The Property Speculator

An Introduction to ‘Pricing’ Development Land

Note, this article should be read in conjunction with the Property Speculator’s Excel-based Residual Valuation Calculator.

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:

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

The undeveloped property might be:

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

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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:

Allow for professional fees and SDLT or property taxes.
Pay interest charges on any money borrowed to fund the development.

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’ 1/3^rdfor land costs, 1/3^rdfor build costs and 1/3^rd 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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Apr 29th, 2012

The Contractors Method of Commercial Property Valuation

In some cases, the 4 other methods of valuation (Comparison, Residual, Profits and Investment) are just not suitable for a particular property. Some buildings are designed to be used by Town Councils or public sector/healthcare/military workers, and are therefore quite unique and it’s simply not appropriate or possible to value it for a commercial use. These properties very rarely change hands and because of this, almost no comparable evidence is available.

© Copyright R Sones and licensed for reuse under this Creative Commons Licence

In this case, the Contractors method of valuation can be used (also known as Summation). It is not without it’s limitations it has to be said, and is sometimes referred to as a ‘last resort’ method. This is because it works on the basis of a building or property’s value being the same as cost (which in most cases is a flawed concept, as ‘cost’ is a fairly definite sum, whereas ‘value’ is not).

The Contractors method works on the idea of the cost of the land plus the cost of the buildings upon it equals the value of the property as a whole. This sounds about as simple as it’s possible to get in Real Estate valuation, however it’s in the detail that the skill lies. The users of these non-commercial buildings could hypothetically move to a different site and have a similar building constructed. As no aspect of competition exists, the value is quite likely to be similar whichever site is used (assuming it’s a similar size). The value of the land should only be based upon the intended use, not best use. This is because land where (for example) offices are permitted to be built would be worth considerably more than land upon which only a fire-station could be built.

Another consideration is that the value of a new building would be worth more (theoretically) than the value of one that which already stood on the site. There must be some amount of depreciation for general wear-and-tear and obsolescence. The basic equation for the Contractor’s Valuation is:

Cost of Building

plus Cost of Site

= Total Cost of Similar Property

less Amount for depreciation and obsolescence

= Value of Existing Property

In practice, the process of establishing the value would be:

Apply build costs (at a rate per Sq Ft/M) at the time of valuation, and discount this by a percentage to allow for depreciation and obsolescence (this could be 25% for obsolescence and a further 15% for depreciation).
Add the revised total build costs to the land value, including costs of plot works and fees.
The result is the value of the property.

Clearly this method has its limitations; Not only can build costs be difficult to establish with accuracy (due to the envisaged specialist nature of the building), but the level of discount to be applied to allow for obsolescence and depreciation must be quite specific.

Valuation is (quoted from the Royal Institute of Chartered Surveyors) ‘an art, not a science’. This means that although the methodology is reasonably straight forward, the application of it not particularly simple.

Aug 17th, 2011

A Quick Guide to Planning Conditions

Receiving the appropriate planning permission to carry out the work you want to, is one of the most important aspects of property development. However the grant of full or outline planning consent will be subject to some conditions that may or may not represent a problem to you.

Whenever full Planning permission is applied for and the developer (i.e. you) is notified of the positive decision, certain rules must be complied with in order to stay within the law. This ensures (from the Local Planning Authority perspective) that the developer does not apply his/her own ‘angle’ on the decision. These conditions will be stated on the decision notice itself or attached on a separate schedule.

To use an example of a ‘sticky’ planning condition that I came up against personally, a group of small-medium sized industrial units were offered to be let. These units were high quality as they were newly built, and a sub-division of a very large worldwide company (our client) was very keen to take on a lease to one of the units. The company required occasional access during unsociable hours in order to supply European factory production line components in the event of a breakdown at short notice. As I was progressing in negotiating favourable terms, it came to my attention that one of the planning conditions was a restriction on the hours that my client’s employees would be able to access the unit. Because of its very close proximity to some houses, the Local Planning Authority had applied a condition that ensured that occupants of the industrial units could not subject nearby residents to excessive noise during the weekend or outside normal working hours. There was not really any way round this, and as a result I had to find alternative premises for my client. The point of this is that although you might be celebrating the grant of planning permission on a plot or a property, the conditions that accompany it are equally important.

