Residual Valuation - Article Example

Valuation In property valuation land is seen as being the basic essential of property development and unlike building commodities such as steel, concrete and labor land supply has a limited supply. The quality of land show variation from one site to another with the value being affected by numerous changing factors that play a role in the determination of economic availability as well as market requirements which in turn play a role in setting the price (The Management Horizons ,2008). The value of land is found through making some calculation using any of the two methods: comparison method and the residual value method. The comparison method Of the two, comparisons method is seen as being more straightforward. It involves assigning a value to a site through comparison with prices that are obtained in the market for sale and sites that exhibit similar characteristics (Financial solutions, 2008). The weight assigned to the elements of comparable evidence is a determination of the value on the basis of their judgment and the knowledge they have on the market. In the process of site comparison the effect it has on valuation include: Location: there can be a lot of variation between site even when they are close to each other Ground conditions: ground condition address issues such as demolition, decontamination and cost of preparation which are very site specific and they may exhibit substantial difference between brownfield and Greenfield Comparable transactions timing: one of the unique characteristics of development property is their tendency of exhibiting volatility with periods of rapid rise and falls being experienced. Acquiring of interest: A freehold is the most expensive, long leasehold is less expensive while short leasehold are the least in worthiness and it requires adjustment to address discrepancies in interest. Property occupation: a property that is not occupied is of higher value in comparison to that with a tenant in situ, and this makes it necessary to put into consideration the cost of obtaining a vacant possession Development proposals: the type of development a land is to be used for has effect on its price with lands for luxury housing being high prices as compared to those for social amenities Allowable density: the general rule is that where the density approved is high in the planning consent , this would make a comparable ground area to have a higher value Planning obligation: this are obligation that are to met by the developer as prescribed in the plan including environmental standards to be adhered to, infrastructure, affordable housing proportion and the general planning gain all of which have impact on pricing. Comparison method find application in small and/or development projects which are straight forward, where there is no likelihood of distortion of the prices by general local value through adjustment. This may also be applicable in valuation for sites involving larger schemes as long as there is sufficient comparable evidence that can facilitate a valuer arriving at an estimate that is reliable (Financial solutions, 2008). Residual value method Residual value is the sum that remains from the property after being completed where measurement is in terms of Net Development Value (NDV), after deduction of cost development creation, Total Development Costs (TDC) as well as Minimum Profit Requirement (MPR) for the developer (English Partnerships, 2007). The calculation involved may sometimes be very complex calling for use of computer spreadsheets alternatively the use of proprietary valuation software programmes (Financial solutions, 2008). So as to populate the calculations, there is need of estimating all the component factors. These are specific to each developer and is a reflection of views about their vision with regards to the projects( as per term of use, quality and density mix), their take on timing of delivery and costs, the anticipated return rate as well as their circumstances (including risk attitude, financial ability, investor relationships and resourcing capability among others) (Mid-Mersey, 2009). Net Development value For properties being let, the expected rental value and the investment yield during sale, net of the purchaser’s acquisition costs and rent fee remainder. For outright sale of properties: the sale price that is expected, net of sales incentives that will result in reduction of realizable price. Cost associated with development Cost associated with acquisition of land including finder’s fee, agent fee, legal fee, stamp duty land tax and options cost Cost that goes in site preparation in conversion of the site from the state at the time of purchase to the desired state that would allow commencement building work which may include demolition activities, remediation, decontamination and site works including roads and diversion of services. Off-site infrastructure cost that are required for accessing the development including immediate roads, roundabouts and road junctions in addition to the cost obligations that the statutory authorities imposes as a requirement of the consent planning for accommodation of new development including motorway junctions as well as contributed towards public transport schemes Construction costs which include building components such as foundations and landscaping Professional advisors fee including architects, project managers, quantity surveyors, engineers depending on their appropriateness to a specific project Cost that goes towards sales and marketing that includes promotion events, show units and commissions earned by the agents Financial costs that results from the interest and arrangement fees by financial institutions that provides funds for buying the land, funds for acquiring planning consent and for carrying out the actual construction as well as for paying for other costs. Other factors that come into play Upon the conception of a project by a developer, there will be many alternatives that will be faced and some