Viability considerations

KEY LEARNING POINTS

  • Private homebuilding projects can be just as viable as market housing
  • Local Plan viability assessments should test impacts on different forms and scales of multi-unit private homebuilding developments as part of wider housing assessments
  • Site-specific viability assessments require more detailed analysis. These should be proportionate and take account of the form, scale and type of private homebuilding development proposed on a specific site.

INTRODUCTION

Viability is an important planning consideration. Opponents to private homebuilding developments and some councils often question the viability of this form of housing. A commonly expressed concern is that if local policies ask landowners and private developers to bring forward serviced plots it can reduce the overall viability of development of a site and limit the ability to secure other local benefits, such as affordable housing. Concerns are also often raised by applicants seeking planning permission that councils don’t understand the impact on the viability of private homebuilding projects when imposing planning obligations.

It is therefore important to consider how viability considerations apply to this form of housing.

POLICY CONTEXT

The National Planning Policy Framework (NPPF) is clear that viability is an important planning consideration when councils prepare their Local Plans and make planning decisions. Planning Practice Guidance that supports the Framework provides further details on how these considerations should be taken into account - including how viability should be considered in the context of private homebuilding developments. Further detail is set out in Annex 1.

About

This is one of more than 20 Briefing Notes that explain resourcing, planning, land, finance, demand, marketing, consumer support and various technical issues. To see the full range of guidance click here.

Definitions

For the purposes of this Toolkit we have made the following definitions:

NOTE

This Briefing Note will be revised when the Regulations to support the commencement of the Self-build and Custom Housebuilding Act 2015 and the Government’s Right to Build policy are finalised.

VIABILITY CONSIDERATIONS FOR PRIVATE HOMEBUILDING

Local Plans

Private homebuilding developments form part of the housing market and, under the NPPF, any Local Plan policies and proposals that affect private homebuilding should be included in the overall viability assessment of the Plan.

Viability assessments of Local Plans are ‘broad brush’ and focus on the overall deliverability of the Plan. The Government’s Planning Practice Guidance advises that Local Plan viability assessments don’t need to test the viability of every identified site - for example site assessment scenarios or samples of different types of sites can be used to establish the impact on viability of different policies. Detailed assessments may, however, still be needed for particular areas or key sites on which the delivery of the Local Plan relies.

Most existing assessments use a residual value methodology to assess viability. Here, the difference between the value and costs of development are compared with land values to determine whether development will be viable when the Plan’s policies are applied. For an overview of different approaches taken by councils to promoting private homebuilding in their Local Plans, see the Briefing Notes on How the planning system can generate more opportunities and Examples of how councils use the planning system to encourage opportunities in this Toolkit.

When undertaking viability assessments councils should have regard to the different forms and scales of private homebuilding that might come forward in their area. There are broadly four types of site: -

  • Larger scale custom build developments (typically projects of 50+ homes, though they could extend to hundreds and even thousands of homes)
  • Medium sites (typically projects of between ten and 50 homes)
  • Small sites (typically projects of between two and ten homes)
  • Sites for single homes or parcels of land for building groups.

Sites can either be stand-alone or form part of a larger development.

The form of development on private homebuilding sites can vary considerably, so there are some general and some specific considerations that should be taken into account when assessing viability at plan-level.

GENERAL CONSIDERATIONS

At the general level it is important for councils to be aware that viability will vary from scheme to scheme and will be impacted by scale.

For example, the traditional speculative volume housebuilder model secures its competitive advantage from economies of scale and easier access to finance. This is different to the multi-unit private homebuilding model. In the latter model the competitive edge is provided by offering improved consumer choice and through reduced levels of development risk and capital employed in the project because plots are sold to private homebuilders and building costs are paid as a site is built out.

There will not be substantial differences between the bottom lines of viability assessments for speculative market housing and private housebuilding. Larger sites will have greater economies of scale than smaller sites so one-off houses, whether private homebuilding or speculative, will cost more than multiple homes on large sites. Values will be size, specification and location dependent in both speculative and private homebuilding.