Planning Conditions can be related to almost anything affecting the property or land. If a newbuild property is planned, then it’s likely that some conditions will be connected to required materials, dimensions, access to the property and landscaping. Clearly you must be familiar with these before you start to build. If you intend to renovate and/or convert an existing property that has listed status, expect much more in the way of conditions. Sometimes the conditions involve something to be agreed to with the local council, in this case a fee is payable to have the conditions ‘discharged’.

Materials are an important aspect of how the finished property will look and how it blends with neighbouring properties and landscape. It’s likely that bricks and roofing tiles will have to be agreed to, prior to construction commencing on a new-build property. The local authority is also certain to take an interest in how the surface and foul water drainage system is planned. Landscaping is also important to the local planning authority; imposed conditions often request that schemes are provided and implemented within a certain period of time.

Both full and outline planning permission are subject to a maximum limit of 3 years. This means that from the date of consent, if works have not begun on the planned development, the permission is considered to have lapsed and will be void. For works to begin, planning permission must again be applied for and obtained before the works can actually begin. So if you already have planning permission for proposed works that is slowly running out, you should definitely get started to avoid a lot of inconvenience later. You should note that land or property that has existing planning consent that is approaching the end of its effective life is worth less than if the consent is fairly ‘fresh’. This is because of the increased risk of not being able to start work immediately before planning permission expires.

Access to the property is also a large consideration for the planners. If the development is substantial, questions will be asked in relation to increased traffic levels. Even if the development is a single dwelling, access to the carriageway will still be important as (for example) it might be on a blind bend in the road. Parking is also considered at some length.

In urban or built-up areas, the local planners might well impose conditions attached to the permitted hours of build. This is usually normal working hours, and there will be a restriction on working weekends and bank holidays. Sometimes if you are extending an existing property as part of the development, the local planning authority might remove some permitted development rights. This is because permitted development allows a certain degree of extension to a property. If the property is extended as part of your development, this in effect ‘uses up’ the degree of extension that is allowed. It doesn’t mean that the property can never be extended at any point in the future; it does mean however that consent must be applied for and granted.

It is common on listed properties to have at least some sign of the presence of bats. A dead bat, signs of droppings or visual signs of their presence is enough to warrant a bat survey. Building work cannot begin if there are grounds to believe that bats inhabit some area of a property. To ignore this is a criminal offence because of the protected nature of bats. A condition might well be attached to consent stipulating that a bat survey must be carried out and work cannot begin until the bats have ceased to occupy.

A very common condition attached to planning consent on rural properties (especially farms) is an Agricultural Restriction (or ‘tie’). This places a control over occupancy that only allows for residents to be involved in farming and must use the property and associated land to produce their main source of income (or words to that effect). This is very strictly enforced by councils, so be very wary of it because a property with an agricultural tie is offered at a hefty discount to one that does not have one in place. There is not really any way round this condition, so keep an eye out for it unless the property will ultimately be getting marketed as an agricultural one.

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As I’ve already mentioned, having an understanding of the importance of planning conditions is very important to a property developer. However what is just as relevant is the understanding that conditions can be appealed against. Obviously there is no guarantee whatsoever that taking this route will provide you with the perfect scenario of having the planning permission that you planned in place, with minimal conditions attached. Professional developers often carry out what is known as ‘twin tracking’. This means that planning permission is applied for and while they await the ruling, identical permission is re-applied for. This is so that if one application is granted but is not what they wish for (i.e. the conditions are not considered viable) when the second permission is granted, the first can be appealed against. Unfortunately if planning consent is re-considered by the local authority, they have the power to decline the consent, meaning that permission to build anything is lost. If the developer holds a second separate certificate, then they have not lost everything and can still build, albeit with less than ideal planning conditions.

