In the city or town most change is delivered by private landowners and developers. Most of the time this involves repairing or redeveloping individual buildings, or sometimes several adjoining buildings. In the British city the majority of the buildings are owned by an investor of some form and leased to an occupier using leases of varying length.
Generally speaking, the entities that own these buildings do so to make a return on their investment. Many are pension funds, institutions, charities, private investors or public bodies. Landlords invest money in property and take a return from it in the form of rent received, less the costs of maintenance, repairs and taxation. In principle this is little different, other than in scale, to your richer relation with the buy-to-let home. Your pension fund almost certainly owns many of these and the level of pension you are able to take on retirement is almost certainly linked to the success of our cities and the level of return the pension funds can make from these buildings.
Development or redevelopment of buildings is mainly undertaken by the private sector to create a return on capital. When anyone (whether public or private) invests funds they expect to receive a return on that investment, and they would expect the return to reflect their objectives and the risk taken relative to other things they could invest in. So if someone invests in a government bond that is very low risk, that means the return is also very low. But if someone invests in something that is high risk they would expect to see a high rate of return if all goes well, simply because there is a much greater risk of all not going well and in that case potentially losing everything.
Property development is a high risk activity, certainly higher risk than many other forms of investment. The people providing the money to undertake the development have a choice of where to put those funds, and in order to fund development they expect the return to be higher than what they would achieve from lower risk non-property investment. Therefore anyone undertaking property development on a commercial basis would expect to make a return of at least 20% of the costs incurred, potentially up to about a third of the value of the completed development, depending on the level of risk involved. In a UK regional town house building context, each of the red, blue and green elements shown below are probably each about a third of the sales price, however in other contexts this changes. For example with central London with lower risk development, the developer will probably expect to make a profit roughly closer to 20% of the costs spend delivering the build.
The three elements that make up the value of any development:
If the sum of these three elements adds up to more than the sale price - or the Gross Development Value then the development cannot be delivered commercially for building it would lose money.
For example if in the diagram above it was necessary to pay 40 to acquire the land then the cost of delivering it would add up to 110 but it would only be worth 100. In that case the development could not be delivered commercially without losing money.
Although much development is delivered by the private sector on a building by building basis, the public sector can and should have a key role to play in shaping our cities. For the public sector can and should in some instances deliver development that does not make a commercial return and can’t be delivered by the market. A combination of private and public sector delivery is the only means to build the number of homes we require in the UK.
Move next to section 5, if you pass go on the Monopoly board getting there donate the £200 to charity.
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