is costly in terms of time and money.

5. Planning permission is not the only permission you need

It’s easy to get carried away with the project at hand, however, before planning permission is even applied for – and ideally before any money is spent on professionals – consider who else might need to give you permission for any works or change of use.

If your property is leasehold, it is likely that permission from a landlord or its agent is required. This is easily forgotten in the case of a long-term leasehold house, for example, where the landlord is largely absent other than an annual collection of nominal rent.

If there’s a clause in the lease that prevents alterations without permission, then consent should be sought. This can be an expensive business as landlords will be aware of the importance of the project and may wish to capitalise on your desperation.

If you go ahead anyway without consent, not only will this cause problems when you come to sell the property, but retrospective permission can be much more expensive to obtain from a landlord than permission in advance – because the landlord knows you need it.

Make sure you check the deeds, even if your property is freehold there may be restrictions (restrictive covenants) in the deeds preventing certain changes to the property. This ranges from properties 200 years old to new build properties.

If you’re unsure about any restrictions that might be present concerning your property, arrange to visit your solicitor who will be able to advise you. Often a quick scan of the deeds is all that will be required.

6. Change of use is no exception

It may be tempting where businesses are concerned, particularly small ones, to not allow planning permission to stand in the way of the perfect space, particularly if it feels the changes and/or occupation of the property are likely to be overlooked. It also may be tempting to persuade oneself that one’s business has not changed the nature of one’s home, for example, when in fact the child-minding business has become more like a nursery.

Care needs to be taken and complicated rules taken into account when dealing with use classes. A café owner may find that they have to grill all their meat and roast all their vegetables for their sandwich fillings off the premises (i.e. at home) because the use class of their leased premises does not allow food to be cooked on-site. The last thing a business needs is a visit from the planning enforcement officer and a breach of the terms of the lease. No premises means no business.

7. Don’t change your mind

Once the planning application has been submitted, it can be difficult to make changes, and even harder once it’s been approved. Anything other than minor changes might require a whole new application. So make sure you check and double check before submitting, not after.

8. You can’t get away with not having planning permission

While there is legislation in place that, in certain circumstances, mean action cannot be taken for works carried out over a number of years ago, this is not the situation you want to find yourself in. There is no guarantee your works will fall into this category, and there are stories of planning enforcement to be found in the media or on the grapevine, from dormer windows having to be removed to whole properties having to be demolished. And while you may live or work happily in a property without planning permission in place, the last thing you want when you move on – whether selling the property or at the end of a lease – are questions being asked and delays being caused – or even claims of damages by a landlord – arising from lack of appropriate consent. Solicitors (especially the other party’s solicitors) can be hard to satisfy when it comes to dotting the I’s and crossing the T’s.

Indemnity insurance is possible, but makes some owners and lawyers uncomfortable, while retrospective planning permission is far from guaranteed – and can invalidate or prevent the obtaining of indemnity insurance.

9. Don’t forget building regulations

The flip side of the planning permission coin is building regulations. It would be rare where planning permission is required not to also have to comply with building regulations. These deal largely with internal changes and energy efficient measures as well as gas and electrical works. These will also need to be signed off, often long after planning permission has been done and dusted.

It is vital not to forget the final signing-off for building regs purposes. It’s much harder to get retrospective building regulation approval, particularly where the site hasn’t been visited mid-job and where structural works such as RSJs need to be assessed.

10. Letting your permission lapse

Planning permission will last for a fixed number of years and can be passed on to future buyers. If you are planning on carrying out the works, don’t let the date pass you by. There is no guarantee that the permission will be re-granted or extended, particularly if legislative or policy changes have been introduced in the meantime, perhaps in relation to the ratio of residential property to business premises in a particular area, or where restrictions have been imposed on the number of houses of multiple occupation in ‘student’ areas.

Eugene O’Sullivan, is a commercial property expert and Director at Morgan Pryce – London office search, negotiation and project management agents who act exclusively for tenants.

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Risk Management in Property Investment & Development

Let’s be clear on this, investing in or developing property represents an element of risk to a greater or lesser degree.