SPECIFIC CONSIDERATIONS ON LARGER PROJECTS

Larger ‘custom build’ projects, where an enabler creates permissioned serviced building plots and works with several home manufacturers to build homes for private homebuilders, are likely to be most viable when they provide at least 100 plots.

This scale achieves an optimum balance between offering sufficient consumer choice on a site and delivering a reasonable return on investment for the home manufacturers involved. For this model, home manufacturers typically require at least 10 to 15 homes per site to enable them to recover their set up costs, and between five and 15 home manufacturers are needed to offer consumers a reasonable range of home options.

At this scale the home manufacturers can then generate a profit margin of about five to ten per cent – their margins are lower because they don’t have any sales risk or significant capital requirements, as their private homebuilder clients pay them in stages.

The value of homes on such projects for private homebuilders will be about the same as equivalent new build market housing in the area, although the custom build properties are likely to be proportionately larger and offer the purchaser a wider range of design and layout options.

However, this is not the only development model for larger sites. Bigger parcels of land can also be set aside to provide a mixture of different forms of private homebuilding (eg. serviced plots, shell homes and design and build options), and these will all have different viability constraints.

Most larger sites should be able to take advantage of economies of scale, particularly with regard to the cost of servicing the plots, and administration and legal costs. This is particularly the case where the provision of plots is conceived as part of a mix of housing types and uses. For example, if a site is delivering a proportion of market and affordable housing (including starter homes) and, perhaps commercial uses, they can share development costs (including the provision of services and other infrastructure) and help improve the viability of the custom build element of a scheme.

At Newcastle Great Park, Charles Church has laid out a ‘self build’ zone consisting of 39 fully serviced building plots for private homebuilders adjacent to its much larger Elmwood Park Views market housing development
 

SPECIFIC CONSIDERATIONS ON OTHER PROJECTS

For medium and smaller sites private homebuilders often pay the builder or enabler for the construction work as the build progresses, so this should be taken into account when assessing viability.

Sites for single homes or parcels of land for group projects are likely to benefit from healthy equity on completion. However, because cash-flow impacts on viability are an important consideration it is important to recognise that these types of project often have restricted cash-flows during the build process, particularly where self build mortgages don’t extend to land purchase and are limited to certain phases of a build. This requires greater use of private capital early in the project.

Depending on the council’s policies and proposals, site assessment scenarios to test viability are best focused on a sample of larger, medium and smaller sites, instead of single home or group projects.

SPECIFIC VIABILITY CONSIDERATIONS

Development Costs

All of these development costs need to be taken into account on multi-unit private homebuilding sites: -

