Guildford Site Development Appraisal - Essay Example

Guildford Site Development Appraisal The following are the important s and assumptions that were used in the appraisal: Rent receivable for two years is to be differed with inflation in mind 3 years for the development period. 7% for short term finance 50% of the costs of construction will be provided for by short term finance. Contingency fund would equal 5% of construction cost to cover unforeseen expenses 2 months allocated for legals and lettings. 6 months allocated for marketing. Cash flow valuation is deferred for 3 years until completion even though the 1st Office building starts to be occupied after 1 year The appropriate cost for Office blocks that meets specification is £1,500 2,400 m2 as lettable area to include spaces for internal walls and service shafts. Construction for the first phase lasts for 12 months while the second phase starts after the 12 months and lasts for 24 months. Income £ Expected annual income ( £320 per m² x 2,400 m² ) 768,000 ( £340 per m² x 4,760 m² ) 1,618,400 YP @ 6.5% in perpetuity 15.38 Gross Development Value ( GDV ) 36,702,832 Less purchase costs ( 5.5% of GDV ) 2,018,655 Net Development Value ( NDV ) 34,684,177 Costs Site cost 10,000,000 Acquisition costs (2% of site costs) 200,000 Construction 8,400 m² @ £1,500 m² 12,600,000 Contingency @ 5% 630,000 Demolition & Statutory @ 3.5% 441,000 Total Construction costs 13,671,000 Construction fees @ 12% 1,640,520 Legal and letting costs @ 2.5% 341,775 Marketing costs @ 1% 136,710 Short Term Finance £ Demolition & Statutory ½ x 441,000 @ 7% for 36 months 46,305 Construction, Fees & Demolition (incl 36 months interest) ½ x 15,357,825 @ 7% for 36 months ( £12.6m+ £630,000 + £441,000 + £46,305 + £1,640,520 ) 3,225,143.25 Legals and Lettings ( £341,775 @ 7% for 2 months ) 382,788 Marketing ( £136,710 @ 7% for 6 months ) 4,784.85 Land Cost including acquisition £10,200,000 @ 7% for 3 years 2,142,000 Total Cost 31,791,026.10 Net Development Value 34,684,177 Total Cost 31,791,026.10 Gross Profit 2,893,150.90 Return On Capital Employed ( ROCE ) is 9.1% Development Yield = 2,459,062 / 31,791,026.10 x 100 = 7.74% Profit Erosion with 6% priority yield = 2,893,150.90 / ( 31,791,026.10 x 0.06 ) = 1.52 years Profit Erosion Remarks Profit erosion presents itself as a possible avenue for funding the project. The Lending Firm and the Developer negotiates on the amount of short term and long term funds and the corresponding interest rates. As a rule of thumb, the long term interest rate should be lower as these represents a broader time period for compounding to accrue. Usually, the lending firm would set interest rates at priority yields where they can achieve the minimum return they want to realise from the scheme. The developer should, before hand, analyze whether there is maximization of rent from the scheme adapted. Considering that the scheme is not fully pre-let, a higher rent is obtainable so long as it remains competitive. To calculate ₤ Cost (from appraisal) 31,791,026.10 Developers guaranteed fee 3,500,000 Total cost to fund 35,291,026.10 At 6% funds priority yield, minimum rent going to the fund is given by the equation 2,117,461.57 (£35,291,026.10 x 0.06) Under this scheme, the difference between the Developer’s fee and the minimum rent going to the fund is split between them at share percentage agreed early on. If the two parties opted for tranches of rent, then computation would proceed as in the following section. Tranches of Rent Tranche A – 70% of the amount the rent exceeds 6% but does not exceed 9% (funds expenditure) £ Expenditure 35,291,026.10 x 0.09 = 3,176,192 Expenditure 35,291,026.10 x 0.06 = 2,117,461 Difference 1,058,731 Tranche B – 100% of the amount the annual rent exceeds 9% of the funds expenditure £ Rent achieved 3,500,000 Expenditure 35,291,026.10 x 0.09 = 3,176,192 Difference 323,808 Final returns Total of both tranches = 323,808 + 1,058,731 = £1,382,539 This total is then used as capital with the rate stated in the contract. It is attractive for the developer as it provides additional incentive fee together with the rent payment. If the contract states that the capitalisation rate to be applied is 2% higher than the priority yield, then the rate becomes 8%. 8% in perpetuity is 12.5 1,382,539 x 12.5 ( 8% perp ) = £17,281,737.50 The funds costs can now be calculated as follows; £ Scheme (w/ short term interest) 35,291,026.10 Developers Incentive Fee 17,281,737.50 Developers Guaranteed Fee 3,500,000 Total cost to the Lending Firm £56,072,763.60 Commercial Mortgage Funding The use of mortgages is widely used in the industry for long-term funding. What the developer can offer as security is the first constructed building. Mortgages serve as a source for capital for the next phase construction and can also be used to pay accrued interests. The going rates for mortgages are usually at 2% over base rate (which is currently 5.25%). Therefore, a mortgage payable in 20 years at 7.25% ahs the following cash flow: Annual Repayment ]35,291,026.10 x 0.8020 x 12 £3,396,408.36 100 Repayments and Potential Developers Profit Rents £2,380,000 Yield 6.5% Capital Value £36,702,832 Cost of Development £31,791,026.10 Mortgage as a % of GDV 65% Annual repayment 23,856,840.8 x 0.8020 x 12 = £2,295,982.40 100 Rental income £2,380,000 Mortgage repayments £2,295,982.40 Surplus to Developer £84,017.64 It can be seen that there is a rather large savings for the developer. Forward Sale A forward sale is when a party agrees to purchase part or the whole of the development after it is completed. Payment occurs at an agreed scheme but a part of it is usually paid before hand. The money from the sale can serve as the capital for the succeeding phases of the development. Analysis of different funding methods The Local Authority may have the necessary funds to build the proposed development. This may work for the developer as he no longer need to expose himself to risks of interest rates and pressure from repayment schedule. However, it is highly unlikely that the Local Authority would concentrate such a larger amount of their budget to the venture. Profit erosion with priority yield is a convenient