Most prospective property developers and investors realise this but some subsequently procrastinate over taking positive steps to progress their venture.  Perceived risk can include:

  1. Getting a property project only partially complete before running out of cash.
  2. Experiencing a problem during build of such scale that the contingency fund does not cover it.
  3. Finishing the build and not being able to sell or let the property in order to recoup costs.
  4. The property build/conversion will cost so much that the developer with experience substantial financial hardship in order to get it finished.

All these concerns can be effectively managed and guarded against prior to the start of the project.  This is where a particular approach is vital; these risks should not put anyone off engaging in a property development or investment project.

Vacant Development Property @ The Property Speculator

© Copyright Jeremy Bolwell and licensed for reuse under this Creative Commons Licence

Risk is the ‘price’ of the return from a venture.  It’s been said that ‘the higher the risk, the greater the reward’; however this seems (to me anyway) to be a contradiction in terms.  If risk is high, then there is no guarantee of reward at all.  People generally have very differing views on the amount of risk they are comfortable to adopt.  However, if a developer is looking to borrow in order to fund the purchase and renovation/conversion of a property, then the mortgage provider will be very keen to see the project organised as low a risk as possible.  This includes the developer putting around 50% (for first-time developers) of their own money into it.

So in conclusion, it’s important to minimise risk wherever possible.  And to be honest, property is one of the lower-risk methods of investment and capital building.  It’s not THE lowest, but there are far riskier investments available to those with the appetite.

To address the points above in turn:

1.   Running out of cash mid-project.

This element of risk is managed by careful planning of the project.  Many novice developers run low on cash, but it’s almost always because the budget has not been organised properly.  The principles of running a financially viable project are:

  • Purchasing the property at a good price.  It takes time to select the right property; it must fulfil many criteria – purchase price being one of the most important.  If you are purchasing at an auction and the bid goes above your maximum level, you MUST resist the temptation to continue bidding.  In my experience, if one opportunity has come along, then the chances are that another is not far behind.  Once in a lifetime chances are just not that common.  It’s far better to purchase a property at a good price and sell at an average one, rather than buying at an average price and hoping to sell at an exceptional one.
  • Agreeing a fixed-price contract with the builder.  This is insisted on in many cases when obtaining development finance.  It should be possible to agree stages of build with the contractor, where you pay a proportion at the end of a stage before moving on to the next.  The agreement is likely to specify what is not covered in a fixed-price agreement.  This might be substantial ground work or structural alterations.  This is all in the negotiation.
  • Sourcing materials shrewdly.  This might fall into the principle above, but if you intend to do it yourself, approach it as a business and not a personal ‘statement’.  Buying the property and approaching the building work with your head, not your heart helps so much in this.  Keep in your mind that the aim is to get the property let or sold and move on to the next.

2.   Blowing the contingency fund on an unforeseen problem.

A contingency fund is an excellent idea.  This is usually around 10% of the whole project budget.  A fund of this amount will actually be a condition of borrowing with many companies (you’ll have to produce proof of the amount in a bank account).

So if a whole project budget is £240,000 for example, a contingency of £24,000 should be available in addition.

If the principles above are followed, there really should not be any reason for unforeseen problems to require more than 10% of the budget to rectify.  Ground, structural and roof problems are usually the most expensive to sort out, but almost all of these can be taken into consideration if a good survey is carried out prior to purchase.  Excessive build/conversion costs are another one of the criteria that should be considered before purchasing the property.

In some cases, problems do arise that there really was no way of knowing about before the project is bought.  In this case, a degree of imagination is sometimes called for to resolve it without blowing that contingency fund.  The most expensive and challenging problems are things like disused wells or buried objects.  However these are rare.

3.   Not being able to sell or let the property at the end of the building phase.

This is a problem that has affected many aspiring property developers over the past 4 years.  As mortgage companies suddenly tightened their criteria for lending, the amount of buyers across the market as a whole reduced to such an extent that demand came to an abrupt halt.

This might be regarded as the greatest of all the risks involved in a property venture.  It is theoretically possible to have a property advertised for sale for an indefinite period of time; and this scares the life out of many prospective developers.

Property is widely regarded as being highly ‘illiquid’.  This means that the value cannot easily be released.  The opposite end of the scale is cash; this is obviously a ready source of capital that can be used easily.  Because of the nature of property’s lack of liquidity, it has certain characteristics such as a degree of stability of value (due to the fact that it is a tangible item, unlike for example – company shares).  Unfortunately because of this shortcoming, capital can be ‘wrapped up’ in a property with little way of extracting it.

