Residual Valuations &

Development Appraisals
Speaker: Richard Johnson
Presentation to the SCSI
28th May 2015
Savills
33 Molesworth Street, Dublin 2

T: +353 (0) 1 618 1344

E: richard.johnson@savills.ie

savills.ie
Overview of Presentation

Why, When and What??

Residual Valuation Vs Development appraisal

Highest and Best Use (HBU)

Process and Worked Examples

Advantages and Disadvantages

Sensitivity Analysis

Summary

Questions
Why, When and What??
It is a method of valuation used to;
1) Value land and property with development, redevelopment and refurbishment potential.
2) To determine the viability or assess the likely profit (developers) from a particular scheme.

It’s therefore a method of valuation used when there is an element of latent value in a
property which can be realised by spending money on the property.

It’s a simple Equation……..

A = Value of Completed Development

B = Development Costs
C = Developers Profit

A – (B + C) = Site Value
Residual Valuation

Month
Net Development Value
12

Month
Less Developers Profit
12

Month
Less Construction Cost
1 -12

Month
1 - 12
Less Finance Cost %

Month
1
Residual Site Value

Date of Valuation
Development Appraisal

Month
1
Residual Site Value

Month
Plus Construction Cost
1 -12

Month
Plus Finance Cost %
1 -12

Month
Less Development Value
12

Month
Developers Profit
12
Highest and Best Use (HBU)
 If a site doesn’t have an extant PP a valuer must determine the sites HBU.
 A HBU analysis offers a rational approach which facilitates consideration of all possible
development opportunities in order to identify the most profitable feasible development for
a given site.

Physically Possible Legally Possible Market Demand

1) Site size 1) Planning permission 1) Surrounding uses

2) Gradient 2) Land use zoning 2) House types
3) Aspect 3) Density 3) Over supply
4) Access 4) Plot ratio 4) Under supply
5) Infrastructure 5) Site coverage
6) Soil type 6) Building height
7) Surrounding uses
The Process
1) Gross Development Value

For viability it needs to exceed existing use value plus all development costs.

Residential – Comparable Method Commercial – Investment Method

Market Value of Sold Unit €900,000 Size Sq.Ft (NIA) 15,000
Deduct VAT @ 13.5% 1.135 ERV psf x €40
€792,951 ERV P.A €600,000
Residential NDV €800,000 YP into Perp @ 6% 16.66
€9,996,000
Less Acquisition Costs @ 4.46% 1.0446
€9,569,213
Say Commercial NDV €9,600,000
2) Initial Development Costs

Demolition, Site Clearance & preparation, planning fees, capital contributions, Part V, Utility connections, Finance on these costs.

3) Construction Costs

• Build costs based on psf on GIA.

• Car park provision.
• Professional Fees
• Contingency Fee
• Landscaping
• Cost of Finance – S Curve
The Process (Cont’d)
4) Marketing Costs

• May begin at start or middle

• Determined by type of property.
• Sales off plan.
• Advertising, Show units or marketing suite fit out, finance.

5) Disposal Costs

• Agents fees for sale of investment or resi units

• Legal fees for disposal of investment or resi units
• Usually paid on completion

6) Finance Costs

• Mix of equity and debt.

• Short term finance is usually arranged for development finance.
• Finance for site purchase and development costs.

7) Developers Profit

• Must be financial benefit to developer

• Returns expected will depend on risk
• Can vary between 10 – 20%
• Anticipated returns are often used by developers to compare projects
A worked Example (Residential)
Size of House Sq.Ft 2,000
Price psf €450
Market Value of House €900,000
Less VAT @ 13.5% 1.135
€792,952

A Net Development Value €800,000

Less

Site Clearance €25,000

1 Cost of Construction Say €200 psf €400,000
Construction Fees Say 10% of 1 €40,000
Cost of Finance €50,000
Contingency Say 5% of 1 €20,000
Agent's / Legal Fees Say 2% of GDV €18,000
Acquisition Costs €9,000
B Development Costs €562,000

