Land valuations are imperative before a decision can be made on whether to invest or not. They form a crucial part of the business plan as they calculate the current value of the land, potential yield from development, levels of profit or residual values of existing assets, all before providing a method of overall valuation that can determine the actual value of the land for purchase or development.
Clearly then, a structure imposed on the method of valuation is logical such that uniformity can be reached when providing land valuations, and this is where the RICS come into play with their Red Book Global Standards, which incorporates International Valuation Standards (IVS).
When we think of development, this typically extends to residential projects; retail parks; industrial schemes; office developments and also mixed-use developments.
The need for valuation reports can arise in many different scenarios, for example, where the development owner needs advice before setting a sale price or a developer wishes to know the potential yield of a particular site before deciding to invest. Equally, either owner or prospective buyer may need a valuation report for finance or re-financing a development.
Methods of valuation
There are three main valuation methods. Still, they are rarely entirely independent from one another, and a valuation report is likely to consider overlap depending on how much information is available to base the report on, e.g., the different methods are scalable from a time perspective and how in-depth the analysis goes.
Market Approach: Information that is available in terms of sale prices of other similar assets or developments nearby. Details include factors such as size and location, what the condition was, how quickly these assets sold and for how much. All the information can be presented back in a weighted table with those most similar to your development being matched at the top.
Whilst providing an indication and this is based on factual records, there are many variables to consider, such as if the site is within a dense urban area, the costs can differ significantly due to adjoining sites and access constraints and the proximity to infrastructure services.
Of course, the difference between greenfield and brownfield sites will also significantly differ in terms of residual values and time taken to proceed, including planning.
Income Approach: This method looks at the potential income of the development after it has been completed less the cost of the development itself. Another way to evaluate the income approach is to look at the ‘cap rate’ or capitalisation rate, which is, in effect, the annual income once the development is entirely divided by its current market value.
For example, if the income were £100k divided over a development valuation of £1m, the ‘cap rate’ would be 10%. When reviewing the position, the variables to consider are to look at the gross income or net income less costs, as looking only at the gross position could distort the true underlying cap rate.
There are a few ways to calculate the value in considering the development value, including the basic residual method. Essentially, it works top-down by taking the capitalised income, then taking off the construction costs before taking away the planning costs. Allowing for the developer’s profit leaves a residual value that informs the land value.
The principle is clear in terms of the residual method, but clearly, there are many variables to this. In terms of the construction costs, the valuation report should consider any costs associated with, remediation, site acquisition, contingency allowances, development profit, design, construction, professional fees (including construction management fees, health and safety consultancy, environmental impact assessments, site inspection plus management and cost control fees), planning fees plus the cost of finance.
Cost Approach: A broader approach to valuation is the cost approach that is predominantly used to consider an existing property. It works by estimating the value of the land by comparing it to previous and nearby sales using the market approach where possible. Then an estimate of the costs to replace the existing building draws parallels with the calculation of construction costs in the income method.
However, it might be that the existing building is renovated instead of demolished and rebuilt. Therefore, whilst the headings are similar in build costs, fees, planning etc., the actual prices are likely to differ depending on the scheduled work level.
What also needs to be considered is depreciation of the development so think of this valuation method as the cost of replacement and renovation less depreciation plus the value of the land equals the value of the property.
A criticism of this valuation method is that it needs certain assumptions to work, such as the depreciation, which, when calculating for older properties, can become less accurate. Also, the land value can again be subject to a level of assumptive calculation.
This valuation method is perhaps best suited for specific use properties such as churches or similar properties. If the development involved residential evaluation, more information would be available to use the market approach or income approach to value the development more accurately (or a mix of the two).
Specific Factors to Consider – Topographical Survey
When producing a land valuation, one of the key variables to assess is the site’s existing topography. You will complete a survey, and it will review if the area is prone to flooding what the condition of the soil make-up is. If it might be suitable for being built on, from a wildlife perspective, it should consider if there are protected species on-site and as a result, could this limit the potential of the development, or will they be able to be moved?
The site might be the location of Site of Special Scientific Interest (SSSI), which could mean the site is protected from development, albeit the site’s protection from development is not absolute but is likely to mean increased costs and delay through any planning process.
Further considerations in a topography survey will include:
- What is the current situation in terms of infrastructure, i.e., is there already a means of clean water inlet and foul sewers on-site, or will these be required and if so, how much work this could involve? The same considerations are also for power, communications, and technology availability.
- If the site is classified as brownfield or greenfield and if there may be a contaminated waste, that could mean that it is cost-prohibitive to develop the site, so this is a pivotal point to check for. What is the mitigation available to deal with this if toxic waste is identified? Can it be contained on-site, or is it to be taken off-site etc.?
- To consider the presence of contaminated waste, the survey should establish any previous land-uses by reviewing all information reasonably available. This may identify historical land-working and should also consider unexploded ordnance records.
- If there are any existing on-site features, then what is the current condition. Whether they are protected and whether this will impede future developments. At this stage, it may be advisable to consider if an intrusive survey is required depending on the intent for the existing features. The topographical survey may make such a recommendation.
- The presence of archaeological features, which may include 3-D mapping of the existing site plus any that may be evident, or the survey could identify that there is a high probability of archaeological features due to the proximity of other nearby features.
- If there are any public right of way issues, issues regarding shared access or a private legal agreement may cause access issues. Searching for such an agreement may prove difficult at the topographical stage, but if access is identified, then searching for what you should establish rights of way there are at this access point.
Specific Factors to Consider – Planning
Getting through planning successfully can be time-consuming and resource-heavy. Identifying existing planning applications which could include the title of ‘zoning’ parts of the site, i.e., recognising them for different uses. Other factors or considerations to be identified include:
- If there are any planning applications, what is the status is, e.g., has it been granted in whole or in part and if there are reserved matters. If this can be established, it can be necessary for several reasons, such as whether similar planning would be granted again.
- Regarding planning having been granted but with reserved matters, these should be identified as a risk in the survey report. Such risks could include environmental protection legislation and issues such as heritage constraints on existing features.
Any final report will depend on what instructions were given when commissioning one; however, looking at reporting from a general sense, there are similar themes and content that you should expect to see in all reports, and these are:
- Which valuation method has been used and why the writer chose to should include such a valuation method, including explanation.
- If assumptions have been made after choosing one of the valuations methods, these should be clearly stated.
In terms of assumptions and exclusions, it is commonplace to have these listed out but what you should check for is that they do not preclude your use of the report for any business planning decisions, i.e., if a vital part of the development has been qualified out then it could mean the entire report becomes undermined so still review the list even if they seem generic.
In producing a report and taking account of the very nature of this type of valuation, there are so many variables that there is undoubtedly a range that you can produce; however, you should expect to see a single valuation. The report should describe the variables, including the risk assessment undertaken and the potential outcome if these risks materialise.
The size and importance of the development will no doubt play into the length and effort you may desire to be applied to the land valuation report. Still, any report should include open and transparent conclusions which enable informed and well-judged decisions.
Photo by Josh Appel on Unsplash
About Dean Suttling
A member of the Royal Institution of Chartered Surveyors, Dean has twenty years of experience in commercial management and quantity surveying, undertaking roles for contractors, clients, and consultants.
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