Episode 1: The V Team

According to a number of reports, apparently the Mayor is setting up a “crack team in City Hall” in London to deal with viability reports.

The reports, which are used by developers to justify affordable housing contributions lower than council targets, are considered by many to be a smoke-and-mirrors exercise that serves the sole purpose of driving up developers’ profits…One reason for the controversy is that the reports are not made available to councillors or the public and are instead assessed by an independent consultant who then provides a report to the council. But this could be set to change…Already, some councils across London, such as Greenwich and Islington, are seeking to open viability reports up to public scrutiny and now the mayor of London, Sadiq Khan, has said he will assemble a crack team in City Hall to examine the financial details behind the reports…So could the tide be turning against the ‘dark art’ of viability?

I’m sure a good satirical writer could have a lot of fun at the Batmanesque tone of the Mayor’s language.

I suspect that the tide is turning in London. However, from what I hear I’m pretty sure that some of the deplorables at the RICS will be fighting back with new guidance heavily biased in favour of land owners and contrary to the interests of anyone needing affordable housing. But, hey, land owners are members of the public and the RICS has a remit to act in the public interest.

I’m struggling to see the need for a crack team myself. Most of the inputs into a viability statement are relatively uncontroversial and all the arguments have been well-rehearsed.  Most reasonable parties can agree on most inputs into a viability appraisal.  You can make a lot of noise about normal profit levels (a competitive return to the developer) and the use of forecasts but the central issue usually come down to the definition of what is a competitive return to a land owner.

The problem is fairly easy to grasp. Let’s say that a low density retail building (the current use value is £7,000 psm) is expected to generate sale values of £50,000 per sq m of site area assuming 20% affordable housing.

Each square metre of site area costs:

  • £20,000 to develop excluding land costs but including professional fees, interest etc.   (See previous post to see the technical problems here but it is a standard method)
  • The developer takes a normal profit of £7,500 per sq m of site area.  (See previous post to see the technical problems here but it is a standard method)

After transaction costs, that leaves about £21,000 per sq m for the land owner. Is this enough to get the land owner to release the site? Who knows?  It’ll depend on the land owner.  Some might want more. Some might want less.

What if similar sites had been selling at £25,000 psm because they had 10% affordable housing? Should affordable housing contributions be lowered from 20% to 10% to ensure that the land owner gets a land value of £25,000 psm? In this case, the land owner would getting most of the latent value released by planning permission.

Some would argue that the land owner should be entitled to a return over current use value. This is (for some reason) typically 25% and that the surplus should be used for more affordable housing. This mean that the competitive return to the land owner should be assumed to be £8750 psm and the surplus can be used for more affordable housing. In this case, the community is getting most of the latent value released by planning permission.

Alternatively, there is an argument that the land owner should get the alternative use value plus a premium (of, let’s say, 25%). Let’s say that the site would work as an office location and this is likely to obtain planning permission.  The land would sell for £16,000 psm for office use. This would take a competitive land owner’s return up to £20000 psm.  In this case, the land owner is getting most of the latent value released by planning permission.  Clearly, also in this case, no matter what the planning policy, the land owner is unlikely to go for any housing project that generates a land price below £16,000 psm.   If the planning obligations for housing use were so high that they generated a land value below £16,000, the land owner would sell the site for offices rather than residential.

Then, there is an argument that the competitive return to the land owner should be based upon policy compliance. Let’s say that the affordable housing policy is 30% and this generates a land value of £17,000 psm, then this should set the competitive return to the land owner.  Both the community and the land owner seem to do reasonably well here.

Fundamentally, the issue boils down to the optimal split between community and the land owner that will enable sites to come forward for housing. This issue has been fudged and, perhaps not surprisingly, vested interests have tried to fill the void in guidance.

If the issue isn’t resolved, a so-called crack team is a waste of time. Fundamentally, this is a political decision about the distribution of land value uplifts between the community and land owners.  Once the principle is decided, the technical operation should become as straightforward (usually it isn’t and there’s some haggling) as estimating and agreeing the other inputs into a development appraisal.  But, until the principle of what a competitive return to a land owner involves is resolved, then we won’t get any further.

If a crack team can resolve it once and for all – then less unhappy days.

 

 

 

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