From £4.8m to £9.2m: 'Doubling the value of a land sale

Housebuilders and developers, like any other business, need to make a profit. However, their gain will usually be to the landowner's loss and, as with any negotiation, a strong and professional challenge may reap rewards for the landowner.

If you are advising a client on
a land sale, would you be able
to make this challenge and negotiate the best value for
their asset?

A recent example of this situation is at a site near Birmingham. A land asset was secured by an option agreement and the housebuilder gained outline planning permission.
At this point, the housebuilder valued the site at £4.8m.
An estate agent tried to contest this valuation using a 'comparable site' basis but this was flatly rejected by the housebuilder, which threatened adjudication.

Profit margins

However, after a detailed examination of the housebuilder's proposals,
we found it had unnecessarily increased construction costs and reduced the land value required to achieve its profit margin.
We then suggested new proposals (including a full construction cost estimate, construction method statement, cash flow analysis, marketing statement, and an assessment of typical housebuilder's margins)
and the agreed land value was finally improved from £4.8m to £9.2m, representing a significant increase in value for the landowner.

The valuation expectations
of a landowner and their advisers often vary considerably due to
an incomplete knowledge of housebuilder's business models.

A landowner will typically sell
a land asset that does not have planning permission to a housebuilder or developer.
The price will usually be at the open market value, subject to a discount, which is used to fund the cost of achieving planning permission and rezoning (changing its permitted use).
The housebuilder calculates the gross development value (total sales revenue) and subtracts all of its costs (e.g. construction, fees, planning obligations, etc.) to arrive at a value that will achieve its profit target.

This is a common process across the housebuilding
and development industry. Unfortunately, it's also common for landowners to sell land assets that have been undervalued
by developers. Often these
deals will make the headlines, especially if it is public land being sold 'on the cheap'.

Taking control

Why does this situation exist? Well, the housebuilder has a detailed understanding of this complex business model, which puts it in the driving seat when valuing a site.

So, when a housebuilder
starts using terms such as 'section 106 contributions', 'affordable housing contributions', and 'community infrastructure levies', it can put them in a strong negotiating position. Landowners and their advisers shouldn't be bamboozled by jargon, but how many could have a detailed discussion about the 'return on capital' and 'net margin' on a construction project?

Also, land without planning consent is an asset that hasn't reached its potential value because someone must fund the planning and promotion process. Usually, landowners won't know about these activities and other professionals (for example, solicitors and estate agents) may only know about part of the development process.

Estate agents, for example, typically value completed buildings or land assets on a comparable site approach, but this method is inadequate for the valuation of development land assets, which is heavily impacted by planning contributions levied by local authorities and national planning policies and directives. This is a specialist field that one could not reasonably expect a solicitor or estate agent to be experienced in.

There are clearly risks with land development: it requires funding and expertise without any certainty of outcome. We are
in a period of strong demand
for housing but this is impacted by the availability of business funding, mortgage debt, changing planning directives, and the effect of affordable housing provisions on the desirability/profitability of schemes.

Housebuilders provide
a valuable role, and when negotiating with them you should demonstrate an understanding of their drivers and business models to ensure they can afford to purchase a land asset at a certain price, fund the project, and return an acceptable profit at the end of the scheme.
If you drive too hard a bargain you may put any deal at risk.
You should also recognise that negotiations should be based on a shared understanding of the risks and opportunities that a land asset provides.

Effectively understanding a housebuilder's business models
is crucial to any negotiation and challenge of their proposals.
Only when a landowner has this knowledge available in their armoury are they likely to achieve a sales price that truly reflects the market value of their asset.

Gary Freeman is the chairman of Aria Development Management www.aria.dm