Residual Valuations & Development Appraisals Speaker: Richard Johnson Presentation to the SCSI 28 th May 2015 Savills 33 Molesworth Street, Dublin 2 T: +353 (0) 1 618 1344 E: richard.johnson@savills.ie savills.ie
Overview of Presentation Why, When and What?? Residual Valuation Vs Development appraisal Highest and Best Use (HBU) Process and Worked Examples Advantages and Disadvantages Sensitivity Analysis Summary Questions
Why, When and What?? It is a method of valuation used to; 1) Value land and property with development, redevelopment and refurbishment potential. 2) To determine the viability or assess the likely profit (developers) from a particular scheme. It s therefore a method of valuation used when there is an element of latent value in a property which can be realised by spending money on the property. It s a simple Equation.. A = Value of Completed Development B = Development Costs C = Developers Profit A (B + C) = Site Value
Residual Valuation 12 Net Development Value 12 Less Developers Profit 1-12 1-12 Less Construction Cost Less Finance Cost % 1 Residual Site Value Date of Valuation
Development Appraisal 1 Residual Site Value 1-12 1-12 Plus Construction Cost Plus Finance Cost % 12 12 Less Development Value Developers Profit
Highest and Best Use (HBU) If a site doesn t have an extant PP a valuer must determine the sites HBU. A HBU analysis offers a rational approach which facilitates consideration of all possible development opportunities in order to identify the most profitable feasible development for a given site. Physically Possible 1) Site size 2) Gradient 3) Aspect 4) Access 5) Infrastructure 6) Soil type 7) Surrounding uses Legally Possible 1) Planning permission 2) Land use zoning 3) Density 4) Plot ratio 5) Site coverage 6) Building height Market Demand 1) Surrounding uses 2) House types 3) Over supply 4) Under supply
The Process 1) Gross Development Value For viability it needs to exceed existing use value plus all development costs. Residential Comparable Method Market Value of Sold Unit 900,000 Deduct VAT @ 13.5% 1.135 792,951 Residential NDV 800,000 2) Initial Development Costs Commercial Investment Method Size Sq.Ft (NIA) 15,000 ERV psf x 40 ERV P.A 600,000 YP into Perp @ 6% 16.66 9,996,000 Less Acquisition Costs @ 4.46% 1.0446 9,569,213 Say Commercial NDV 9,600,000 Demolition, Site Clearance & preparation, planning fees, capital contributions, Part V, Utility connections, Finance on these costs. 3) Construction Costs Build costs based on psf on GIA. Car park provision. Professional Fees Contingency Fee Landscaping Cost of Finance S Curve
The Process (Cont d) 4) Marketing Costs May begin at start or middle Determined by type of property. Sales off plan. Advertising, Show units or marketing suite fit out, finance. 5) Disposal Costs Agents fees for sale of investment or resi units Legal fees for disposal of investment or resi units Usually paid on completion 6) Finance Costs Mix of equity and debt. Short term finance is usually arranged for development finance. Finance for site purchase and development costs. 7) Developers Profit Must be financial benefit to developer Returns expected will depend on risk Can vary between 10 20% Anticipated returns are often used by developers to compare projects
A worked Example (Residential) Size of House Sq.Ft 2,000 Price psf 450 Market Value of House 900,000 Less VAT @ 13.5% 1.135 792,952 A Net Development Value 800,000 Less Site Clearance 25,000 1 Cost of Construction Say 200 psf 400,000 Construction Fees Say 10% of 1 40,000 Cost of Finance 50,000 Contingency Say 5% of 1 20,000 Agent's / Legal Fees Say 2% of GDV 18,000 Acquisition Costs 9,000 B Development Costs 562,000 C Developer's Profit 15% of 1 60,000 800,000 - ( 562,000 + 60,000) = 178,000 A ( B + C) = Site Value Residual Site Value Say 180,000
A worked Example (Commercial) Site on Hatch Street Lower Subject Property