Jun 19th, 2011

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:

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.
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’.
The owner of an area of land where contamination is found to have originated from is often liable for the clean-up costs.
Successive UK governments have encouraged development on brownfield sites in preference to greenfield. This makes developers consider purchasing contaminated sites more readily.
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.

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

The original cause of the contamination. I.e. what the substance was/is that resulted in the contamination.
The general response to the scope of the contamination, both by the potential purchaser and the Local Authority.
The amount of work required to establish the level of contamination and what has to be done to remedy it.
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:

Scepticism over the effectiveness of land remediation.
The risk of inadequacy of the remediation process.
The risk of changes in legislation or remediation standards leading to further work.
The difficulty in obtaining finance.
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.

May 11th, 2011

Property Development Finance

Many aspiring Property Developers procrastinate over their plans because they believe they will not get finance to fund their project. This is clearly an extremely important point, because as I’ve written in many posts, even if you can afford to, it does not make good business sense to use 100% equity (capital that is not borrowed) in a venture. One of the main advantages of working in property is that because it is a tangible asset (i.e. not a paper asset) it can be borrowed against.

In the current economic climate, you might be mistaken for believing that it would be impossible for you to get a mortgage based around a property that needs substantial work to put it into a marketable condition. This is not necessarily the case. The vast majority of mortgage providers will be sceptical when you mention ‘property development’. This is because the sum that the developer borrows is secured against the property itself. This is why mortgage debt is the cheapest of all loaned cash; the bank/building society massively reduces its risk by ensuring that it has a legal ‘charge’ over the property in the event of a default of mortgage payment. Essentially meaning it can sell the property to settle your debt if it needs to. If the property were to be repossessed in an uninhabitable state, the banks chances of recouping its loss would be severely compromised.

Another likely scenario is that the mortgage provider might only release a very small proportion of the total amount being borrowed for land/property purchase, and only release the remainder when the project is completed. This obviously means that the developer has to fund the individual build stages out of his own pocket. This can be catered for when you are an established, experienced professional developer. However a novice is likely to be financially stretched.

The alternative to this is to have each payment released at each (pre-agreed) stage. This is a fairly common approach because it’s an established way of only paying interest on what is being borrowed. These payments will however, be released in arrears; meaning that the individual stages must be covered by the developer, but the funds to pay costs and fees will be released in arrears at each stage boundary.

At this point, I’d like to take the opportunity of pointing readers in the direction of my posts on Financial Leverage in Property Investment and Development, and carrying out a Property Development Appraisal. This is so that you are aware of how to calculate how much you need to borrow and why it’s not a good idea to use all your own cash.

Be aware however, specific conditions still apply. Mortgage lenders are now more than ever, quite risk averse. All the usual conditions of obtaining a mortgage approval still apply:

You should definitely not be overstretching yourself too far. This is (arguably) one of the causation factors for the recession, too many people borrowing beyond their means to buy more and more expensive properties. This is currently the most common reason for rejection of mortgage applications. You simply have to be creditworthy.
You must have a good proportion of equity to invest. This is now usually around 10% minimum with the most generous of lenders on an owner-occupier mortgage (this level of gearing would not even be considered for a development project). A realistic figure for a property developer is around 50%-60% of the GDV. An alternative to this would be if you already own the land or pre-development property yourself.

In common with all professional developers, the novice must accept that full compliance with lenders conditions for each individual project is vital. It’s not like a conventional owner-occupier mortgage, where you simply pay the instalment each month and the provider more-or-less leaves you alone. Developing for profit is almost a joint venture with the bank. They must be absolutely 100% happy that you know what you’re getting into, or at the very least employing an experienced professional who does.

Apr 10th, 2011

Finding a Property Development Opportunity (Part 2)

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In the earlier post, I mentioned the 3 most popular places to find opportunities for development. In this post, I look at some less obvious places to look for development opportunities.

1. Local Planning Authority Website.

The property or plot might have been the subject of an unsuccessful planning application in the past, or the application might have been granted but never acted upon. The local planning authority will have a record of all applications regardless of the outcome. If the consent was never acted upon, then it might have expired.

