Careers Advice: Understanding the 'dark art' of financial viability assessments

Written by: Ricky Ching
Published On: 17 Jul 2017

Flats

It is now a frequent occurrence for a detailed financial viability assessment to accompany a planning application. They were once labelled as a ‘dark art’ by the previous Mayor of London, but this does not have to be the case once you get to grips with the fundamental principles.

The initial preparation and review of viability information may often be left to valuers and real estate advisors. However, planning professionals have a valuable role to play in contributing to the accuracy of any viability assessment through an understanding and scrutiny of the results. After all, planners will be most familiar with and have the big picture view of the development proposals. They are certainly best placed to possess the relevant knowledge of the national, regional, and local planning policies that are in play.

The National Planning Policy Framework at paragraph 173, and Planning Practice Guidance at paragraph 16 sets out basis for considering whether a scheme is viable or not. The main elements being the requirement to provide ‘…competitive returns to a willing landowner and willing developer to enable the development to be deliverable’. A site is considered viable ‘…if the value generated by the development exceeds the costs of developing it and also provides a sufficient incentive for the land to come forward and the development to be undertaken’. Put simply, a starting point for a viability assessment is to build up a picture of the financial aspects of (1) the proposed development, and (2) the existing site.

The results of an assessment may be presented in different formats, but in the majority of cases will be in the form of a residual valuation. This is a calculation of the money coming in from the proposed development (development value), deducting the costs incurred to develop it (development costs).

The cumulative effect of small changes in a residual valuation can make a big impact to the overall outcome. Here are a number of key tips for planners to validate and review an appraisal:

The development value is made of up of sales values of the units that will be sold (flats/ houses in a residential development) or capitalised rental values (commercial uses). This is where your experience and local knowledge of the area would come to good use. You should consider the appropriateness of these assumptions, and whether they are the justified by relevant evidence. It is important to check that the evidence relied on by the assessment is up to date (usually from within the last 6 months in an active market), are in a similar quality of location and an appropriate distance from the subject site. Also, do not forget new build properties may command a premium over second-hand properties, so make sure the evidence reflects this or has allowed for suitable adjustments.

The development costs includes build costs, professional fees, finance charges and profit for the developer. Build costs should be compared against the RICS build costs database (BCIS); it is always worth asking for an explanation if there are significant differences from the database estimates. Moreover, there may be a correlation between build costs and assumed sales values; the specifications assumed in the costs should be reflected in the values. Profit levels should be justified and reflect the risk of the development; for example levels of profit for private residential, affordable residential and commercial developments should be clearly distinguished. Professional fees adopted should also have relevance to the complexity of the development.

The amount left over from the above calculation is the residual land value. This amount is considered to see whether it would incentivise the landowner to release the land (known as the benchmark land value). There are a number of methodologies for looking at this:

‘Existing use value plus’ relates to the current use of the site and includes a premium to incentivise it to be released. It considers the value before the grant of planning permission so it identifies the potential uplift in land value as a result. This is the most conducive to achieving the goals of the planning system, and in most circumstances should form the basis for determining the benchmark land value.

Alternative methods such as ‘market value’ should be considered with caution and used in limited circumstances. An erroneous application of the market value approach may inappropriately reduce planning obligations, and such dangers have been highlighted in a 2015 RICS research paper (Crosby, N and Wyatt, P; Financial Viability Appraisals in Planning Decisions).

The ability to understand, scrutinise and decrypt viability results; whether it is for the purposes of engaging with the community at public forums, presenting at committee meetings, or briefing a client, is an excellent skillset to possess. Further guidance on notes/publications on viability in a planning context are available and more are emerging in the form of supplementary planning documents from local planning authorities, such as the examples in the links below from the Islington Council, the GLA and Tower Hamlets Council:

https://www.islington.gov.uk/planning/planningpol/pol_supplement/development-viability-discussion-paper-and-questionnaire

https://www.london.gov.uk/what-we-do/planning/implementing-london-plan/supplementary-planning-guidance/affordable-housing-and

http://www.towerhamlets.gov.uk/lgnl/environment_and_planning/planning/Infrastructure_planning/Development_Viability.aspx

Ricky Ching is deputy team leader of the Development Viability Team at the London Borough of Islington.