would require determination, some of the factors may be influenced while other will be external (Mid-Mersey, 2009). It is upon the developer to make a decision on the outcome that he chooses and that he expects so as to arrive at a cost and value estimates that are required to populate the calculation of residual value. In particular the following may need consideration At the planning application stance, where there is consideration of what one believes in with regards to design, mix and density and the extent to which one is prepared in pushing and the time one may have to wait and other trade-offs that may come into play, and the possibility of there being an appeal inquiry The development plan that could comprise of both issues to do with the appropriate location of the project with regards to expected market, quality and sustainability that have effect on both cost and GDV and the appropriateness of the site putting into consideration the constrains Methodology of delivery : this points to the fact that the developer has at their disposal a range of choices with regards to procurement, materials and project managements all of which affect timing as well as cost Marketing strategy: this is important as more spending in this area may results to increased sales prices and the quantity sold and each developer has their own view on the strategy to be taken and the cost implication Development profit: the applied criteria and required level of return will be dependent on financial positioning of each developer, the cost of their capital, how they perceive risk, the tax position as well as investors expectation Timing of payments for site : if there is future payment of a site, then there will be discounts back to the date of valuation Due to some factors including fast computerization and being more convenient; development that are more complex, high understanding of financial principles and the need of one to be more confident on site pricing and level of profitability; residual valuation have been made to be more easier to carry out as compared to the past and they are more necessary thus resulting to the method being widespread ( HM Treasury Pocket Databank 2010). In cases involving large and complex development the comparison method is rendered inappropriate, either as a result of there being no comparable evidence for similar schemes, or there being need for the available evidence requiring some adjustment and thus making the method of no use or little use if any (Jones Lang La Salle,2009). In such situation residual valuation becomes the method of choice. Because of the residual valuation being a derivative of a number of estimated factors, it makes the method to be highly sensitive to inputs and exhibiting wide variation between different developers, this being all dependent on the assumption used. This is clearly seen in the five projects involving the four Commercial Estate Agents namely: Eckersley, Jones Lang Lasalle, Drivas Janas and HDAK. Developments for various Commercial Estate Agents in Preston Eckersley Total area for development 4 hactares Density (m2/hactrare) 4000 Sales price (£/m2) 2250 Contingency on costs 10% Interest rate 8% Profit Requirement on GDV 15% Residual land value 2200,000 Equivalent RLV per hectare 550 000 Jones Lang Lasalle Total area for development 4 hactares Density (m2/hactrare) 6000 Sales price (£/m2) 2250 Contingency on costs 10% Interest rate 8% Profit Requirement on GDV 15% Residual land value 6700,000 Equivalent RLV per hectare 1675 000 Drivas Janas Total area for development 4 hactares Density (m2/hactrare) 6000 Sales price (£/m2) 2500 Contingency on costs 10% Interest rate 8% Profit Requirement on GDV 15% Residual land value 11300,000 Equivalent RLV per hectare 2825 000 HDAK. Total area for development 4 hactares Density (m2/hactrare) 6000 Sales price (£/m2) 2500 Contingency on costs 5% Interest rate 6% Profit Requirement on GDV 12.50% Residual land value 15400,000 Equivalent RLV per hectare 3 850 000 Drivas Janas Total area for development 2 hactares Density (m2/hactrare) 6000 Sales price (£/m2) 2500 Contingency on costs 10% Interest rate 8% Profit Requirement on GDV 15% Residual land value 5650,000 Equivalent RLV per hectare 2825 000 From the five development it can be seen there is a difference in valuation but all in all the residual method is able to provides a consistent way that is useful in deriving a valuation for land that is appropriate for the developer. Developers will most of the time adopt a Minimum Profit Requirement (MPR) criteria that appears to be appropriate to their business (ONS, 2010). The developers stick to the MPR with variation only in the level of establishing the hurdle which is necessary for the particular project as per specific risk involved in the project. The major MPR methods include Profit Return on Cost (PROC): This involves division of project profit by Total Development Costs Ungeared Internal Rate of Return (UIRR): Considers the IRR cash flow of the project before interest Profit Return on Sales (PROS): This involves division of Project Profit by Net Development Value Gross Margin on Sales (GMOS): This is where Project Profit interest is divided by Net Development Value References Department of Communities and Local Government (2008). “Securing the Future Supply of Brownfield Land: Government Response to English Partnerships' Recommendations on the National Brownfield Strategy” English Partnerships (2007) “National Brownfield Strategy: Recommendations to Government” HM Treasury Pocket Databank (2010). UK GDP 2010 Q1 Halton Core Strategy (Preferred Options) Policy CS1 Halton Core Strategy (Preferred Options) Policy CS1 Jones Lang La Salle(2009). UK Residential Market Forecasts Mid-Mersey (2009). Programme of Development Mid-Mersey (2009). Growth Point- Programme of Development ONS (2010). National Accounts 2009 Q4 The Management Horizons (2008). UK Shopping Index uses a scoring system to rank and classify retail centres across the country by size and content. Read More