2. Large Scale Residential Property Developers.

Companies such as Barratt and Bryant Homes, always develop large areas of land due to their calculated economies of scale. When development plans are drawn up, small pockets of land are sometimes ignored because they do not ‘fit in’ with the flow of the scheme. These areas are often small enough to fit one or two individual houses onto and might be available to purchase from the developer at a price below market value.

3. Land websites (for example Plotsearch and BM Land).

These are sometimes free to use, and sometimes you need to register. You do tend to get what you pay for on these though. The free sites depend upon a finder’s fee from the vendor. The paid sites will offer you a subscription to a selection of counties in which to base your search. The amount of counties offered will depend upon the subscription fee.

Most of the paid websites will concentrate on plots that already have planning consent (outline or full) in place. These plots can sometimes be as much as 10 times more expensive that if planning permission wasn’t in place.

4. Large Utility Companies.

Not many people would relish the idea of living close to an electricity substation or a railway line. However, large companies that run utility services like the railways and electricity/water companies often have land that was originally owned simply to provide access. For example, an electricity company might own a long stretch of land that was once used for access to a substation or supply. If access is no longer required because of decommissioning, this access area might be surplus to their requirement.

Contact their estates department to enquire after any surplus land. Patience is required to follow this approach because having personally worked in an estates department; I know that it is very important to speak to the right person as others might not be familiar with recent company operational reshuffles.

5. Local Newspapers.

Not an obvious place to look in these days of freely-available information on the internet. The fact remains though, that sometimes the ideal plot of land or house can be found by looking in the local papers. The reason is that it is almost always a quick and cheap way of advertising. For an opportunity to be placed on the main property search sites, an agent often has to be appointed first. The owner might not want this, as a quick sale is sought.

Finding a development opportunity is almost never easy. A great deal of pro-activity is normally required, and let’s face it-if it were easy, everyone would be doing it.

Mar 13th, 2011

Using Gross Development Value to carry out a Property Residual Development Appraisal

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The Residual method of property appraisal (or Hypothetical Development Method) is used to help in assessing whether a property development project is financially viable or not. If a property has development value (it can also be known as ‘latent value’), it means that its expected future value after works exceeds the expenditure.

The first value that must be established is the Gross Development Value (GDV). This is the capital value that the completed property is expected to be worth on the open market when sold to a willing purchaser. The GDV is different to the forecast price, where the developer attempts to predict the value of the property in line with a falling or rising market. This is unsurprisingly quite inaccurate, but it’s a common misjudgement among novice developers. The GDV should always be based upon values available at the time the appraisal is carried out. The GDV should be based upon the most efficient use of the property/plot. If a site is available that can accommodate 4 houses (for example) and only 2 are built, the completed value of the development is not the true GDV.

To establish the GDV, the most accurate method is the comparative method of valuation.

The residual appraisal is a very easy concept to understand, the equation is based upon a very logical approach. It is as follows:

The amount available for land purchase is the absolute maximum that the developer should consider paying. This is because there will be other considerations, such as repayments on the development mortgage, legal fees and Stamp Duty Land Tax (SDLT). Therefore, if the developer can purchase the property for less than his budgeted amount, he will certainly benefit.

Through transposition of the individual components within it, the residual method can be used for 3 main purposes:

1. Calculating the potential profit margin where the GDV, build costs and land/property cost is already known.

2. Finding a maximum value for build costs, where profit, GDV and land value is known.

3. Establishing a maximum price to be paid for the land/property when other values are known.

Build costs are probably one of the trickiest aspects to consider when carrying out a residual appraisal. The easiest way to do this is to apply a rate per sq ft or sq M and multiply it by the expected area of the completed property. So if a property of around 2,000 sq ft is to be developed or built, a rate of £100 per sq ft could be applied. This would produce a build cost of around £200,000. However, a more realistic rate is more likely to be closer to £80 per sq ft (by current standards). This will include fees and a contingency amount. If development work is substantial, then a ‘build cost rate’ can be applied as it will be so similar to a ‘renovation cost rate’.