The way this problem is managed, is again by proper financial management.  To reuse my quotation from above…. far better to purchase a property at a good price and sell at an average one, rather than buying at an average price and hoping to sell at an exceptional one. You must remember this!  In many cases, the reason why properties stay on the market for so long is because they are overpriced for resale.  Sticking to a rigid budget dramatically reduces this risk because there is less chance of financial overstretch.  You should certainly make sure that you have planned for the property to be complete yet vacant for around 6 months after the build.

4.   Experiencing financial hardship in order to complete the build.

Clearly, this is a variation on the perceived risks already mentioned.  Most successful private developers have sufficient ‘surplus’ income to cope with the increased monthly outlay to cover another mortgage.

Some amount of flexibility will be needed to cover unforeseen problems, but the contingency fund will be in place to cover them.

There are not really many valid reasons why novice developers should find themselves enduring financial hardship to get their project completed.

To conclude, sensible and realistic budgeting should go a very long way to managing the anticipated risks involved.  However as I’ve mentioned already, property development and investment is risky; if it wasn’t, there would be no money to be made in it.

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Going Underground

The primary factors that drive the value and selling price of a property up are location and usable area.  These are the 2 main considerations that should be considered when selecting a property or site on which to develop.  Leaving the ‘location’ aspect to one side for now, usable area is a very shrewd way of increasing value and in some cases this can be accomplished fairly easily.

I stress the term ‘usable’ area because (to use an example) if a converted loft is not compliant with building and fire regulations, the additional space cannot be marketed as such.  This often works in a private property developer’s favour because carrying out the work to make the room compliant might not involve that much work.  An example of this might be the installation of a fixed stairway and fire doors.  Expenditure of a few thousand pounds to have this work done can release tens of thousands in eventual property value.

Another way to increase internal area is to extend.  It’s important to have quite a good idea of the size, location, shape and design of the extension before even applying for planning consent or a Certificate of Lawful Development.  A design will be needed (this doesn’t have to be professionally produced at this stage) to illustrate what is planned.  Clearly if the property has not even been purchased at this stage, the consideration must be carried out when evaluating the property.

What I’m working my way round to write about is planning the foundations of that extension.  I hasten to add that any detailed advice on this subject should be directed to either a Building Surveyor or a Building Engineer. That said, it’s extremely useful if you can carry out a very quick assessment of the property yourself prior to purchase so that you have an idea of the viability of the project.  One of the issues I have come up against recently is foundation depth due to the very close proximity of tree roots from a neighbouring property.  To ensure compliance with building regulations (and compliance WILL be checked by the purchasers Solicitor when the property is being sold onwards) the foundations must go down to minimum depths below ground level.  It is not unheard of to find that trees up to 30 metres away from a property can have an effect on the foundations.  Therefore it’s very important that this is considered in your overall property plans.

Conventional strip foundations are not suitable when having to dig so far below ground level.  Deep strip or reinforced trench fill will be better suited.  Pile foundations can also be used and might be more economical.

The illustration and table below (please excuse the standard of my drawing) provides a method of assessing how deep the foundations must go to be sufficiently strong enough to withstand the effects of nearby tree roots.  In addition to this, drains must also be incorporated into the design of the foundations.  Again, a Building professional will be able to provide more detailed information on specific situations.

Foundation depth may seem excessive, but the property or extension must be on a base that can withstand not only the penetration of tree roots but the effects trees have on their surrounds.  Large trees can draw hundreds of litres of moisture out of the ground every day.  This has the effect of soil shrinkage which often results in property damage due to the slight ‘drop’ in the side of the property closest to the tree.  If the tree is removed, the opposite effect occurs and the effected side of the property lifts slightly which can also cause damage.

Another factor to consider when evaluating the proximity of trees is Tree Preservation Orders (TPOs).  You might consider the work involved to put in deep foundations is worth carrying out, however the tree roots must not be damaged as this might harm the tree.  In some circumstances, a local planning authority might consider the removal of a tree to be worth the sacrifice if the development is important.  To be realistic though, it’s unlikely a private development would be considered in this way.

