Viability and Developer Risk: A Case Study

Since the introduction of the NPPF, viability has become an issue increasingly at the heart of development in the UK. This is particularly true for smaller residential developers who are more exposed to the risks of the market as profit margins are tighter, mitigation strategies fewer, and cost of finance higher. 

In the context of Brexit, the current economic stagnation and political turmoil, in an industry already by nature fraught with regular cycles of boom and bust, a minimum developer return is required to offset the high risks of business, such as changes in sales values, build costs, land costs, and delays. This minimum is suggested as 15-20% of GDV by both RICS and the NPGV, while Savills suggests that for SME developers a return of 25-30% is more appropriate due in part to the higher cost of finance. Most local authority viability studies, upon which affordable housing and CIL policies are often based, assume as their base a 20% developer return. 

For many people this seems quite high on the face of it. This is to misunderstand what ‘return’ refers to, however.

‘Return’ is commonly misconstrued as ‘all profit’. However, the London Plan Viability Study Technical Report 2017 demonstrates that this ‘return’ can be broken down into the following constituent risk profiles:

Item

% of GDV

Developer overheads

3%

Retained profit for growth

5%

Sale price buffer

6%

Build cost risk factor

2%

Land holding risk

2&

Imposed delay 

1%

Total initial return requirement

19%

'Profit' is the final result after all risks have crystallised over the multiyear lifetime of a development.

Given the above, below we seek to dispel some of the common myths of viability assessment through a demonstrative case study.

From client contact, we obtained details of the target development including address, planning reference, plans, schedule of accommodation and GIA of existing buildings on site and began a valuation of both existing and proposed uses.

The policy compliant contribution towards affordable housing based on the local authority’s contributions calculator was £150,000. The client was concerned this would render the project unviable due to its smaller size.

Extensive research of the local market was completed, involving review of market evidence and in-depth discussions with local agents to ascertain appropriate values. Other inputs including build costs, abnormals, and finance were calculated in detail, with support from RICS Red Book valuation where necessary. These calculations were compiled within an industry standard toolkit, and the draft report completed.

The report concluded that, with a projected developer return of 8% (well below the RICS/NPGV guidance of 15-20%, and the local authority’s own viability study which assumed 20%), this scheme could not contribute the sought section 106 contributions.

Extensive negotiations ensued, with challenges to assumptions, methodology, and interpretation of policy from the local authority’s planning officer. We responded robustly to all arguments, and agreed the way forward, as is standard with viability negotiations, would be for the planning officer to appoint their own viability expert at the client’s expense.

Following this process, the local authority’s appointed consultant produced a viability report which suggested a contribution of £26,000 towards affordable housing might be possible, through different interpretation of market data and selective inputs.

Given the time pressures of an imminent planning decision the client decided to accept the proposed compromise as a win-win. This is not an uncommon outcome.

As a result, the originally sought contribution of £150,000, which was demonstrably not proportionate or related to the financial specifics of the development, was reduced to a more appropriate £26,000, at a saving of £124,000 to the client (c. £110,000 after all fees) which increased the client’s profit margin from 8% to the minimum required 15%.

This demonstrates both the difficulty of applying broad brush policies to individual (particularly smaller) developments, and that collaborative viability negotiations can achieve win-win outcomes for both parties.

For more information on viability assessment and developer return see Planning Portal or S106 Management.


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