Finance costs can vary quite considerably, depending on amount borrowed, construction time and rate of interest. As discussed in many other posts, to provide all project funds in the form of equity (money that has not been borrowed) is not a particularly shrewd idea. Likewise, to borrow too much in the form of a loan is not a good idea either.

If the project takes 12 months from initial completion to sale of the property, then that’s 12 months worth of loan repayments that must be included into the associated costs. For a mortgage of £200,000 that can be around £12,000 in total, depending upon the variable mentioned above.

Profit is also a vital aspect of development. Many novice developers calculate their projects the wrong way, they consider the property cost; add the expected build/renovation costs and the remainder once it has sold is profit. This is not the best way to approach your venture, a business needs profit to survive and you need it to invest in your next property project.

An example of a residual appraisal is as follows:

This calculation shows that around £130,000 (to round the figure up) would be around the price you should be buying the undeveloped house at. This does NOT mean that you should start negotiation at this figure, it would be prudent be place in an initial offer comfortably below this price.

To download the very finest guide available on the internet to Assessing Land Value, the Residual Valuation method and Gross Development Value for only £5, follow this link to my ‘Assessing Land Value‘ page.

Mar 8th, 2011

Finding a Property Development Opportunity (Part 1)

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If you intend to construct a development property as a newbuild, one of the very first considerations you are likely to come up against is where to find suitable land upon which to begin your project. Unfortunately, it’s not simply a case of purchasing a handy field or plot and building a property on it. It’s no secret that there are planning laws that dictate where and what you can build. In fact, planning permission is probably THE most important aspect after location and budget.

Therefore, it is vital that the right opportunity for your needs is found, although a hefty amount of flexibility will be required. It is likely that the plans for a completed property will not be finalised until the actual ‘raw material’ is secured.

So, where should you be looking for opportunities? In order of popularity:

1. Estate Agents.

It’s not just newly-built and pristine properties that are advertised in estate agents windows and subsequently find their way onto Zoopla and Rightmove. Estate Agents also advertise rundown, derelict or just scruffy houses and flats too. Sometimes they also have plots of land for sale, although this will be heavily dependent upon the particular area you are looking in. As many self-builders will confirm, there are significantly less Greenfield plots for sale in the South-East of the UK.

It’s very important to build a relationship with the estate agent. It’s so easy to look for plots of land online that you might be surprised at the number of people who do it. Subsequently, if you meet estate agents face-to-face it will set you apart from all the dreamers who email and call the agents with little idea of what they are looking for and even less conviction to actually buy anything.

2. Property Auctions.

Auctions are still an excellent way of finding potential development projects. A quick look at any of the auctioneer’s websites will advise you of future property auctions and what will be on offer. This guide to buying property at auction is available, including a full list of auctioneers with individual links to their websites. Be aware that on auction day itself, it will be too late to browse the catalogue picking the properties that interest you. That MUST be done far in advance of the auction so that you can inspect the property (many auctioneers have viewing days to enable potential bidders to assess it and take a builder or building surveyor along too) and sort out finance (you will be required to place a 10% deposit down with a cheque or bankers draft if you are the successful bidder on a lot).

3. Observation.

This is a much underrated way of identifying plots that for some reason are not up for sale or being auctioned. If an obvious plot between 2 existing properties is found, it might be that the existing owner simply hasn’t thought of putting it on the market. If an old ‘for sale’ sign is around, it is worth trying the agent’s phone number to get some further information or contact details of the owner. If there is no obvious sign of the land or property have ever been up for sale, then the detective work begins.

The Land Registry is an excellent place to begin. It is fairly straightforward to pinpoint the property on their interactive map. You can then download a pdf copy of the Title Deeds for no more than around £4-£5. Unfortunately, not every single piece of land or property is registered with the Land Registry. The practice of collecting property ownership details is only done when the property changes hands. If this hasn’t been done in the last 30 years or so, then it’s unlikely to be listed.
The next option is to ask around in the local area. This could be the nearest house, shop or pub. This is likely to be more straight-forward in a rural or suburban area because areas of land are not divided up into such small parcels as that in urban areas. In these urban areas, boundaries are often moved and there is also a chance (believe it or not) that the actual property owner has lost track of what they actually own.