If you think the close proximity of tree roots will compromise your proposed development, speak to a Building professional or the local building control department.

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Why it Pays to Tread Carefully

The vast majority of prospective property developers and investors will have to borrow money (probably in the form of a mortgage) in order to realise their plans and actually purchase a property.  In many ways it appears to make sense to avoid borrowing the funds as an individual (that is to say one of a pair or a group).  This is because a private developer might initially feel slightly intimidated by the scale of the project being considered and invite a friend or associate into the venture.  The main benefit however is that in most cases, it’s possible to combine deposits/equity and borrow more from a bank as a pair than might be possible as an individual.

There is an important point to consider when borrowing in this way though.  Recent research by the Debt Advisory Centre (link below) suggests that 1 in 5 borrowers do not realise that they are very likely to be liable for the whole debt if their partner (business or personal) cannot pay their portion of a joint debt.  Interestingly, 1 in 10 borrowers mistakenly believe that the debt is divided equally between parties.

Borrowers are usually ‘joint & severally liable’ for shared borrowing, such as a mortgage, loan or overdraft – meaning they are both responsible for the full amount if one partner can’t pay their way. But almost one in five respondents to the survey (18%) didn’t understand this.  In fact, just over one in ten (11%) thought each partner is liable for exactly half the amount borrowed, while 2% thought each borrower owes an amount in proportion to their income.  The reality of it is that in a serious financial emergency – such as relationship breakdown or redundancy – one partner could be left with responsibility for the whole debt, regardless of whether they can realistically afford it.

Ian Williams of Debt Advisory Centre comments:

“It’s easy to see how joint borrowing can become a serious problem when one partner can’t afford to repay.  In many cases, relationship breakdowns can cause the problem when one partner refuses to pay. In fact debt problems caused by separation affect one in ten people we help” 

It can be a confusing area – for example joint credit cards are usually based on a single credit agreement with the-first named cardholder responsible for paying the whole balance if things go wrong.  This is in contrast to debt secured on a property; the Mortgagee (the lender) has a ‘charge’ over the property.  This means that the lender has the legal right to take control of the property and sell it in order to recoup its losses.

  © Copyright Stephen Dawson and licensed for reuse under this Creative Commons Licence

Ian Williams goes on to say “Whatever the situation, there is help available. Lenders understand that things can go wrong, and will often agree to an affordable repayment plan if you tell them how much you can realistically afford to pay. If you are struggling to keep up with your debt repayments it makes sense to seek expert debt help sooner rather than later.”

This is not to say that all property ventures should only be approached as an individual, but the research above suggests it’s extremely important to be fully aware of the consequences and repercussions if it doesn’t go according to plan.

For more information on this subject, follow the link to the Debt Advisory Centre, or follow this link to follow on Twitter

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Understanding Caveat Emptor

The term caveat emptor is often used on The Property Speculator site and a thought occurred to me that I should explain it in more detail.

 ‘Caveat Emptor’ simply means ‘let the Buyer beware’.  In terms of property transactions it means that in almost all circumstances, the onus is on the Purchaser of a plot of land or property to find out as much as he/she can prior to committing themselves in the purchase.

That said, if there is a major issue with the property and the Vendor deliberately remains silent or misrepresents the truth in some way, the Purchaser might have a case to claim damages.  For example if construction or renovation work has been carried out that is sub-standard, if the Vendor is aware of this and does not disclose it prior to the sale it is likely the Purchaser will have some right to recourse when it is eventually discovered.

In the case of environmental issues (a common occurrence on brownfield sites), the Purchaser will often adopt any liabilities arising from contamination that has originated from the site during his ownership.  It can often take a substantial amount of time for some forms of contamination to appear.  Just because a site has remained unused for some years, it does not necessarily mean that “all contamination would have been discovered by now”.

 It is the decision of the Purchaser to decide upon how deep the investigations should go.  Commercial developers now place a great deal of emphasis on the results of an environmental survey.  This is carried out prior to purchase and will have an effect on the negotiation of the purchase price.  Environmental consultant fees can amount to around 2%-3% of the build costs for a large commercial project.