  • Build Cost - Where a project provides only serviced plots for sale to private homebuilders there will be no build costs incurred, other than a proportional cost of the infrastructure (site servicing) and perhaps the cost of the foundations if a ‘Golden Brick’ solution is offered (see Briefing Note on Taxation). Where shells or completed homes are sold the build costs will be paid by private homebuilders as the homes are constructed
  • Cumulative costs arising from policy (eg. CIL and Section 106 obligations) - Private homebuilders are exempt from the Community Infrastructure Levy (CIL). Developers or custom build enablers who discharge any CIL liability to their private homebuilder clients will therefore not incur any costs (see Briefing Note on Community Infrastructure Levy). Planning obligations and other costs arising from planning policy will apply in the same way as they apply to market housing, unless there are local exceptions
  • Building Regulation compliance costs - Where serviced plots are sold enablers of multi-unit projects will not incur these costs, because the individual private homebuilders will pay for the construction of their homes as they are built
  • Stamp Duty Land Tax (SDLT) and VAT – Where serviced plots are sold enablers will not incur these taxes, because the individual private homebuilders will pay the SDLT on the purchase of the land. Any VAT costs incurred will however need to be taken into account (the Briefing Note on Taxation provides further details)
  • Finance costs - It is typical for multi-unit private homebuilding projects to incur costs before income is generated from the sale of serviced plots. In many cases the developer/enabler will need to borrow to fund a project, so this should be taken into account when assessing the viability of projects. Any assumptions about plot sales rates should be realistic and take account of local market conditions and demand for private homebuilding. Cash-flow constraints could also be relevant although multi-unit private homebuilding sites are likely to have comparatively lower constraints (because upfront investment is only likely to be required to buy the land and provide infrastructure, not to fund site build out). Also, on larger sites, a custom build enabler can use sales proceeds from early phases towards the infrastructure costs of later phases. In the private homebuilder model, clients will pay for the building of the homes as they are built. In many cases the private homebuilder will also need to pay for the costs of a stage payment mortgage (in the same way that a housebuilder would need to meet their finance costs)
  • Infrastructure costs - These are likely to vary from site to site and will depend on how much work the enabling developer does before plots are brought to market. For serviced plot projects the work will usually involve the provision of access roads and utilities to plot boundaries, as well as landscaping and the public realm, as for speculative housebuilding. The Briefing Note on How to deliver serviced plots assumes about £10,000 to £30,000 to service each plot, depending upon the size of the overall development
Urban Self Build’s Hempsted Green custom build development comprises 11 three and four bedroom detached homes facing a large open green space. The plots are all fully serviced. Private homebuilders can choose from a range of homes and then specify and customise their design, both inside and out.
  • Abnormal costs - These are development costs that a ‘normal’ residential development on a flat greenfield site would not incur. This can include, for example, land remediation work and the more complex foundations needed to deal with a sloping site or other difficult ground conditions. Such costs will be the same as for speculatively built market housing
  • Professional, project management, sales and legal costs - On speculatively built market housing sites where standard house types are being built an allowance of around three to five per cent of the gross development value is usually made to cover fees (depending on the relative strength of the local market). Where bespoke housing products are used design, planning and other professional fees (excluding costs for applying for planning permission) can range from eight to ten per cent for straightforward sites up to 20 per cent for complex, multi-phase developments

Larger and medium-sized multi-unit private homebuilding sites are likely to require lower marketing costs compared to speculatively built market housing as they rarely need to fund show homes. Marketing costs for such developments will instead focus on softer publicity material (eg. ‘teaser marketing’, computer animation and staging local events). This position may change as the larger-scale model evolves. Location and the intended speed of site build-out will also be influencing factors. On smaller sites marketing and other costs will be similar to speculatively built market housing.

Indicative cash-flow implications for two housing projects on the same multi-unit site over time. A promoter of a private homebuilding development (the red line) is likely to require less cash for a shorter period of time. Operating profit on completion is slightly higher for a builder bringing forward a traditional housing development (the blue line) but requires considerable upfront capital

Top Tip

Be aware of how viability affects different forms of project

Viability assessments for private homebuilding developments should form part of the overall Local Plan viability assessment. They should also test the impacts of different forms and scales of multi-unit private homebuilding development

Land Value 

Land values are an important viability indicator. The land value (residual development value) is initially calculated by subtracting all the project costs (including the developer’s profit) from the total revenues generated from the sale of the homes. It is sensible to then compare this figure to other land values in the local area. However, it is important to take account of site-specific factors when making comparisons. For example, do the comparable sites have the same planning status (one may have broad recognition in the Local Plan for housing, another may have detailed planning with a reduced level of affordable housing or Section 106 contributions negotiated)? Also are the sites capable of accommodating similar levels of development (one site may be level and another may include a slope which reduces development)?

To determine an accurate land value for a site, councils should seek up-to-date advice from local agents and valuers. These professionals can also estimate the likely sales value of fully-serviced plots in an area.

Gross Development Value 

Gross Development Value (GDV) is the potential value generated by a development. On speculative housing schemes, this is often the total sales income. For private homebuilding GDV varies depending on whether the project provides ‘shovel-ready’ serviced building plots, shell homes or the landowner, developer or enabler stipulates that private homebuilders have to enter into a design and build contract when they buy plots.