A worked Example (Commercial) Cont d Proposed Development Dev Plan Zoning Z6 Plot Ratio 2.0:3.0-1 Indicative Site Coverage 60% Site Area Ha 0.06 Ac 0.15 M Sq 607 Building Size Gross Internal Area Sq.Ft 20,000 Sq.M 1,858 Gross to Net 75% Net Internal Area Sq.Ft 15,000 Sq.M 1,394 Actual Site Coverage 65.00% Actual Plot Ratio 3.06 Analysis On Gross Buildable 182 On Net Buildable 243 On Price Per Acre 24,266,667 Comparisons Suggest Land Value is 30,000,000 Residual Valuation GIA of Office Sq.Ft 20,000 NIA of office Sq.Ft 15,000 ERV psf 40 ERV p.a 600,000 YP into Perp @ 6% 1/.06 16.66 Gross Development Value 9,996,000 Less acquisition Costs @ 4.46% 1.0446 A Net Development Value 9,569,213 Less 1 Cost of Construction Say 200 psf 4,000,000 Construction Fees Say 10% 1 400,000 Cost of Finance 250,000 Contingency Say 5% of 1 200,000 Agent's / Legal Fees Say 2% of GDV 199,920 Planning Contributions 130,000 Acquisition Costs 150,000 B Development Costs 5,329,920 C Developer's Profit 15% of 1 600,000 9,569,213 - ( 5,329,920 + 600,000) = 3,639,293 Residual Site Value Say 3,640,000
Advantages and Disadvantages Advantages Useful in analysing and comparing competing development sites. It is useful at the early stages of a development when more detailed cashflow analysis is difficult due to lack of information Provides early indication of the viability of a project without incurring costs of more detailed feasibility studies. Disadvantages Larger number of estimates can create inaccuracies. Valuer often determines HBU, when no PP. Time lag in development means that the valuation may be accurate when it was undertaken but may not be realistic when completed. Valuation is only as accurate as the inputs. Valuation is carried out at a point in time and estimates made at that time. Discounted cashflow method gives a more accurate result.
Sensitivity Analysis As many of the variables in a residual are speculative, there is a high degree of uncertainty with this method of valuation. A risk and sensitivity analysis should be carried out on the main variables in the valuation to examine the viability of a particular scheme and its susceptibility to change. The aim of a sensitivity analysis is to examine the effects of changes in variables on the residual value. The % change in the variable is compared with the % change in the residual amount. If a small % change in the variable produces a large % change in the residual amount, then this variable can be classified as very sensitive. A residual would be sensitive to minor changes in; GDV, Construction Costs, Interest Rate, Capitalisation Rate, ERV. These would influence the inter-dependent variables like; developers profit, professional fees and agents fees. Optimistic and Pessimistic Scenario.
Sensitivity Analysis on Residential Worked Example 50% Reduction on MV 25% Reduction on Construction Cost Size of House Sq.Ft 2,000 Size of House Sq.Ft 2,000 Price psf 225 Price psf 450 Market Value of House 450,000 Market Value of House 900,000 Less VAT @ 13.5% 1.135 Less VAT @ 13.5% 1.135 396,476 792,952 A Net Development Value 400,000 A Net Development Value 800,000 Less Less Site Clearance 25,000 Site Clearance 25,000 1 Cost of Construction Say 200 psf 400,000 1 Cost of Construction Say 150 psf 300,000 Construction Fees Say 10% 1 40,000 Construction Fees Say 10% 1 30,000 Cost of Finance 50,000 Cost of Finance 50,000 Contingency Say 5% of 1 20,000 Contingency Say 5% of 1 15,000 Agent's / Legal Fees Say 2% of GDV 9,000 Agent's / Legal Fees Say 2% of GDV 18,000 Acquisition Costs 9,000 Acquisition Costs 14,000 B Development Costs 553,000 B Development Costs 438,000 C Developer's Profit 15% of 1 60,000 C Developer's Profit 15% of 1 45,000 800,000 - ( 553,000 + 60,000) = - 213,000 800,000 - ( 438,000 + 60,000) = 303,000 Residual Site Value Say - 210,000 Residual Site Value Say 300,000
Summary Used to value land with development, refurbishment potential. Residual valuations assess site Value. Development appraisals assess the viability of a proposed development. Without planning permission, a valuer must assess the highest and best use. Always back up the residual method with the comparison method. The method has its advantages and disadvantages. A sensitivity analysis is a useful tool.
Questions A bit of an art and a science