Optimism and pessimism in viability appraisals

I was at a meeting last week to discuss viability issues.  One issue that came up was how the combination of lack of independence of consultants and inherent uncertainty in estimated appraisal inputs (constructions costs, sales values, profit levels etc.) permits all the input estimates in a viability appraisal to be biased.  Given the inherent uncertainty in the estimates, it is extremely difficult to prove bias in any of the individual appraisal estimated inputs.  It doesn’t help that the viability guidance is also contested.

 I can’t think of an easy answer to this problem.  It really needs the web of economic relationships between consultants and developers/land owners to be appreciated and conflicts of interest to be governed properly.  Viability reports are not going to be independent if they are paid for by parties with a strong motive to bias the appraisal.  Consultants are going to try to try to please clients in order to get repeat business.  Inherent uncertainty means that there is very little risk of reputational damage to consultants given the difficulties of proving bias.  This is all pretty well-known.  It’s a typical moral hazard problem in most consultancy situations.

Given the well-rehearsed arguments to use market prices as the Benchmark Land Value, it also occurs to me that using transaction evidence introduces another bias.  Transaction prices tend to be the result of what, economists call, the marginal buyer will pay.  The marginal buyer will inevitably be the bidder with, on average, the most optimistic set of assumptions on appraisal inputs (construction costs, sales prices, planning obligations etc.).  Of course, there’s more fundamental reasons not to use market prices as the basis for Benchmark Land Value – not least the circularity problem. 

So – if you were cynical, you could conclude that developers, promoters etc. are using pessimistic assumptions about expected costs and revenues from development projects to demonstrate that their project does not generate a return to land owners that has been set by the most optimistic developers, promoters etc.                

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