© Copyright Gordon Hatton and licensed for reuse under this Creative Commons Licence

 Clearly if the land has been used only as residential for as far back as is possible to investigate, the likelihood of contamination is minimal.  However it is still possible that leakage from an oil-powered heating system or a sceptic tank has occurred on the site.It is highly recommended that a thorough site investigation is carried out and any suspicion of contamination is investigated further.

It’s not just contamination that should be considered.  It is a criminal offence under the Conservation (Natural Habitats &c.) Regulations 1994 (‘the Habitats Regulations’) to deliberately disturb protected species, this can be in the normal course of carrying out building work on a property.  The only defence to this is if the property is a dwelling house (residential property) and the event was an inadvertent consequence of carrying out some action that was permissible.  Bats are an exception to this however and they can only be disturbed if they inhabit the living area of a residential property*.  Therefore it’s extremely important to understand the consequences of what you might be taking on.

* Source – (Disturbance and protected species: understanding and applying the law in England and Wales) Natural England.

If the property poses a threat to the public in general (for example loose roof tiles),the issue must be addressed as part of the purchase process.  The potential consequences of this are 3rd party injury and subsequent legal action against the new owner under the tort of negligence.

Other issues might not be quite so dramatic in their consequences but could still result in a substantial financial loss.  These include:

  1. Sub-surface obstructions.  In most cases, these are not detected until after the site has been purchased.  In one extreme case, several heavily crash-damaged London double-decker buses were discovered buried beneath the surface.  This element of risk should be considered when negotiating the site price.
  2. Hidden mine shafts.  Again, it’s often impossible to detect these until after the site has been purchased.  These are probably more common than one might initially think and (although likely to be expensive) many building contractors are experienced in remediation work.
  3. Subsidence in a renovation property.  Again, many building contractors are experienced in this type of work but there is usually evidence of the problem before it becomes a major structural hazard.  A structural survey can drastically minimise the risk of inheriting this problem.
  4. Complicated easements across the land.  Although this does not represent a particular physical or financial hazard, it can still have a significant effect on the resale value of a property.  Look for things like gates in unusual places within a fenceline.  It could suggest a right of way or a neighbours right of access across the land you intend to purchase.  A conveyancing solicitor should identify this in the local search, but things are occasionally overlooked…

Therefore it’s important to ask the right questions prior to purchase and preferably before a price is agreed upon:

  1. What was the historical use of the land/site/plot (if it isn’t obvious)?
  2. Any disputes with local or regulatory bodies?
  3. What is the history of previous occupants?
  4. What is the planning history of the site (including rejected applications)?

When making enquiries, it is certainly possible the Vendor will reply with a standard answer of ‘not so far as the seller is aware, please rely on own investigations and surveys’.  In which case, the potential Purchaser must make his own enquiries.  There is however an implication that the Vendor has not made his own enquiries into the respective issues.  If it transpires that the Vendor did make an enquiry and subsequently chose not to disclose some problem, financial remediation might be available to the Purchaser.

 When relying on the advice of professionals to make a decision, it is important to ensure they have sufficient Professional Indemnity insurance in place.  If they are of chartered status, it is far more likely they have.

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An Introduction to ‘Pricing’ Development Land

The primary use for a residual appraisal is to produce a figure for land or undeveloped property purchase, in addition it can also be used to:

  1. Establish a required profit from a project and place that figure into the calculation.
  2. Consideration of the maximum value available for build costs, above which the project will become less financially attractive.

The undeveloped property might be:

  1. Brownfield or Greenfield land where buildings have never stood.
  2. A cleared site where the property has been demolished.
  3. A property that requires renovation or conversion to a lesser or greater degree.

© Copyright Robin Webster and licensed for reuse under thisCreative Commons Licence

The very basic formula for a Residual Valuation is:

Gross Development Value or Value completed

Less

Costs and Profit

Equals

Amount available for Land Purchase/Pre-Development Property

The first value that has to be established is the Gross Development Value.  This is essentially the total value of the completely finished project.  In most cases, the comparable method of valuation will be used to obtain reasonably accurate values for Sq Ft or Sq M.  Recent transactions can be analysed and the selling price or annual rent compared to the property in question.  Although the comparable method is not flawless, it is about the most accurate method to establish (completed) property value available.

