Gross Development Value and Profits

From this value, the most important valuation metric for a Property Developer is probably the percentage profit on Gross Development Value. This calculation is effectively whether a development has, or will, turn a profit at completion. Profit on Gross Development Value is calculated by assessing the cost of development versus the sale of the completed properties to create a total profit value which is then calculated into percentage terms.

Here’s an example:

The development is 5 houses which sell at £200,000 each. The overall cost in funding, land acquisition, construction and sales are £750,000. Gross Development Value is therefore calculated as below:

• GDV: £1,000,000
• Costs: £750,000
• Profit: £250,000
• Profit on GDV: 25%

It’s best to calculate Gross Development Value by first running a detailed analysis of both the forecast cost and sale. Creating an analysis of the recent property transactions in the area of the development versus the overall cost of delivery, including funding, planning and construction.

The value of the recent property transactions is critical in the calculation. It can be based on both capital and rental value, as well as including some form of forecast because construction works will mean the scheme is delivered some time in the future.

Gross Development Value forms the foundation of any financial appraisal on a project. It’s the figure that allows the required profit to be counterbalanced against the building costs, legal costs, land acquisition and funding expenses.

Property Development companies must be dynamic in their approach to achieving profit targets that are set. This article will explore the possibilities available to Property Development companies to increase their Gross Development Value during the 5 stages of a project as noted below:

• Development Appraisal and Budgeting
• Land Acquisition
• Funding
• Pre-Commencement Stage
• Construction

1. Development Appraisal & Budgeting

Development Appraisals define whether a scheme is viable commercially or otherwise. The Royal Institute of Chartered Surveyors (RICS) define a Development Appraisal as:

…an objective financial viability test of the ability of a development project to meet its costs including the cost of planning obligations, whilst ensuring an appropriate site value for the landowner and a market risk adjusted return to the developer in delivering the project.

Development Appraisals come in different shapes and sizes, but the UK Government does provide a template for Developers that includes all the essentials. A good Development Appraisal should include Gross Development Value calculations, budgets, cash flows and much more.

2. Land Acquisition

When it comes to project profitability one of the largest impacting factors is the successful identification and acquisition of the land for development. A large portion of a project’s overall spend is on the land and the quality of this transaction will often drive the success of the development.

When it comes to Land Acquisition there are three types of sites in the UK that are referred to:

• Brownfield: Sites previously built on that are currently vacant or in need of redevelopment. Re-development of this type of land is actively encouraged by the UK Government
• Greenfield: Land that has not been developed before (agricultural/ grassland).
• Green Belt: Highly protected land with tight restrictions on development. The Green Belt was created to control urban expansion and is basically a ‘no build’ zone.

Green Belt land is generally cheaper to buy because of the major planning restrictions applied to it; however, in locations where councils aren’t on track to fulfil their housing targets, arguments can be made to develop on Green Belt land. In these cases, major opportunities exist for Developers to deliver schemes with large, better protected Gross Development Values.

Planning authorities take a holistic view when making decisions on developments. They want to see residents economically and socially involved in the community and developments that help fulfil these goals have the edge.

So, what do savvy Developers look out for?

• Locations in desperate need of housing will be much easier to get planning on regardless of whether the site is Brownfield, Greenfield or Green Belt
• Locations with quality transport infrastructure and proximity to stations will typically be more attractive to prospective buyers and therefore, yield a large Gross Development Value.
• Schemes which can have a positive environmental impact and reduce the reliance on cars will often be considered favourably.
• Developments in proximity to existing economic infrastructure i.e. areas of employment and close to shops will be more attractive to prospective buyers and therefore, yield a large Gross Development Value.
• Social infrastructure is also important with quality hospitals and schools sought after by buyers

There will always be strategic land opportunities across the country and Developers who are not tied to one area are best placed assessing the current need for housing nationally. The two large metropolitan areas (London & the North West) are deeply stressed for housing and other major cities are not to be ignored either.

In the South East, once you move outside of London’s Green Belt area, you can find smaller towns and villages with good amenities surrounded by greenfield land that represent really good value for money.

If you are a local developer and want to stick to a certain area, seeking out greenfield and greenbelt land at the edge of settlements is often the most profitable. Assess those sites based on the criteria above and their commercial viability in order to will help deliver highly profitable projects.

3. Funding

The next stage of the development is project funding. It’s a challenge for SME developers to secure funding. Even if a loan is agreed, difficulties with lending policies can arise or timings for the release of crucial funds are delayed – a housebuilder’s number one enemy.

What’s more, Developers often have profits embedded in work in progress, so cashflow strain and servicing pain can hit hard.

Securing a flexible and supportive funding partner who can not only understand the complexity of cashflow management, but who can also provide specialist expertise in terms of accounting (especially managing VAT) planning legislation, sales and marketing strategy, is key.

It is always recommended that any Developer produces three separate exit pricing models for their scheme; optimum, normal and ‘haircut’. If the site is profitable on the ‘haircut’ model, e.g. in a downturn, should unit values rise due to a more positive environment, then clearly the resulting upside is that margins are increased.