Mar 6th, 2011

Developing Property on Contaminated Land

There is a (reasonably) well known quote by Mark Twain that goes:

“Buy land! They’re not making it anymore”

I personally quite like this, as it is a very succinct way of reminding people of the relative scarcity and finite nature of land.

What this means to the novice property developer and investor is that theoretically, at some point all land could be bought and developed upon. Of course, this is never likely to happen but what is foreseeable is a point where all available land has become so sought after that the asking price has been driven up to a level where it renders a project financially unviable.

In this situation, brownfield sites (sites that have developed previously and are currently available for a new use; possibly subject to a grant of planning permission) might have to be considered. Sometimes, these plots will have been used for activities that would render them contaminated (for example, a filling station). When novice developers think about a contaminated site, they might visualise being ankle-deep in oil or waste fuel while the building work is carried out. The reality is that this could never be the case.

The control of contaminated areas of land is governed by either the planning process as a whole, or Part IIA of The Environmental Protection Act 1990 (EPA 1990). Under Planning Policy Statement 23, a property developer is responsible for making sure the development is safe for its intended use. So if the site is suspected or there is proof of it being contaminated, the planning authority will require assessments to be carried out before any planning consent is granted.

Under EPA 1990 Pt IIA, if the site is not dealt with through the planning process, then a local authority has an obligation to investigate any potentially contaminated land within its boundaries. If any contamination is found, then the developer must carry out a clean-up if the contamination is considered a risk to people, property or the environment. Clean up of an area will include some or all of the following:

‘Desktop study’, site visit and initial risk assessment. This will entail an appreciation of the site history; original, current and future/proposed use; information on expected contaminants and their sources; information on potential ‘receptors’ such as people and flora/fauna. When Phase 1 has been completed, a report containing a preliminary risk assessment and recommendations for further investigative work will be submitted to the local authority and the Environmental Agency prior to moving on to Phase 2.
Site investigation and risk assessment. This phase involves the investigation into the scale of the contamination. This could be heavy metals, oil and fuels or gas. A ‘Sampling Strategy’ will be drawn up to specify the depth, scope, pattern and frequency of sampling. An assessment of risk to human health, waterways and other receptors will also be carried out at this stage. Upon completion, a report will have to be submitted to the local authority and The Environmental Agency detailing the recommendation as to whether remedial action is required to make the ground fit for use.
Remediation approach and works. The approach to be adopted for remediation will include the intended standard to be achieved. The works is when the physical work is actually carried out to make the site fit for development. It might include the removal of contaminated soil from the site and/or the introduction of a layer of impermeable material to prevent contamination seeping through. Any potential source of contamination will also be remedied to prevent further contamination.
Validation of remedial works. This is when the ground will be re-sampled to establish how effective the works have been. A Remedial Works and Supporting Validation Report must be submitted to the local authority and the Environment Agency. If it has been successful, then a written decision will be issued and the usual application for planning consent can be submitted.

Clearly, this is not a particularly speedy process. And it is also unlikely to be particularly cheap. However, there are specialist companies who will look after the process for you. Assessing the cost involved is a difficult thing to do because it depends entirely upon the scope and nature of the contamination, the size and location of the site and the intended eventual use of the site.

A very approximate indication of prices however is:

Removal of contaminated material – £50-£170 per cubic metre.

On-site encapsulation – £40-£100 per cubic metre.

Soil washing £60-£120 per tonne.

Items that might have to be included in the above are:

Haulage costs

Landfill tax

Accommodation of personnel (if required)

Traffic management

The best recommendation I can provide if you are considering developing on a site you suspect to be contaminated, is to speak to one of the specialist companies (links provided below). They are fairly unlikely to be able to give you a very accurate quote for clean-up, but should be able to give you some idea of approximate costs. An appraisal could then be carried out to see if the project is financially viable.

Building on a contaminated site might financially benefit you, as many other developers might be unwilling to use the land, even post clear-up. Subsequently, if you considered this a worthwhile idea, the land cost might prove to be substantially cheaper than the alternatives even after inclusion of the cost of clean-up.

