Producing an OCE for an initial Development Appraisal or to determine Site Residual Value In this article, we looked at how effective cost management...Read more +
Robust Development Appraisal Preparation:
Assessing the risk in your numbers
When developers carry out an initial development appraisal for a potential development project, whether for funding purposes or to work out the residual site value in order to make an offer, it is normal for some assumptions to be made.
In fact, it is not uncommon for a developer to visit the site, undertake a review of site particulars, and then start punching numbers into a generic proforma spreadsheet to create the development appraisal.
The problem is, these assumptions can come with huge risk if they are not managed effectively or do not play out as assumed – i.e. you plan for the best-case scenario but the worst-case becomes reality.
Here are five simple things you can do to reduce risk and improve the robustness of your appraisal; which will give funders and investors confidence in you, the proposed development and the professional approach to the project.
Gross Development Value (GDV)
In the early stages of assessing a development, the GDV is usually informed by either the vendor agent, who would have undertaken an appraisal to work out the residual site value for their client, or as a result of high-level advice provided by a commercial or estate agent. Sales figures are vitally important and are based on £/sqft.
It’s important that you do your homework about these values. Most often selling agents provide the Gross Internal Area (GIA) and selling price on their websites and it’s well worth investing a few hours of your time to scour agents’ sites and record sales values in a spreadsheet.
This will enable you to work out an average £/sqft for buildings of a similar size and specification level, which you can compare with the numbers previously provided to you by the vendor’s representatives.
Zoopla and Rightmove are also useful tools that you can use as an additional measure to check properties sold in the area against assumptions that are being made. If time permits, you could also approach several estate agents for their assessment of the market.
GDV for the development appraisal should be based on current value and it is good to make the baseline clear in the development appraisal (for example, ‘3Q20’ = July to September 2020).
For the first draft of your development appraisal, it is prudent to be conservative rather than over-optimistic.
Selling agents and developers estimate build costs based on £/m2 at the development appraisal stage. Those with experience of delivering a consistent product over numerous developments sites with a reliable, established supply-chain will be able determine the £/m2 rate easily. However, developers without this background, simply cannot.
A common issue for both types of developer is comparable data.
In development appraisals or selling agent residual site value assessments, the build cost is usually fully inclusive, which means it includes external works, abnormals, etc. However, reliable cost data such as BCIS (the standardised data used by RICS), does not include external works, facilitating works, abnormalities and so on in the £/m2.
This results in problems when advisers, agents and consultants are throwing build cost numbers around, after all, what do they all really mean?
- Does their number include preliminaries?
- Does it include contractor overhead and profit?
- Or are you using a construction management company, or even doing it yourself?
- Do you have good access, or will you need specialist plant?
- Are there existing buildings or concrete slabs to remove?
- Is the ground in poor condition requiring piling instead of the strip foundations which would be assumed in the basic £/m2 number?
You get the point!
That is why it’s a great idea to consult with a friendly, experienced, quantity surveyor/cost consultant (QS) firm (like evolution5.co.uk) to provide a high-level £/m2 in an Order of Cost Estimate (OCE) format, which will inform the build cost element or verify assumptions made.
Consultants that you potentially plan to work with on the development project, will usually provide this information free of charge (known as ‘at risk’ because they invest time in you now, in the hope that you will choose to use them on the project).
We also strongly recommend that a more detailed OCE or Cost Plan, depending on the level of information available, is produced by your QS prior to purchase/finalising the facility.
That OCE/Cost Plan should be in elemental format, detailing cost allowances for each build item, but moreover, should give further consideration to external work items such as drainage, attenuation, access roads, boundary treatment, hard and soft landscaping, Section 278 works and so on.
Abnormalities are potentially expensive, site specific risks that may occur on any project. There are several abnormalities that exist for all development projects and these need early review as they can have a considerable cost implication.
Here are a few that crop up commonly but are still considered “abnormal” when using cost data. That means that the cost of dealing with them, must be added to the basic £/m2 rate and external works applied:
- Contamination – Does the site need decontaminating? If you know the site’s previous use, you will have an indication of whether you are likely to need to decontaminate the site or implement remediation measures? For example, was it a petrol filling station, farm or other use which may have resulted in land contamination?
- Existing buildings – Are there existing buildings to be demolished? If so, how old are the buildings? The age will give you a clue as to the likely building materials used, such as asbestos, lead or other dangerous materials requiring specialist removal and disposal. For a nominal cost, you can request a desktop study to give you a clearer picture of these issues.