It’s a very straightforward approach albeit one that few developers adopt, even though it’s a highly effective mechanism for mitigating risk and protecting profit.

What are the main challenges of raising funding?

Most lenders like to see an established portfolio of successful projects when approached for funding on a new development. A developer is typically required to demonstrate the Gross Development Value achieved on previous projects in order to build a strong case to support an application of funds for a new scheme.

For an established developer this isn’t an issue; however, for new entrants to the market this poses a challenge and therefore a lateral thought process pays dividends. Demonstrating past success is important, even if the development wasn’t your own. For example, success as the Project Manager or Quantity Surveyor on a scheme can be enough evidence to provide assurance to funders.

One strategy for new developers is to create a portfolio of work on previous projects that contains the projections and budgets provided pre-commencement. These are the processes implemented during the scheme with an overview of your project management strategy and, most importantly, evidence of the final Gross Development Value delivered.

A portfolio of this type together with a solid set of references, a project plan for the new site, a watertight set of numbers and cost plan provide the best chance possible to convince a funder to accept your proposal and at a reasonable cost. The result is that you protect the profitability of the scheme.

Another major hurdle for SME developers that hinders their funding application is lack of initial capital. Many developers have substantial funds tied up in on-going projects when they identify the next potential site. New entrants have of course yet to build up capital in order to invest.

Many conventional and alternative funding models require applicants to have some financial risk on a project, both as a means of demonstrating commitment, but also sharing risk. Funders will often reject proposals that are submitted without any initial capital from the Developer.

Both examples noted above neatly lead to the third: lending criteria. Underwriters are under pressure to mitigate as much risk as possible. This means that conventional and alternative funding options often involve a strict set of criteria which need to be met.

Most funders have a particular type of risk that they can tolerate . This may be for particular locations they favour due to market growth opportunities, or a particular property type that may be in short supply.

For Developers to have the best chance of success, take time to build a business case for the Underwriter that clearly demonstrates:

• How the scheme will stay on programme
• Why there is a demand in that particular area for the sorts of units being proposed
• Why the GDV forecast is realistic.

Developers should always provide comparisons in terms of specification, layout and market value where possible. The more evidence supplied, the better the chance that the proposal will be approved, and at a viable cost.

By creating a robust and detailed business case, developers give themselves the best opportunity to attract investment at competitive prices.

Will cash flow have an impact?

If you asked most SME housebuilders, many would probably identify the interest on any capital borrowed to fund their projects as one of the primary cash-flow issues.

Given that it’s rare for SME developers to have the cash available to completely underwrite their projects, many turn to banks, alternative funding platforms or private equity models for additional finance. This means that the interest on the outstanding amount must serviced monthly. It also means any issues that delay completion of the project will lead to additional interest until the capital borrowed has been repaid.

Cash-flow management is a specific skill set that can heavily impact the profitability of the Gross Development Value. The primary focus is to complete the works on time to avoid additional interest re-payments. It’s also important to secure your site subcontractors on manageable payment terms that are back-to-back with progress on site.

One of the best ways to achieve this is by recruiting a Project Manager with strong financial acumen as well as bringing a Quantity Surveyor on board. When it comes to protecting every last penny of margin on a project, the devil is in the detail and it must be given the necessary attention.

4. Pre-Commencement Stage

Identifying the target market

First time buyers are a ‘golden customer’ for many SME housebuilders and developers. They’re the fastest growing home-buying demographic and with no chain.

Nearly 5 million households in England and Wales are in private rented accommodation. Two fifths of renters aspire to own their own home in the next two years. This means that the entry level market provides significant opportunities for developers, particularly as the current ‘Help To Buy’ scheme will be extended until 2023.

There are a number of mainstream mortgage lenders who offer low deposit mortgages for first time buyers. For example, 5% deposit mortgages are now widely available and competitively priced. There are also the more specialist breed of ‘family springboard’ products which allow parents and other family members to assist in the purchase without having to gift a deposit.

‘Help To Buy’ should be one of the main factors of a scheme aimed at first time buyers, and the numbers speak for themselves. ‘Help To Buy’ has supported 36% of new build home sales in England since 2013, with 81% of those units being sold to first time buyers. 58% of first time buyers cite Help to Buy eligibility as a key criteria when selecting a home.

Developers should incorporate all of the above into their Gross Development Value forecasts for any schemes aimed at entry level. It’s all about focusing on how to exit; who is going to buy the units and how will they afford to purchase them?

These questions fundamentally determine what, where and how to build.

It is always advisable for developers to study the locality of a planned development thoroughly before drawing up plans. The cornerstones of a profitable strategy are:

• Identify competitive sites – either under construction or currently in planning
• Review the current local housing stock and identify a shortage of particular property type
• Understand price sensitivity in relation to the income of the target demographic

It’s essential that schemes aimed at first time buyers qualify for ‘Help To Buy’. This is particularly relevant now affordability caps will be introduced from 2021. Developers who are yet to break ground need to incorporate relevant pricing into their strategy to ensure their anticipated Gross Development Value stacks up.

