So here we try to build on what we have set out before without losing sane people in the dullness of the detail. Before we go on to detail and diagrams please watch our Making S**t Happen video if you haven't already:
Well the first thing to remember is there is no magic money pot. If the private sector builds something, they do it to make a return on investment and that return needs to be consummate to the risks relative to other forms of investment.
The following equations are key to understanding how development can be achieved commercially- for the numbers have to balance:
If the costs of delivering a development exceeds the sum of its overall value (GDV), it simply cannot be achieved commercially, because the private sector will make a greater and safer return investing its money elsewhere.
Even the public sector or quasi-public sector such as housing associations will generally try to deliver development which achieves a return (profit). In some instances, they may achieve less than a commercial return if the development achieves other objectives, such as the provision of social housing or enabling the re-development of a long standing detracting eyesore site. In such a scenario, if the sum of the cost of the land plus the delivery costs are still less than the GDV (the overall value of the development when completed) even with no profit made, then some additional funds will have to be found in the form of subsidy otherwise the development would lose money and won’t be achieved.
One of the big risks with property development is the uncertainty over the cost of delivery as major projects are inherently complex and are built over many years in the future. There only needs to be small overspend to significantly increase delivery costs. Imagine if a developer has borrowed £10 million to fund a scheme at an interest rate of £6.5% per annum. If the project is delayed by 6 months that is £325,000 of additional cost that has arisen.
Scheme infrastructure and phasing
Big schemes generally require new infrastructure in some form or another. That could be big ticket items such as a new station or school, or smaller stuff such as links to parks, new streets, perhaps water, gas and drainage within the streets and buildings. All of this costs money and doesn’t always bring in money through increased sales values. In most schemes these infrastructure items are part or wholly funded through the scheme, so if you buy a apartment on a scheme where there is a new school, chances are you are at least part funding that with your property purchase. These infrastructure requirements have a major impact on scheme viability, as some or all of them need to be delivered before any properties are sold, so a huge amount of cost and interest is paid until income arises from selling properties in later phases. For this reason, it is common for the early phases of complex regeneration schemes to break even at best and for the infrastructure to be provided on a phased basis where possible.
With large and complex schemes, much work goes into the phasing of the infrastructure and income generating parts to reduce the cost of delivery and interest on finance as much as possible. Small changes to phasing can make the difference between a scheme being deliverable or not- between it making or losing money.
Affordable housing
One major and contentious factor that has a very significant impact on project viability is affordable housing. Despite such housing being a significant social good, our government has privatised delivery of much of it, and requires it to be delivered as a proportion of new private development. To explain this further let’s go back to the example of the apartment scheme in Hull considered earlier.
Let’s assume the Council requires that 2 of the 20 apartments (flats) to be sold as affordable houses- meaning they have to be sold at a reduced rent/price. That means the overall value of the scheme is reduced as can be seen in the scenarios table below. Given the delivery cost and developers profit have to remain broadly the same- otherwise it wouldn't get built - that means less money is left to pay for the land shown in green.
If we assume the site proposed for redevelopment is currently used as a garage which is worth 20 based on the rent that could be received for the garage use, then only one of the above scenarios could be delivered commercially. In scenario 2 above, if the council requires 20% affordable housing the scheme won't get built. This is because the land is worth more staying as a garage, so it stays as a garage.
Affordable housing affects project delivery for affordable housing must be sold or let at less than general market rents or values. This means that the scheme’s overall value (GDV) is less, but its delivery costs are about the same, or perhaps slightly less if there are fewer “bells and whistles” applied to the fit out of the affordable homes. In many cases a lower or nil land value will arise on the affordable parts, just to try and make them deliverable. However, the affordable homes also are usually sold up front to a social housing provider, so they are less risky to deliver than the market development which may take time to sell. Therefore a developer will usually be willing to take a lower profit margin on the affordable housing of around 6% compared to around 20%. The diagram below roughly illustrates the comparison with market housing:
In scenario 2 in the table further up the page, the affordable housing means the scheme is unviable and undeliverable so the site stays as a garage and none of the houses get built by the market. However, if public funding was available for the affordable housing (as it used to be) that could pay for the viability gap and make the scheme happen with a mixture of private and affordable housing.
Alternatively, if the public sector acquired the site, it could choose to develop the site itself. To achieve specific objectives (say removing an eyesore garage) it could take a lower level of return as illustrated in scenario 2a in the table below. However, to do that the public sector would then have to deliver the development and carry the project risk.
Instead, if the council really wanted the scheme to be built and did not ant to build it itself, it could look to allow the development to go ahead with a lower quantum of affordable housing, say 1 affordable home as shown in scenario 2b. In this case the resultant land value is the same as the garage use, so the development may happen. But it may also stay as a garage as there is little commercial incentive for the landowner to change its use. If the land was worth more on a redevelopment basis then there would be a greater commercial incentive for the landowner to redevelop.
When a developer has planning permission for a scheme but is not building it out, it probably means that the scheme is not viable. Just because a site has planning permission does not mean that development is viable or deliverable. Significant amounts of money are spent on securing planning permission and no one in their right mind will spend that and allow it to go to waste by sitting on a deliverable permission and never using it.
When some bemoan that a developer has “got away” with providing reduced affordable housing (say 25% rather than 30%), that is because the council has decided it would prefer 25% of something rather than 30% of nothing in deciding whether or not to allow development to proceed with less affordable housing. The end result is that some houses have been built on that site rather than no houses, and given we desperately need more houses, something is better than nothing.
Councils are provided with a very large amount of information on the viability of each development as part of the planning application process, much of which is obviously drafted in a way that favours the developer. The council then instructs its own specialists to audit this and undertake their own calculations- specialists that the council can sue if they get things wrong.
Assuming both parties are reasonable, some form of compromise will be agreed where the council agrees to grant a planning permission that balances delivering as much affordable housing as possible, without stopping the scheme from being built. Then we get a percentage of something rather than nothing delivered as affordable homes, and also the much needed market housing.
Frankly, if we want all schemes to go ahead and none of them to be delivered with a reduced amount of affordable homes, we need to go back to the situation of government providing grant funding to meet any gap. That means you funding that through your taxes.
If a council sits there wanting the full amount of affordable homes to be delivered on a scheme where doing that makes it unviable, the council will find the scheme doesn't get built. That means the people who the council serve will get no additional market homes and no affordable housing from that scheme. That lack of homes contributes to making supply worse, which pushes up prices which worsens affordability further.
Right section 25 next.
Commentaires