At Local Plan level, average figures will need to be used for viability assessments, based on the types of development that the Plan is seeking to bring forward. Care should be taken to reflect current sales values and rates, and should recognise that there can be a significant difference between asking prices and the actual net sales revenues achieved (net revenue is the actual revenue received after allowing for discounts, sales incentives etc). It is also important to recognise that low risk, permissioned, ‘shovel-ready’ serviced building plots are currently in very short supply, particularly in areas of high demand, and therefore can in some cases command high premiums compared to un-serviced land with no planning permission.

There is also often a big difference between what a private homebuilder is willing to pay for a plot, compared to a traditional builder or property developer. Property developers are good negotiators and are often able to buy land for much less. They also need to take into account their profit margin and they will price-in risk. Indeed, much of their profit margin comes from their land buying skills. So, for example, while a private homebuilder might pay £200,000 for a plot, a developer would probably only be prepared to offer about £140,000. Private homebuilders are usually prepared to pay a premium to get a plot of land, and this can be up to 30 per cent more than a builder would pay, particularly in high demand areas.

Competitive Return

Viability assessments require assumptions to be made about the average level of developer or enabler overhead and profit (before interest and tax).

This will depend on the nature, riskiness and scale of the projects. A ‘normal’ level of profit margin, adjusted for development risk, can be determined from market evidence available from other similar projects and having regard to the profit requirements of the providers of development finance. Returns on capital are similar for both speculative market housing and private housebuilding.

Most individual private homebuilders do not build for profit; their priority is usually to get a tailor-made home to match their needs. Some are also able to build more affordably because they can make construction savings (depending on their build route) and because they don’t have to pay the full developer profit that is charged on market housing. They also usually live in their new property for many years, and they frequently benefit from a healthy equity stake (as it is often worth more than it cost to build).

Competitive return considerations therefore only apply to multi-unit sites brought forward by custom build enablers, builders, developers and landowners.

Conventional housebuilders are exposed to significant risk and therefore need to set high target returns; they typically aim for gross profit margins of around 20 to 25 per cent. However, once Corporation Tax and overheads have been deducted net profit margins range between about ten and 15 per cent.

The return on capital employed (ROCE) is a key measure used in the development industry, and it represents the level of profit relative to the level of capital required to deliver a project, including build costs, land purchase, infrastructure, etc. ROCE is likely to be lower for traditional builders or property developers compared to those who bring forward private homebuilding opportunities because of the comparatively large capital requirement needed to build out traditional speculative schemes.

Custom build developers and enablers function more like contractors, preparing sites and plots and then (depending on their business model) building homes on behalf of their clients. This means they can operate at a lower profit margin because they do not build homes speculatively. Their ROCE is likely to be higher because they have lower marketing costs and overheads and use less capital to build the homes. In the private homebuilding model clients finance their homes as they are constructed so the capital outlay for the enabler is lower. Any lost ‘opportunity costs’ arising from not building houses can also be partly mitigated by custom build enablers, builders, developers and landowners constructing shell homes or providing a full build out service when they sell the plots (this can be mandatory or optional).

This means that while sales incomes will be lower for multi-unit custom build sites, ROCE is likely to be higher compared to speculatively built market housing.

Private Homebuilding as Affordable Housing 

As explained in the Briefing Note on Affordable Housing and Exception Sites, national planning policy enables private homebuilding to be delivered through local affordable housing policies.

The delivery of private homebuilding opportunities through affordable housing policies in a Local Plan will need to be considered under the viability assessments that relate to affordable housing. This includes the provision of ‘starter homes’ (see Briefing Note on How the planning system can generate more opportunities).

Single Homes and Group Projects

It is important to distinguish between: -

  • Multi-unit sites brought forward by custom build enablers, builders, developers and landowners for private homebuilders to buy land and build homes
  • Projects on single plots
  • Groups of private homebuilders who work together to build their own homes, with or without the help of enabler or contractors

The cost of constructing homes are, on average, likely to be more for single plots (in many cases as much as a third more) because it is not possible to take advantage of the economies of scale achieved by a builder, particularly on multi-unit sites.