- Ground Conditions – What is the water table level? If it’s high, the site will need dewatering during construction and additional waterproofing measures. Does the ground have high salt levels? If so, you might need sulphate resisting concrete in the foundations. What is the make-up of the existing soils/substrate? Is it suitable for strip foundations or will you need deep trench fill foundations, a raft or even piling? Again, a desktop study can be carried out at a nominal cost to give a clearer picture of these issues on site.
- Utilities – Is the site already supplied with electricity, gas, water, and telecommunications? If so, do they have sufficient capacity for your proposed development? If not, where is the nearest supply located? Basic searches and enquiries can be made at the development appraisal stage to obtain this information, along with utility maps. It’s a good idea to start obtaining quotations based on initial information and potential loads at an early stage. Likewise, it’s never too early to deal with statutory undertakers, as the timescales involved can be very long. This is something that catches developers out all too often.
- Drainage – where is the nearest storm connection? Is there a foul connection or does the area use cesspits/septic tank? Where is the nearest foul connection? Is the area combined foul/storm? What are the planning requirements i.e. SUDs? Does the site need an attenuation tank to meet SUDs or other storm drainage requirements? Site drainage information is obtainable through Ordnance Survey, by inspection during a site visit, and through the use of site-specific software (subscriptions may be necessary).
- Rights of Way/Covenants/Easements – Rights of way, covenants and easements place restrictions on sites and can be prohibitive to the proposed development. This information should be provided by the vendor, although it is advisable to carry out your own checks. A solicitor should be able to do this for you. We suggest reviewing these as early as possible and understanding any restrictions, in order that they can be dealt with appropriately.
- Flood Risk – Is the site in a high or low flood risk area? The risk level may make it difficult for the purchaser to get a mortgage or to obtain insurance at a reasonable premium. What flood risk mitigation measures will need to be carried out? As an example, a simple search on https://flood-warning-information.service.gov.uk/ reveals that our office in Southampton is at ‘Low Risk’ for Surface Water and ‘Very Low Risk’ for Rivers and the Sea.
The above list is not exhaustive.
Each development project is unique and will therefore require input from different consultants and at a differing level of effort. Specialist consultants may also be required. The average percentage of build cost for projects between £1-10m across all sectors, is around 9.8% ranging typically from 6-12%. Below is a list of consultants to consider when budgeting fees in the development appraisal.
- Cost Consultant
- Structural and Civil Engineer
- Services Engineer
- Project Manager/Employers Agent/Contract Administrator
- CDM Consultant / Principal Designer
- Building Control
- Landscape designer
- Specialists (traffic engineer, acoustics, party wall etc.
Other Development Costs
Other development costs can end with a list as long as your arm. Below is a list of some common costs that arise on residential developments, once again, this list is not exhaustive:
- Building Warranty – An allowance between £1,500 – 1,800 is usually sufficient for a Lloyds syndicate cover-holder.
- Empty building rates – Will there be any buildings left unoccupied for a period of 3-months or more, either before or after purchase? How long will they be empty before demolition, change of use, development permitted under planning, and so on? These costs will need to be factored into the appraisal.
- Project Insurances – There are number of insurances associated with development projects. Depending on the method of procurement, the developer will need to consider public liability insurance, works insurance, existing property insurance just as a start point.
- Collateral Warranties – An extended duty of care may be required by funders, investors, purchasers and tenants. If collateral warranties are not expressed at appointment stage, consultants might request a further cost to cover provision of a collateral warranty. Making a provision for collateral warranties either under professional fees or as a separate item under Other Development Costs is always a good idea.
- Planning Contributions – Check to see if there is an applicable Section 106 and/or Construction Infrastructure Levy (CIL) applicable to the site, area, parish etc. Most local authorities publish this information on their website, allowing you to make an early judgement as to whether contributions are applicable and how much they might be.
As you can see, there are many things to consider at the initial development appraisal stage.
The more robust the development appraisal is, the greater confidence you will enjoy from funders, investors and key stakeholders. Yet, that comes at a cost which, when a project is not certain to go ahead, can be daunting.
Sadly, we often speak to developers who have not been advised to consider some of these very important issues during the development appraisal stage and, as a result, are presented with significant problems at a later date.
They find their costs spiralling out of control and budgets unravelling when they’ve passed the point of no return. Far better to invest sufficient time, effort and resource to formulate a robust development appraisal that will help you build realistic budgets and, ultimately, result in successful project completion.