Development Context

Development Economics

AN OVERVIEW OF DEVELOPMENT ECONOMICS

This section aims to give a general and simplified overview of how developments are costed to give planners a starting point in understanding where there may be flexibility for incorporating SDC measures in a development.  It is possible to incorporate sustainable construction measures at different stages of the development process but it becomes more problematic and less likely further down the line.

The costing process
Incorporating sustainable construction in a development

THE COSTING PROCESS – DEVELOPMENT APPRAISALS

   Value of the Development

less      Cost of Development
less      Profit

=          Residual Land Value
           
(What the developer will bid/pay for the land)

Value of the development

When developers are considering the purchase of a piece of land, they consider what value they can get from this land – either income through sales (for housing) or through rental value or yields (for commercial).  This will typically be done with input from property agents. The valuation will consider current market trends, drivers and conditions:

  • Affordable housing
  • Stamp duty thresholds
  • Buy to let investors increasing demand for 2 bed 2 bath flat market (but there is a potential over supply of these)
  • Now a demand for ‘sustainable’ homes?

Developers do not always get the market right!

Cost of Development

There are a number of components to the costing of a development (explained below) including:

  • The cost of a standard building type
  • The cost of ‘abnormals’ associated with a site
  • Additional design codes or standards required for a site
  • Other associated costs.

1. Cost of standard building type

Each developer will have a standard building type cost/m2 (for houses / flats / offices etc) – this is the basic costing block for the developer. They are likely to have a detailed specification for this standard building type.

2. Cost of “abnormals”

These are specific items associated with a site that must either be dealt with or provided. These could include a new traffic junction, decontaminating land, or levelling land. Often the abnormals must be dealt with in order for the site to be in a suitable state for building. Section 106 agreements are sometimes used to negotiate abnormals such as affordable housing and schools. All items will add a premium to the overall cost. Some times the s106 requirements are such that a negative land value results. Sometimes the site might be made affordable by allowing more units to be built on the site.

2. Cost of design codes

Design codes are items for a development which fall outside the standard for that building type. They are often for the external fabric of the building such as a metal roof or premium for the architect. Design codes will increase the cost of the building per sq ft.

Sustainability requirements may fall into this: e.g. Ecohomes, BREEAM, NHER, PV panels etc

3. Additional components and costs

The developer also needs to take into account a number of factors which usually total 25-30% of total income:

Overheads and site preliminaries – about 7-8% of income value

Finance – 2% of income value (cost of borrowing)

Marketing – 4-5% of income value (or whatever it takes to sell the units)

Professional fees (% of build cost)

Contingency

The contingency will be linked to the risk associated with a particular site. This risk could be related to the construction process, the site or future market conditions. Higher risk means higher costs, which means that the development viability reduces. A developer’s objective is to eliminate as many risks as possible as there are some risks (e.g. market conditions at point of sale) that are difficult to manage. Developers want to minimize aspects of a development that are unpredictable or innovative. Sustainable construction techniques, particularly the more innovative such as renewable energy may fall into this category.

Profit

A target profit is set up-front, generally about 14% of income value. Once set this figure is considered un-touchable.

Residual Land Value

The value of the development, cost of the development and profit are then used to calculate the residual land value placed on a piece of land for development.  This represents what the developer will pay/bid for a site.

Appraisal variables

Development appraisals are not however an exact science and there are many factors which may result in variations within the calculation, including:

  • One agent’s £300 sq.ft. is another’s £360 sq. ft.
  • Does the developer want to do the deal?
  • Approach to design varies: Standardise or not?
  • Construction costs will vary with procurement
  • Boxes in fields: £90 sq. ft./ Flats £150 sq. ft.
  • Fine art in getting it right

INCORPORATING SUSTAINABLE CONSTRUCTION IN A DEVELOPMENT

Financing green developments

The perception is that sustainable design and construction measures always incur additional costs.  However this cost may be reduced, sometimes removed, by integrating measures into designs rather than treating them as additive measures.  For example community based systems such as district heating using combined heat and power generation may reduce the total capital costs.

Many measures are of similar costs to standard versions such as low/dual flush WCs and water/energy efficient appliances.

Therefore developers should consider reviewing their standard designs.

A developer could also consider take a strategic partner with a long term view, for example to set up an Energy Service Companies (ESCO) to fund and manage district heating and/or private wire (private electricity networks).

Including sustainable design and construction through planning

A developer could be told at a number of stages in the development process that the local authority / landowner / client requires sustainable construction techniques to be employed on the development. The earlier the developer is informed of this, more likely it will be for the measures to be incorporated. Main scenarios include (considered in more detail below):

  • The developer knowing details of sustainable construction requirements before the land is bought / project bid for
  • The developer has the land already and the property value has gone up more than build cost enabling additional costs to be covered.
  • Flexibility to adjust figures depending on Return on Capital Employed (RoCE).
  • If the developer has the land already and the property value has not gone up.

 

1. Knowing before the land is bought

If a developers knows BEFORE bidding for land that renewables are going to be a requirement, they can factor that into the price they are willing to pay for the land. If the local authority owns the land they are likely to receive a smaller receipt by putting extra demands on the developer.

As long all the developers bidding for the land are in the same situation, there is a level playing field and renewable energy technologies can be factored in.

This is the scenario when it is most likely that developers will effectively deliver the requirements of the planning authority.

2. Development on ‘land banked’ piece of land

If a developer owns a piece of land and has done so for some years, the build cost may have gone up since they bought the land and so might the value that can be gained from sale of the new properties.

There may be situations where the land value has increased more than the build cost, in which case the developer may be able to bear more costs and retain the set profit.

3. Flexibility to adjust figures

Developers want to get their money invested back as quickly as possible, particularly as much of it may be borrowed. Paying for land up front and dealing with a large number of site abnormals before any houses are sold means tying up capital upfront which won’t be recouped until the first house is sold, which could be years.

Any items that require upfront infrastructure works such as community heating systems are therefore more problematic to implement. Technologies which can be installed later in the process, such as solar water heating or photovoltaics will not have such an impact on Return on Capital Employed (RoCE.)

If landowners can be flexible in the way they receive payment for land sold, such as allowing developers to pay in installations or in relation to houses sold, then more abnormals may be possible. This however can be difficult for local authorities due to their accounting procedures, and for private owners for cash flow reasons.

4. The developer has the land already and the property value has not gone up

If the developer already owns the land and has paid a price for the land based on a particular build cost, design codes and abnormals, they may not have any spare capital for additional abnormals such as renewable energy technologies.

SUMMARY

To be implemented effectively, it is very important that developers know before they enter into a bidding process for land that sustainable construction measures will be a requirement for any development on that piece of land. Local authorities will have to decide what their priorities are for a piece of land so that a negative land value doesn’t result. Negotiation may be possible if the value of the land has increased more than build cost. Being told that sustainable construction is required shortly after a piece of land has been bought may make it difficult for measures to be negotiated.

What can planners do?

  • Increase knowledge of development economics
  • Get conversant with the development appraisal
  • Be consistent in what you are asking
  • Try to create a sense of certainty – developer knows where they stand
  • Enhance your carbon literacy
  • Be a developer for a day and present a project to a board

What can developers do?

  • Recognise that the standard business model may not fit with the need for sustainability
  • Look at how the business can become an sustainability innovator
  • Successful innovation is about the leap
  • Those standard house types may have to go
  • Apply creative financing approach
  • Enhance your carbon literacy
  • Be a planner for a day and see how it works


 


Other links in this section