However, it is important to remember that private homebuilders are exempt from CIL so, if there is a CIL charge in place, they will not incur this cost. Planning obligations and other costs arising from planning policy will, however, still be incurred in the same way as they apply to market housing (unless there are local exceptions). Costs arising from Building Regulations will be incurred by individual private homebuilders on multi-unit sites and apply in the same way as they apply to market housing.

Cash-flow is a key consideration for single plot projects as a private homebuilder will need to invest considerable upfront capital to buy the land and pay for the construction of the home before completion.

For single unit projects infrastructure costs are likely to be limited to the costs of linking the home to surrounding infrastructure. An average cost of about £10,000 to pay for on-plot utility connections is a reasonable assumption, excluding any hard landscaping that might be required to link the plot to the public highway.

Single unit sites, where the private homebuilder builds or commissions their own build, will have no marketing costs. However professional, project management and legal costs can be expected to be higher as private homebuilders will be arranging these on an individual basis, and cannot benefit from any economies of scale.

Single unit projects often benefit from an equity of between five and 30 per cent, depending on the build route chosen (eg. a self build project using local labour or ‘sweat equity’ will generally be cheaper to construct compared to a contractor-led project).

Private homebuilders who build as a collective will be affected in a similar way.

APPROACHES APPLIED BY LOCAL AUTHORITIES

At present there are few examples of council assessments of the viability of private homebuilding policies in Local Plans. This is because few plans have so far made provision for this form of housing, and there is currently very limited guidance provided by Government.

Councils that ask for a percentage of plots to be set aside on larger sites should be cautious and check that there is sufficient local demand and that this approach will not hold back larger custom build opportunities.

Two approaches to viability considerations which have been identified to date are worth highlighting.

Stroud’s adopted District Local Plan (November 2015) asks for strategic sites allocated within the Plan to reserve a minimum of two per cent of the homes for private homesbuilders, subject to appropriate demand being identified. Viability considerations and specific site circumstances will also be taken into account when applying this policy.

The Council’s Local Plan Viability Study did not model the application of this policy separately but instead concluded that private homebuilders pay a premium for their plots. The council felt that this premium would more-or-less equal the ‘loss’ (opportunity cost) the site owner/developer would have incurred if they were not able to develop the site for conventional market housing (with the commensurate profits). For each strategic site assessed the council therefore assumed that the developer would sell fully serviced plots and that the overall cost would be neutral.

West Oxfordshire’s draft District Local Plan requires larger development schemes of 100 or more homes to set aside five per cent of the plots for private homebuilders. The council’s viability assessment says that plots made available under this policy would come forward at market value and therefore would not impact greatly on viability. It also reasoned that larger development schemes on greenfield sites are typically able to return a significant residual land value (well in excess of threshold land values) and therefore the five per cent policy is unlikely to have a significant negative effect on the viability of such schemes.

Planning applications

Viability is an important material consideration in the determination of planning applications as it is linked to the deliverability of a project, whether a single home or a multi-unit site of hundreds of properties. A site is normally considered to be viable if the value generated by its development exceeds the costs of delivery (and also provides a sufficient incentive for the developer to undertake the work and the landowner to release the site).

Assessing the viability of a particular site always requires more detailed analysis than at Local Plan level.

When determining planning applications financial viability is particularly important, especially when it comes to negotiating Section 106 obligations, including those for affordable housing. For homes to be delivered, willing landowners require a ‘competitive return’ to encourage them to release land. This return usually takes the form of uplift in land value that generates an appropriate level of profit for the developer or enabler. Section 106 obligations are a development cost, and the level of affordable housing that may be required by a council can affect the GDV of a project. In turn this can impact on the residual land value and profit that will be generated, and, if the return is not reasonable, developers or landowners may decide not to proceed.

Indicative example of viability assessment of a small private homebuilding (custom build) project involving the sale of 19 serviced plots. Note - this excludes any profit for optional design and build contracts on the plots

Screen Shot 2016-05-20 at 11.30.45

 

The NPPF recognises the importance of taking account of the viability impacts on individual private homebuilding projects (see Annex 1). The above viability considerations for Local Plan assessments are also applicable when considering the viability of specific private homebuilding projects. However, they must be tested against local policies and take account of the form, scale and way the development is coming forward on a specific site.

