Net Letting area 10,400 sq m Architect 12.50%
Rent £270 per sq m Quantity surveyor 0.00%
Yield 7.25% Project Man 0.00%
Purchase costs 5.75%
-0.00%
Site Cost 8,000,000.00 Marketing £ 75,000.00
Acquisition costs 5.75% Agents 12.00%Profit 9,027,835
legals £50,000
Constr area 13,000 sq m
Constr costs £1,050 per sq m Interest 7.00% p.a
Contingency 10.00% Est Dev length (mths) 12
Stat costs 400,000.00 Est void period (mths) 0
Demolition 150,000.00 23.31% 7.00% 7.25% 7.50% 7.75% 8.00%
1000 27.84% 25.46% 23.07% 20.69% 18.31%
21.16% 18.63% 16.10% 13.57%
Profit = Investment Value − (Site Cost + Development Cost)
+ Investment Value
Years Purchase in perp at 7.25% 13.79 1600 2.95%
GDV 38,731,034.48
Construction £1,050 per sq m 13,650,000.00
Contingency 10.00% 1,365,000.00
Demolition & statutory costs 7.00% 38,500.00
Building costs & fees 3.44% 600,140.79
Marketing 3.44% 2,580.60
Agents 12.00% 336,960.00
Marketing 75,000.00
legals £50,000 £50,000
Figure 3.1 Development appraisal and sensitivity analysis.
judgement and analysis of the regional property and development markets, the future trends and actions, and the decisions of other potential developers, investors and purchasers in the same market.
Sensitivity analysis
All initial development valuations and appraisals must be based on a consid-erable number of estimated inputs. The more complex the scheme, the more likely it is that inaccuracies will occur. This places a premium on experience and up-to-date local market knowledge. With such analysis, the reliability of the outputs and results is not dependent on the method employed as on the
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quality of information and data used in the analysis. Indicated in the table are the effects of changes in inputs such as rents, yields, building costs and inter-est rates on profit. Constant reworking of calculations or sensitivity analysis to demonstrate the influence on land values or rental value or other input alterations is relatively easy to assess with the use of spreadsheet packages.
Estimates of the effects on the profit of rising or falling rental values can be determined almost instantaneously. In the recent volatile market period, the demand for a more explicitly analytical evidence for property development appraisals has become even more important. While the standard approach remains to estimate whether a proposal or intended scheme is likely to prove viable based on assumptions made, this is usually accompanied by feasibility studies, discounted cash flow (DCF) analysis and scenario testing based on the ranges of probable costs and returns. In particular, PPPs may involve the appraisal of complex development options with cash flows on completed schemes. For such purposes, project-tailored appraisals may be developed in a user friendly manner and options in terms of sensitivity analysis, phasing and financing can be looked at in greater detail by all participants. From such analysis, it can be seen that changes to the various components of rent, yield, cost, finance and time can have dramatic effects upon the profitability of a scheme when tested. The next table from the spreadsheet indicates how such uncertainty can be analysed. Here the best and worst outcomes, which are expected, are inputted and their impact on the outcome assessed. Figure 3.2 shows a scenario summary.
A DCF analysis is considered to produce a more accurate basis for analysis and appraisal of the development situation. Ratcliffe and Williams (2000) found that the principal advantage of using cash flows is that there is considerably more flexibility in assessing the timing of payments and receipts.
As the same information (costs and values) is used initially in residuals and cash flows, inaccuracies in these inputs will lead to errors whichever method or approach is adopted. In negotiations with an investment and development appraisal focus, DCF approaches are regularly used. The standard net present value (NPV) approach involves the discounting of all inflows and outflows.
The computation of the sum of discounted inflows and outflows produces the NPV of the development profit. Individual developers have their own ‘target’
Scenario Summary
Current Values: Worst Case Best Outcome
Changing Cells: 50% 30% 20%
Investment Yield 7.50% 8.50% 7.25%
Building cost £1,000 per sq m £1,200 per sq m £900 per sq m
interest 7.50% p.a 8.50% p.a 7.00% p.a
Result Cells: Average 18.73%
Profit 23.35% −3.19% 36.04% STD 0.20018
Notes: Current Values column represents values of changing cells at time Scenario Summary Report was created. Changing cells for each scenario are highlighted in grey.
Expected risk adjusted profit 17.92%
Figure 3.2 A scenario summary.
Chapter3 Partnership Negotiations Using Property Development Appraisal Techniques 61
discount rates but for initial appraisals it is logical to use the short-term finance rate as this is the real cost of money at that point in time for that interest. A positive NPV indicates that allowing for the time cost of money, the scheme is profitable and a negative NPV indicates on the same basis that a loss is likely. A DCF analysis can be carried out on all elements of the project. A DCF spreadsheet on one of the scenarios for this project is shown in Figure 3.3.
At acquisition and site assembly stage, uncertainty exists often as to the physical suitability of the land for development and its cost implications, along with the legal and planning difficulties that may arise in obtaining permission for the required development. Buying an option on the prop-erty, with final payment subject to planning, legal and other issues being resolved, restricts this risk element. The acquisition of development rights on public lands under a joint venture or PPP-type arrangement at a less than market price is, therefore, an attractive option for private market interests, especially during very strong market periods. This makes the prospects of PPPs for land development purposes attractive, especially during periods of upward market price movement.
If a site is purchased or capital committed, the interest payments com-mence immediately. Risks of unforeseen expenditures increase during the
Month
Period costs based on S Curve 403200 672000 1209600 1612800 2822400 2822400 1612800 1209600 672000 403200
Cumulative total 403200 1075200 2284800 3897600 6720000 9542400 11155200 12364800 13036800 13440000
S Curve fo construction costs
Figure 3.3 A DCF from a spreadsheet.
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construction phase. It is at the later stages following fitting out that major risk is involved. Instead of an option on a site or ownership of a piece of development land with many possible uses, the developer has now a partially finished product. This product is physically fixed at a specific location with its future economic and market context when completed out of the developer’s control. Many developments are for sale as investments, on the open market, which can be volatile and unpredictable. In this context, the public sector development element of a PPP must be guaranteed and needs to be covered by the profitability of the remaining components.
In such situations, the developer and other participants are faced with the most difficult uncertainty, that is, the timing, as developments will often take more than 2 years from initiation to completion. The determination of accurate assessments of costs and expenditures throughout the project development period presents major problems and a detailed forecasting is needed for feasibility studies. However accurate these may be, they remain only estimates based on incomplete knowledge. Changes in the property market and other economic cycles present different scenarios and difficult problems for all decision makers. Cyclical development patterns often involve developments being completed during periods of oversupply in the market.
Development interests, therefore, at no stage can avoid risks, but different attitudes can be taken to potential risks based on information, analysis and forecasts.
Development decisions therefore rely heavily on the quality of information and analysis. A detailed analysis can highlight those factors representing the highest risk elements of a project and indicate the role of various input factors in deciding on the feasibility of such projects. Such analysis assists in understanding the critical elements in decision-making for property development and highlights those factors most sensitive to change.
Knowing which factors are most sensitive to change and whose movement plays a critical role in decisions to initiate or defer development provides a basis for the evaluation of partnership arrangements in the property devel-opment process. In carrying out such analysis, use is made of a conventional spreadsheet to give computer-aided calculations of numerous variations of the inputs involved. With this type of knowledge on the operations of the property development process, it is possible to examine the partnership arrangements in context and assess their ongoing impact on decision makers in the process.