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Why a robust development appraisal is essential to secure development finance
As a property developer you may know you need a development appraisal, but do you fully understand why, or what it should include?
The RICS definition of a development appraisal is;
“an objective financial viability test of the ability of a development project to meet its costs including the cost of planning obligations, whilst ensuring an appropriate site value for the landowner and a market risk-adjusted return to the developer in delivering the project”.
Clearly, a thorough development appraisal is not only an essential tool for you, the developer, to assess an asset’s value (land, building, site), it is equally important when it comes to acquiring the necessary development finance.
What do funders want to know?
Broadly speaking, different development funders will apply the same criteria to borrowers when considering financing a property development project.
This usually comprises (the list is not exhaustive and covers initial enquiries):
- Market value of asset
- Purchase price of asset
- Build cost
- Gross Development Value
- Length of funding term
- Build period
For the purposes of this article, my focus is on the cost elements of development appraisals.
Gross Development Value
A robust development appraisal starts with the gross development value, more often referred to as GDV.
The GDV is the expected end value or calculated revenue for the completed development. The GDV is critical to the success of a development project, as such it is vital that you undertake a comprehensive and sound due diligence process prior to approaching a prospective funder.
At this point in the process, you would be well-advised to source comparable data for recent property sales and rental transactions in the asset location. This is also the time to approach estate and/or commercial agents for advice based on their knowledge of the locale.
In addition to sales or lettings, other sources of GDV should be included such as ground rent income or the sale of car parking.
It is prudent to take a conservative approach at this stage. Your GDV is only as good as the information used to inform it. Development projects can take a long time from this development appraisal stage to achieving completed sales or lettings, and any market swing in the wrong direction can have far-reaching consequences.
Having completed a thorough analysis and established the GDV, you now need to assess the costs associated with the proposed development project.
Typically, a development project will incur the followings costs:
- Legal fees
- Finder fees, if applicable
- Stamp duty
- Monitoring survey due diligence fees
- Holding costs such as council tax or business rates
- Pre-purchase surveys
- Demolition or site enabling costs
- Cost to build, convert or refurbish asset
- Professional fees including project manager, cost consultant, architect and engineers
- Design and Construction risk (also referred to as Contingency)
Other Developer Costs
(term used by cost consultants when producing an Order of Cost Estimate)
- Construction Infrastructure Levy (CIL)
- Section 106, 278 etc.
- Building Regulations
- Planning fees
- Building warranty (residential)
Cost of finance
- Arrangement fees
- Funders legal fees
- Interest on capital borrowed
Marketing & Sales
- Solicitor conveyancing fees
- Sales agents fees
- Marketing costs (photography, website, launch events, brochures, floor plans, virtual walk-throughs.)
- Sale suite, showrooms or showhomes
- Furnishings of showrooms and showhomes
You have probably noticed that the above costs at this stage of the development appraisal do not include the purchase price of the asset. This is for two reasons.
Firstly, you may already own the asset or been gifted it.
Secondly, and most importantly, if you don’t already own it, you will need to determine how much you are prepared to pay to acquire the asset. In order to make that decision, you need to know how much profit you want, or need, to achieve from the completed project.
After all, committing to a property development comes with inherent, and unavoidable risks including the potential debt. Why would you take this risk on without there being a good chance of a significant return?
This point is equally important if you need to secure finance for the project as any potential funders will expect you to demonstrate their investment will deliver a healthy value to cost ratio.
In order to satisfy potential lenders or investors to secure the funding you need for your development project; you must produce a robust development appraisal that will maximise profit, reduce risk and demonstrate that a healthy profit margin can be maintained.
Doing so relies on a robust GDV supported by a thorough and conservative review of costs drawing on realistic data. The accuracy of your development appraisal is entirely reliant on the quality of the information used to compile it.
It is for this reason that you should engage professionals with proven experience to act on your behalf. By doing so sooner, rather than later, you give your project the greatest chance of success and can avoid costly mistakes.
One final tip is to keep this equation in mind;
GDV – Development Costs – Profit = Maximum asset purchase price