Buyers at all levels are now far more sophisticated in both their research and decision-making processes. As a result, it’s not enough to presume what the target audience may want and commence a multi-million-pound project based on speculation. A detailed understanding of the target demographic should consider every point of a project, from site acquisition, unit layout and design, specification and finish, through to sales and marketing strategy.

Building with the client in mind

Every touchpoint should be focused on who will be buying the product. It’s dangerous to assume that just because the UK has a housing shortage, first time buyers aren’t selective. 42% of prospective buyers consider eco-credentials as one of their top priorities when deciding on a home for example. This creates a significant opportunity for developers, as modern construction standards ensure that new build homes are far more energy efficient. Increased energy efficiency means that they are cheaper to run and maintain, but also reduces the carbon footprint of the property.

Developers give themselves a valuable competitive edge at the point of exit when they incorporate ‘green credentials’. Elements such as electric vehicle charging points and ‘smart home’ technology help meet the expectations of first time buyers. That competitive edge is strengthened further when you introduce the details of quality wood or stone floors, chrome fixtures and fittings, quality hardware and branded white goods.

Enhanced specification supports a timely exit from a development, which assists the stakeholders in realising optimum profit levels.

5. Construction Stage

The skill of a property developer and the overall success of a Property Development is ensuring their Development Appraisal is accurate. The effectiveness of any appraisal is based solely on the quality of inputs used. One area where value can be extracted is by having a greater understanding of construction. Budgeting will allow for better definition on the overall costs on therefore your overall Profit on Gross Development Value calculations – potentially allowing you to operate differently and make different decisions.

What do Developers need to consider?

Firstly, which companies have the required skills to do the particular project that is being contemplated in terms of scale, complexity and type? This applies to both the design and the construction.

For example, if the project is on a green field site, the suitable designer and contractor will be very different from those with the skills and capabilities to deliver the conversion of a Victorian prison. A scheme with 12 residential units is very different from one with 1200 units with a leisure centre and retail space.

Spending time at the beginning to identify the key success criteria for the project before will pay dividends. What are the particular ‘abnormals’ or differentiators for the particular scheme that will drive you down one route or another? Once you answer this question, it’s a matter of identifying suitable businesses to bring into the project delivery team.

The lowest entry price is seldom the most effective method of procurement. Avoiding duplication of effort and waste is key:

• Define the task
• Define the critical success factors
• Determine who has the capabilities to deliver the project
• Define an appropriate procurement and contracting solution

Programming and Risk Allocation

At the outset, It’s important to develop a project programme from inception to final occupation. Also important is the logistics plan, showing how the scheme will be serviced, constructed and occupied. These will help to shape the sequence, procurement and contracting choices for the scheme.

The allocation of risk and in particular design risk, may dictate the overall cost levels for the project. Whilst it’s common to bundle up the project risks and allocate them to one party, a Main Contractor, in a comprehensive risk transfer this is unlikely to deliver the most cost-effective project. Where onerous terms are imposed, contingencies and risk pots usually follow. The concept of ‘risk being allocated where it can best be managed’ is all too often ignored in favour of having a single point of responsibility irrespective of the premium that might come with that.

Taking references and looking at which companies that have successfully delivered similar projects is a good starting point for selecting businesses with appropriate skill sets and capabilities.

Early collaborative involvement of a lead designer and/or a project manager should be hugely beneficial. To get good advice, you need to pay for it and set a good brief with defined deliverables.

Construction Management

Construction management is becoming popular once again for certain types of projects. This is particularly true for complex, technically challenging projects with long durations.

You can earn benefits through optimising project durations since designs for the project may be progressed in parallel with the construction works of earlier elements. The absence of hidden risk and contingency pots are advantageous for construction management. However, remember that this is because the employer generally retains the risks.

Flexibility is the biggest gain. You can let trade packages in a number of different ways depending on what is required. This means that you can benefit directly from the specialists’ design skills rather than through a vague pass through of responsibilities, as can be the case in other contracting arrangements.

The main considerations to be taken in Construction Management are:

• Programme compatibility
• Design co-ordination
• Management of information flow
• Programme management
• Administration of the various contracts including payments and notices
• Impacts of the various subcontract works upon each other
• Budget control
• There is no single point responsibility for delivery.

This approach needs dedicated resources of varying disciplines. The Client must have the infrastructure to manage this contract arrangement and deliver the project.

There will be no Main Contractor margin or Construction Manager fee to pay. However, be aware that, where there is a margin, there is also risk. Take careful consideration of what is being ‘given up’ as well as ‘what is being gained’.

Final Takeaway Thoughts

A focused and detailed plan is a driver to the success of every development. Development Appraisals are an important part of the process and define whether a scheme is viable commercially or otherwise. A focused plan together with a good site and good project management throughout the scheme should help a Developer protect the percentage profit they achieve on a project’s Gross Development Value.