C Developer's Profit 15% of 1 €60,000

€800,000 - (€562,000 + €60,000) = €178,000

A –( B + C) = Site Value

Residual Site Value Say €180,000

A worked Example (Commercial)
Site on Hatch Street Lower

Subject Property
A worked Example (Commercial) Cont’d
Proposed Development Residual Valuation
GIA of Office Sq.Ft 20,000
Dev Plan Zoning Z6 NIA of office Sq.Ft 15,000
Plot Ratio 2.0:3.0 - 1 ERV psf €40
Indicative Site Coverage 60% ERV p.a €600,000
Site Area Ha 0.06 YP into Perp @ 6% 1/.06 16.66
Ac 0.15 Gross Development Value €9,996,000
M Sq 607 Less acquisition Costs @ 4.46% 1.0446
Building Size Gross Internal Area A Net Development Value €9,569,213
Sq.Ft 20,000
Sq.M 1,858 Less
Gross to Net 75%
1 Cost of Construction Say €200 psf €4,000,000
Net Internal Area
Construction Fees Say 10% 1 €400,000
Sq.Ft 15,000
Cost of Finance €250,000
Sq.M 1,394
Contingency Say 5% of 1 €200,000
Agent's / Legal Fees Say 2% of GDV €199,920
Actual Site Coverage 65.00% Planning Contributions €130,000
Acquisition Costs €150,000
Actual Plot Ratio 3.06 B Development Costs €5,329,920
Analysis
On Gross Buildable €182 C Developer's Profit 15% of 1 €600,000
On Net Buildable €243
On Price Per Acre €24,266,667 €9,569,213 - (€5,329,920 + €600,000) = €3,639,293
Comparisons Suggest Land Value is €30,000,000 Residual Site Value Say €3,640,000
Advantages and Disadvantages
Advantages
• Useful in analysing and comparing
competing development sites.
• It is useful at the early stages of a
development when more detailed
cashflow analysis is difficult due to
lack of information
• Provides early indication of the
viability of a project without incurring
costs of more detailed feasibility
studies.
Disadvantages
• Larger number of estimates can create
inaccuracies.
• Valuer often determines HBU, when no PP.
• Time lag in development means that the
valuation may be accurate when it was
undertaken but may not be realistic when
completed.
• Valuation is only as accurate as the inputs.
• Valuation is carried out at a point in time
and estimates made at that time.
• Discounted cashflow method gives a more
accurate result.
Sensitivity Analysis
 As many of the variables in a residual are speculative, there is a high degree of
uncertainty with this method of valuation.
 A risk and sensitivity analysis should be carried out on the main variables in the valuation
to examine the viability of a particular scheme and its susceptibility to change.
 The aim of a sensitivity analysis is to examine the effects of changes in variables on the
residual value.
 The % change in the variable is compared with the % change in the residual amount.
 If a small % change in the variable produces a large % change in the residual amount,
then this variable can be classified as very sensitive.
 A residual would be sensitive to minor changes in; GDV, Construction Costs, Interest Rate,
Capitalisation Rate, ERV.
 These would influence the inter-dependent variables like; developers profit, professional
fees and agents fees.
 Optimistic and Pessimistic Scenario.
Sensitivity Analysis on Residential Worked Example
50% Reduction on MV 25% Reduction on Construction Cost
Size of House Sq.Ft 2,000 Size of House Sq.Ft 2,000
Price psf €225 Price psf €450
Market Value of House €450,000 Market Value of House €900,000
Less VAT @ 13.5% 1.135 Less VAT @ 13.5% 1.135
€396,476 €792,952

A Net Development Value €400,000 A Net Development Value €800,000

Less Less

Site Clearance €25,000 Site Clearance €25,000

1 Cost of Construction Say €200 psf €400,000 1 Cost of Construction Say €150 psf €300,000
Construction Fees Say 10% 1 €40,000 Construction Fees Say 10% 1 €30,000
Cost of Finance €50,000 Cost of Finance €50,000
Contingency Say 5% of 1 €20,000 Contingency Say 5% of 1 €15,000
Agent's / Legal Fees Say 2% of GDV €9,000 Agent's / Legal Fees Say 2% of GDV €18,000
Acquisition Costs €9,000 Acquisition Costs €14,000
B Development Costs €553,000 B Development Costs €438,000

C Developer's Profit 15% of 1 €60,000 C Developer's Profit 15% of 1 €45,000

€800,000 - (€553,000 + €60,000) = -€213,000 €800,000 - (€438,000 + €60,000) = €303,000

Residual Site Value Say -€210,000 Residual Site Value Say €300,000
Summary
 Used to value land with development, refurbishment potential.
 Residual valuations assess site Value.
 Development appraisals assess the viability of a proposed
development.
 Without planning permission, a valuer must assess the highest and
best use.
 Always back up the residual method with the comparison method.
 The method has its advantages and disadvantages.
 A sensitivity analysis is a useful tool.
Questions

A bit of an art and a science