Top Tip

Viability differs between different scales of project

Viability assessments should distinguish between developer or custom build-enabled private homebuilding projects on multi-unit sites, projects on single plots, and projects where a number of private homebuilders work together as a group to build their own homes

Top Tip

Project-specific viability assessments require detailed analysis

Viability impacts on individual private homebuilding projects differ from market housing and will always require a more detailed assessment than at Local Plan level

Further Reading

Viability testing local plans: advice for planning practitioners

http://www.nhbc.co.uk/NewsandComment/Documents/filedownload,47339,en.pdf

Two other sources of information are also relevant when considering viability, (although these are not considered particularly helpful when assessing viability for private homebuilding projects) : -

  • Financial viability in planning: RICS guidance note
  • Development appraisal tool (Homes and Communities Agency)

CREDITS

The NaCSBA Research & Development Programme is funded by the Nationwide Foundation and aims to promote the self-build and custom build sector as an affordable route into housing for a greater number of people in the UK.

For further information, please visit:

www.nacsba.org.uk or www.selfbuildportal.org.uk

ANNEX 1: Policy Context

The National Planning Policy Framework says that Local Plans have to be deliverable and that sites and the scale of development identified in the Plan should not be subject to excessive obligations and policy burdens that threaten their viability. Understanding Local Plan viability is therefore critical to the overall assessment of deliverability.

The Planning Practice Guidance that supports the NPPF advises that the viability of Plans does not require the individual testing of every site or assurance that individual sites are viable; site typologies can be used to determine viability at policy level. Assessment of samples of sites may be helpful to support evidence and more detailed assessment may be necessary for particular areas or key sites on which the delivery of the Plan relies.

The Guidance also advises that different types of residential development, such as people wanting to build their own homes, are funded and delivered in different ways. This should be reflected in viability assessments.

Key generic considerations in viability assessments are: -

  • Gross Development Value - The potential value generated by development in the area, such as the total sales and/or capitalised rental income from developments
  • Development costs - These include: -
    • Build costs based on appropriate data
    • Known abnormal costs, including those associated with treating contaminated sites or listed buildings, or historic costs associated with brownfield, phased or complex sites
    • Infrastructure costs, which might include roads, sustainable drainage systems, and other green infrastructure, connection to utilities and decentralised energy, and provision of social and cultural infrastructure
    • The potential cumulative costs of emerging policy requirements and standards, emerging planning obligations policy and CIL charges
    • General finance costs including those incurred through loans, and
    • Professional, project management, sales and legal costs
  • Land Value - This should take account of policy requirements and planning obligations and, where applicable, any CIL charge
  • Competitive return to developers and landowners - This should recognise that returns will vary significantly between projects to reflect their size and risk profile. A rigid approach to assumed profit levels should be avoided and comparable schemes or data sources reflected wherever possible.

Viability considerations also apply to the consideration of planning applications. Although the Planning Practice Guidance advises that decision-taking on individual schemes does not normally require an assessment of viability it can be important where planning obligations or other costs are being introduced. The Guidance therefore advises that decisions must be underpinned by an understanding of viability; ensuring realistic decisions are made to support development and promote economic growth. It also says that where the viability of a development is in question, councils should, wherever possible, look to be flexible in applying policy requirements.

Assessing the viability of a particular site requires more detailed analysis than at Plan level and it will vary from site to site. Such assessments should also consider the viability of different development models, which can vary from one model to another. Private homebuilding development is specifically recognised in this context (see box below).

The key principle to apply is to assess if the value generated by the development exceeds the costs of developing it and also provides sufficient incentive for the land to come forward and the development to be undertaken. If so, the site is considered viable.

PEOPLE WISHING TO BUILD THEIR OWN HOMES

“Any viability assessment should take account of average plot values and build costs for such development. The build route proposed (e.g whether it is contractor-led or a DIY project) and any non-development costs related to the project such as project management and professional fees should be considered.”

Extract from Planning Practice Guidance (Paragraph: 018 Reference ID: 10-018-20150326)