Links:

Environmental Agency page on Contaminated Land

http://www.environment-agency.gov.uk/research/planning/33710.aspx

Land Remediation Specialists

http://www.trm-ltd.com/

http://www.ecologia-environmental.com/

http://www.thelkgroup.com/

Jan 24th, 2011

Using a Property Purchase Option

Quite often, a property developer feels that it is a better idea to build a property from the ground up rather than renovating an existing one. There are advantages to this approach, as there are definitely economies of scale involved when buying a suitable building plot. It usually works out far cheaper (per individual unit) to build several properties on a slightly larger plot, than one on a small plot.

With this in mind, one of the most important (if not THE most important factor at this point) is the establishment of planning permission for the build you intend to carry out. Once you have this, the capital value of the site can increase many, many times over.

This causes a problem if you intend to be particularly prudent with your finances. Do you:

Buy the land without planning permission and run the risk of not getting consent, and owning a useless plot that cannot be built upon? Or
Purchase a plot that already has planning permission in place at up to 10 times the price it was prior to the grant of planning consent?

Most novice developers follow option 2 and purchase the plot with either outline or full planning permission already in place. This offers the least amount of risk but is also the most expensive choice by quite some margin.

Professional property developers are not in the habit of spending money unnecessarily, they will seek the establishment of a Purchase Option on the land prior to buying it. This is a contract between the two parties (Vendor & Purchaser) that is ‘open-ended’. This means that one party can choose to exercise their right to buy something (at a price agreed prior to contract finalisation) or they can allow it to expire and take no further action.

The way a Purchase Option works is thus:

1. A property developer believes a particular plot of land is suitable for development, but presently has no planning permission in place. The plot is not currently for sale, so he traces the owner of the land through the HM Land Registry.

2. He consults the local Planning Authority as to the viability of obtaining planning consent on the plot. This is done informally and may only amount to a phone call, although a planning officer might visit the site to discuss the developer’s plans with him. If the planning officer believes that there are no obvious problems at this point, the developer is likely to be invited to submit a planning application.

3. The owner of the land is then approached by the developer and asked if he would sell the land to the developer subject to the satisfactory grant of appropriate planning consent. If the landowner agrees to this, a purchase price is agreed to (this is normally considerably below the full value of the site with consent in place, as the developer is still taking some degree of risk).

4. The developer usually pays the landowner a fee for the facility of agreeing to this contract, this is known as the Option Fee. It could be around a thousand pounds or so, depending on the size and scale of the project. This fee is the landowner’s, regardless of the outcome of any planning decision.

5. The Purchase Option contract is drawn up by a property Solicitor. It states:

a. The names of the two parties

b. An indication of the area of land (maybe accompanied by a plan)

c. The Option fee

d. The agreed purchase price of the plot

e. The term of the contract (this could be for 6 months, for example)

f. The precise conditions of the planning consent required by the Developer

6. The full version of the option contract is then signed by both parties. Now, at any time for the remaining term of the option contract, the purchaser (developer) can buy the plot from the vendor at the agreed price, provided the planning consent is satisfactory and any associated conditions are acceptable to the purchaser. The developer then has the plot he wanted, with suitable planning permission in place, at a price that was significantly less than it could have been.

7. If the planning permission is not granted on the terms the developer hoped for and it is unlikely that it will be granted, the developer can simply allow the term of the option contract to expire. This becomes worthless upon expiry and the developer is not financially committed to the land at all. The prospective vendor however, gets to keep the option fee regardless.

Option contracts are now fairly common, a lease option and a double lease-option are available but work in different ways to the purchase option. It is simply a contract that one party can choose to exercise or not, but the other party is legally bound to adhere to.

Purchase options can be fairly complicated, reflecting the nature of English & Welsh property law. Because of this, it is not really possible to download a contract template that will serve all situations. I highly recommend a Property Solicitor is consulted and asked to draw up the draft and final copies of the contract.

Jan 18th, 2011