Property Development Appraisal

Take the guesswork out of your next property development

‘While anything technically feasible is possible, not everything that is possible is financially feasible’.

Just because you can do it, it does not mean that it always makes financial sense to go ahead. Stakes become higher the more complex the development and timeframes have the potential to shift in the wrong direction.

But don’t be put off. A development appraisal is the way to remove guesswork and confidently test the financial feasibility of a development opportunity before you start.

What is a development appraisal?

Fundamentally, it is a process whereby you gather as much information as you can on the constraints and opportunities for your chosen site so that you can assess the viability. It takes time and effort and is an additional cost, but it is essential to see if the figures stack up.

Just because you are keen to do a particular development, don’t try to make the numbers add up from the start. Take an unbiased view as you gather data. The key component is research, so make your mantra: research, research, research.

A quick formula

End value of completed buildings minus (all) land costs minus (all) development costs = PROFITABILITY

A simple formula. Now follows the more complex assessment of each element of the equation: end value, land costs and development costs. Accuracy is crucial if you are to compile an appraisal that you can trust.

End value

The biggest figure in the formula is the end value of completed buildings, or Gross Development Value (GDV). It is the most important number to get right, but also the most difficult as you will have to make a number of assumptions. This is where research is the absolute key.

What is going to be included in your end value? It will depend on whether you are developing for:

• a short-term return, selling the properties so that you can re-invest in your next development, or
• a longer-term investment, where your end value will be rental income, ground rent and other related revenues.

Costs of selling or renting are not deducted from the end value at this point as they are included in the development costs.

Establish a realistic end value by undertaking a sales and marketing assessment. Ask local estate agents who have a finger on the pulse of local property sales. Looking for comparable data, checking Land Registry and reviewing other developments planned in the area are a few of the ways in which you can gather data.

Don’t be tempted to assume property prices will rise by the time your development is completed. Prices can go down as well as up. The sensible route is to assume current values and not to build house price growth into your end value.

Land costs

The cost of land is not just what is paid to the landowner. Other costs include:

• Finder fees if you have sourced the land through an intermediary
• Solicitors’ fees
• Surveys prior to purchase to assess suitability
• Stamp duty
• Financing costs of loans for the land purchase
• Arrangement fees
• Insurance

Development costs

Development costs can be broken down into legal, professional and statutory costs, build costs, selling costs and finance costs:

• Legal, professional and statutory costs: planning application preparation; consultation with local residents; planning application fees; pre-construction surveys; building regulations; Community Infrastructure Levy (CIL) and Section 106; party wall agreements
• Build costs: demolition; site conditions such as contamination and levelling; structural and other surveys; construction costs; professional fees; project management; contingency
• Selling costs: marketing; show flats or houses; sales agents’ fees; PR, photography and brochures; websites; solicitors’ fees; holding costs such as council tax and utility bills
• Finance costs: arrangement fees; funding legal fees; interest on capital borrowed; insurance; building warranties

Profitability stress test

This is the final piece of the formula and the most important part of the appraisal. It helps to have a set target profit for each development site. If not, you will need to assess the level of profit that is acceptable to you and your investors.

Having produced your appraisal, stress test your assumptions by setting different values and seeing how that impacts on profitability.

An example of the impact of a variance:

Say the project end value is nearly three times the development costs, and we vary each by 5%.

• A 5% fall in end value takes nearly three times as much off the profit as a 5% rise in development costs.

Clearly the reduction in end value has the bigger impact on profitability, as it is the largest figure in the formula. Try a range of combinations to see the impact of rising costs and falling sales.

Development appraisal outcomes

Careful analysis lets you gauge the profitability of a potential opportunity. Once completed, be prepared to walk away if the numbers don’t add up, even though you have invested time and money in the process.

If you can get the return you require, the appraisal gives you the budgets on which to go ahead. Careful financial management is then vital to protect your profit.

It all starts with the appraisal: doing the research and getting figures as accurate as you can for a realistic overview. If it seems daunting, an experienced developer or cost consultant can help you check the assumptions.