way to finance the development project. However, the developer should determine whether he will avail of short-term, long term or a combination. With the right choice, he may even realize a profit from the payments. Construction mortgages are offered by a variety of various institutions. Availing of one especially in financing construction projects is widely practiced. It falls upon the developer to find the bank with the least interest rate and flexible repayment schedule appropriate for the development. However, some developers have established such a good reputation that they obtain certain perks from lending firms (i.e. lower than usual interest rate and flexible repayment schedule). Note that the developer should offer some security or collateral. To avoid the ever increasing effect of inflation, most developers would start repaying mortgages before any income is realised from the development. This strategy is better known as deficit financing. Forward sale is a very good way of generating capital for the completion of the project. Because of the lesser pressure, the developer can seek a lower interest rate from other financing schemes. Pricing for the forward sales may be lower than when the project is already completed. Yet, the savings from smaller interest payments can balance this out. Accuracy of Methods With the availability of spreadsheet and statistical software such as Excel, an appraisal can be done with results showing fluctuations for every specified period. Conventional methods of appraisal do not factor in the time scale and is thus less accurate than the spreadsheet. Construction costs in the traditional method are computed with an interest rate which is the same all throughout the period. Yet, construction costs are subjected to different interest rate for the construction period. Thus, the costs computed would not be representative of real-word events. In the spreadsheet, many tools are available that enables computation of costs with their corresponding interest rate and this could even be plotted on an S-curve (a chart showing accumulated costs as a function of time). Determination of finance also suffers from the lack of a time scale in the conventional format as the finance is computed with an even interest rate. With the spreadsheet, one can perform a quarterly analysis of finance which makes it more accurate. The traditional method can be useful for those who are not still capable of performing functions in the spreadsheet. However, with the exposure to computers nowadays, it is expected that more and more people can become aware of the spreadsheet and its uses. Once this happens, the traditional method may become useful only for arriving at crude figures. Q2 Simon Goff Development Consultants 20-22 Landmark St Edinburgh ED7 2XJ Planning & Development Dept Local Authority Address AB1 2CD Re: Town Centre Development Options Dear Sir, Thank you for choosing Simon Goff Development Consultants. Attached is your report into the options available and the risks of developing your town centre site. We hope this meets your requirements. Please contact us if you have any queries. Yours Sincerely Simon Goff Contents 1. Introduction 2. Main Aims 3. Research & Analysis 4. Producing a Development Brief 5. Advertising & Promotion 6. Procuring a Developer (Tendering) 7. Negotiations 8. Agreement with Developer 9. Funding Arrangement 10. Design & Build 11. Post Development 12. Bibliography 1. INTRODUCTION Ideally, the development process would be designed such that the project is accomplished at the least cost and least amount of time yet with quality assured. In real life, however, the construction is very prone to external factors that may hamper progress or may even stop the venture. All projects of this scale and monetary value require meticulous consideration of factors such as sources of funds, legal compliance and market viability. Suffice it to say, every detail should be considered such that “no stone is left unturned”. 2. MAIN AIMS It is desired by the Local Authority to provide a financially viable development of an area. This planned development involves the building of infrastructures and landscape suitable for retail and leisure activities. It is also of utmost important that the venture be accomplished in a manner that no legislation is violated. 3. RESEARCH & ANALYSIS Development projects, with financial viability in mind, are undertaken only after a feasibility study has given a go signal for the project. It is expected then that the local authority has undertaken such activity. With regards to the finding the most cost-efficient source of funding, a detailed analysis of various scenarios should be undertaken. It may also turn out that a mix of funding methods be more appropriate so this should be investigated as well. It must be ensured that the data acquisition process is correct and complete and that the methodology to be employed is already established. Even small mistakes or seemingly logical assumptions can under/overestimate market projections. Existing laws that is related to the development must be reviewed and analyzed as thoroughly as possible to prevent future legal disputes. Any contradictions or violations should be identified and addressed. The Local Authority should avail of its legal arm in this regard. Some of the legislation that must be checked are the Planning Policy Statements. PPS 3, or the Town Centre Planning, and PPS 12 or the Local Development Framework is relevant to this type of project. 4. PRODUCING A DEVELOPMENT BRIEF After data has been gathered regarding the site, a basic development brief is to be composed. The document contains preliminary information on the features of the site such as location, physical features, current use, proposed use and other basic information. The purpose of the development brief is to generate interest in the project. As such, it should be composed in a manner that it relays sufficient information. Care should be taken not to make the brief very detailed or very uninformative. 