Some important considerations are:

  • If a project containing multiple dwellings is to be analysed, the GDV will be based upon the total value obtained from the sale of all the units.  The value that can be obtained on the market can be expressed as a rate per M² and can be established through the study of comparable, similar properties recent sold prices (NOT the values they are offered at).
  • When establishing the total value of the finished project, remember that common areas such as stairways, hallways and foyers are not included within this value, but they will be included in build costs.
  • The amount available for land purchase is the absolute maximum that the developer would pay for the undeveloped project.  In practice however, this figure is likely to become the Gross Land Value because he has to:
  1. Allow for professional fees (Agents and Legal) and SDLT/property taxes.
  2. Consider discounting the land value to account for general economic inflation that will occur during the development period.
  3. Any interest payable on capital used to fund the land purchase (not already included in the main finance total).

When the above have been subtracted, the Developer is left with the Net Land Value.

The second value to be looked at is the total costs of the project.  This will include build costs, consultant’s fees, finance costs, infrastructure/landscaping costs and any obligation for S.106 agreement (a contribution to the Local Council in connection with the project) or Community Infrastructure Levy (CIL).  Considerations are:

  • As mentioned above, build costs will include the total value of the units to be sold and any common built areas (based upon Gross Internal Area).  Build costs can range from £600 per M² to £1600 per M² depending on the area of your project (obviously London/South east will be more expensive than Northern England and Wales) the required quality of finish and who you intend to do the work (Main Contractors is the most expensive route).  Click on the link for information on build costs.  VAT can often be reclaimed on many costs involved with new-builds.
  • The amount spent on consultants will vary according to the size of the project.  However for the purpose of appraising the project, using percentages is the most appropriate way for the majority of projects to be looked at.  Examples are:  Architect 5-7.5% of build costs and a Project Manager around 2% of build costs) VAT will almost always be payable on consultant’s fees.
  • Site infrastructure will include drainage, water, gas and electricity supplies.  For small projects, the cost will be negligible and the same goes for landscaping costs.  This is why a percentage calculation is appropriate.
  • Finance costs will depend heavily upon the amount borrowed and the rate it’s borrowed at.  If the project is intended to be solely a development (rather than a development with the aim of letting at the end of the construction phase) then the costs should be recouped as soon as possible.  Obviously the longer it takes to recoup all construction costs; the more must be paid in finance costs.  For the purposes of calculation, a construction period of 1-12 months and a post-construction marketing period of 2-8 months should cover the vast majority of situations.
  • S.106 costs will be related to how the project as a whole ‘fits in’ to the local environment.  A contribution is often requested by the local authority to pay for changed infrastructure to serve the project.  This might be a widened road leading to the development to serve the occupants.  Follow the link to read more about s.106 obligations for developers.
  • Estate agents fees are quite negotiable depending on the size of the development.  It would not be unreasonable to attempt to negotiate a slight discount of half a percent or so for sole agents that will be acting for a large development.

The next figure is the required profit level.  This is often calculated as a percentage of the GDV value.   It’s important that the profit is considered in the equation, because it’s surprising how many novice developers regard a profit as a bonus.  To continue developing property must be regarded as a business.  If no profit is made, then the business will not survive for long.

Clearly, the higher the required profit level, the less will be available to purchase the land.  So a balance must be struck.  Pre-recession profits could be around 33% of GDV (a very crude assessment of a property development was’ 1/3rdfor land costs, 1/3rdfor build costs and 1/3rd for profit’).  It’s very doubtful whether this would still be attainable now, in practice a rate of around 15% of GDV is realistic.  It certainly helps to be conservative and cautious when appraising a development.

The final and eventual figure to be generated is the sum available for land purchase.  This can be changed considerably if the input figures are changed.  In fact one of the criticisms of the residual valuation method is that for relatively small changes in the input figures, large changes in the eventual values can be seen.  This is why it helps to be cautious with input figures, overestimation of costs is better than underestimation.

The land purchase figure is the figure that forms the basis of your negotiation.  If the property is being bid on at an auction, obviously no opportunity to negotiate will exist.  It will however provide you with a good idea of how your project finances will work and if you bid above your ideal value, the other figures will be reduced accordingly (profit is usually first to suffer).

To download the very finest guide to Assessing Land Value, the Residual Valuation method and Gross Development Value currently available on the internet for only £5, please have a look at my ‘How to Price Development Land‘ page.

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