5. ADVERTISING & PROMOTION Next in the line of activities would be an advertisement relaying the basic information regarding the project and the desire to hire a developer which can accomplish the project. May media avenues are available such as newspapers and construction. A very good avenue would be posting at the OJEC (Official Journal of the European Communities). This tender database journal is subscribed upon by many contractors and developers. In here, the employer provides background information, project outline and would sometimes include -price quotes. Thru this, the Local Authority can seek out more competitive developer and contractors. The Local Authority can also make use of the services of past contractors who have proven themselves very capable. 6. PROCURING A DEVELOPER (TENDERING) After the project availability has been made known, the Local Authority could expect correspondence from interested developers. Usually, the correspondence includes company information, portfolio perhaps, response to the project stating their desire to qualify for the project and the financial capacity of the firm. Of utmost concern to the council would be the authenticity of their financial capability. Out of all the prospective developers, the Local Authority chooses at most 6 from the tender list. These firms are then notified of their qualification together with more information and specification. Developers respond by sending their feedback, options to which the council can choose from and any other remarks regarding the project and terms. After these have been received, the Local Authority now analyzes the options and would normally be drawn towards the option with the lowest cost for the council or the most profitable for the council (as low cost does not ensure maximum profit). All these activities are to be conducted with legal compliance. 7. NEGOTIATIONS When the rigorous process of selecting a developer has been finished, the two parties now enter into negotiations to settle matters such as terms of payment, legal interests for the property, construction provisions, dispute settlement mechanisms and other pertinent details, Basically, in this stage the two parties are trying to come into terms regarding the different facets of the project. All aspects must be smoothened out leaving no room for misinterpretations. This is crucial to achieve because it will affect future transactions. Negotiations don’t always go smoothly as certain terms or conditions related to site options are not agreeable to one party. In this case, negotiations break down and the Local Authority contacts the next ranking developer. Legal compliance should always be observed. 8. AGREEMENT WITH DEVELOPER When the client and the developer have come to terms, a contract is now signed. This activity is usually accomplished with a legal council as witness. All future disputes are referred to the contract. There shall be no provisions or clause in the contract which violates any legal covenant. At this stage, a permit to operate in the site is issued by the Local Authority to the developer. This arrangement ensures that the ground site is ultimately owned by the local Authority and allows the developer to carry out the work. 9. FUNDING ARANGEMENT Finding the right source and mix of financing the project is imperative as this will ultimately determine the financial viability of the project. Interest rates and payment schedules of loans must be fully analyzed. The combination of long term and short term financing should also be investigated. Ultimately, the aim would be to come up with the best funding arrangement that would be beneficial for both parties. If borrowing from international agencies, an analysis of fluctuations and exchange rates must be conducted. It is common practice that the foreign lending firm and developer to agree on an exchange rate applicable to the date of payment. The Local Authority may have already allocated the necessary funds for the project. However, this is not always efficient for the council as a large amount of their budget is appropriated for the endeavour When both parties have agreed to the terms, they can now proceed to the construction proper. 10. DESIGN & BUILD The site is now investigated to acquire data that would be used for the analysis and design of structures and landscape. Onsite activities include geotechnical investigation for soil properties, hydraulic and hydrological investigation for water flow properties, geodetic surveying for definition of topography and other pertinent site characteristics necessary for a complete analysis. Offsite investigation includes zoning and environmental concerns. After all the data have been achieved, some modifications become necessary. This results to changes in costs and agreed options. The client and developer go back to the negotiating table and try to come to terms again. After the final plan has been drafted, work commences. This is basically the stage given with the most attention as this is where many unforeseen problems and issues suddenly spring out. Each one must be addressed as efficiently as possible to ensure the completion of the project. This will involve a conscientious effort of the two parties to find solutions acceptable to both parties. Sales agents are activated in this stage and the number of tenants they are able to attract will determine how financially viable the project is. 11. POST DEVELOPMENT After all the activities have been completed, many agreed terms and processes come into execution. This may include activities such as selling the right to lease the ground to the developer. Post-Tests may also be conducted to ensure that the project complies to specifications. 12. BIBLIOGRAPHY Books: Baum, A & Crosby N (1995). Property Investment Appraisal. Routledge:UK Dubben, N & S Sayce (1991). Property portfolio management. Routledge: UK Isaac, D & T Steley (1991). Property Valuation Techniques. Macmillan:UK Isaac, David (1996). Property Development Appraisal and Finance. Palgrave :UK Isaac, David (2003). Property Finance 2nd edition. Macmillan: UK Journals and documents: “The Property Development Process of Phases and their degrees of Importance” Professor George S Birrell Estates Gazette Journals and RICS papers Websites: www.egi.co.uk www.odpm.gov.uk www.ojec.com www.rics.org Read More