Property and Construction
Expansion & Improvement
The underlying financial value of your property business can (and will) fluctuate over time. It’s good practice to get the business valued at regular intervals, so you know the current market value of your sites, your properties and the overall company. But what key drivers are likely to affect your end value? And what are the different ways that property development and property investment companies will be affected by these external conditions?
Gary Cleaver runs through the key factors that can impact on your property business’s value, and the important parts that planning permission and rental return play in this calculation.
Key reasons for getting your property business valued
There are multiple reasons why you might need to get your property business valued. The obvious one is that you’re planning to sell the business and need a price to put out in the market. But there are other key reasons why that valuation might be needed
You may be looking to take out a business loan where the lender wants to secure the loan against the properties in your portfolio.
You might be taking out building insurance where the insurer needs to know the value of the business to provide the right premium.
You might be taking out a mortgage to buy a new property and the mortgage lender wants to understand the full value of the business.
Whatever the reasons behind the valuation, it’s important to understand what drives the value, and whether there’s anything you can do to push that value up.
Within the property sector, I deal with two different types of client – property development businesses and property investment businesses.
1. Value for property developers:
For developers, most developments will be run through a corporate vehicle, usually as a limited company either on a standalone basis or as a single purpose vehicle within a larger group structure. The value lies in the stock in hand in the business, or, in other words, the sites and ongoing developments that the business owns.
A developer will own one or more sites, and they’ll have clear plans around what they want to do with each site and how it will be developed. The balance sheet shows the value of these assets. Complications may arise from the potentially differing nature of each site and how far along you are with the actual development process.
You need to look at value on a site-by-site basis and then aggregate matters to get to your full value. If you own the site but don’t yet have planning permission, that can change the end value very substantially.
There will be various conditions to be met for the planning permission, and this can result in different prices, depending on the current status of planning permission and around the timescales of the building project.
Adding value through management
There are a number of ways to add value through proactive management of the asset. For example, it is important to keep up to date with changes in planning legislation such as the recent “permitted development” guidelines which provide deemed planning permission for certain properties to be extended by up to two stories.
Developers and the potential for risk
There are two distinct values - one with planning and one without. Obtaining planning permission will be a major goal in the project timeline.
Larger development businesses may have their own in-house architects who design the building and liaise with the relevant authorities re planning. But for smaller developers, it’s more likely that you’ll engage an external architect to do this on a case-by-case basis. Completing a project can take years and the key thing to bear in mind is that nothing is guaranteed. You can buy the site, do the drawings and apply for planning and the plans can still be rejected – leaving you with a defunct site, sunken costs and no ROI.
That risk has to be borne and has to be factored into your potential end value. For this reason, most companies are set up as single entities to isolate this risk. You cannot realise your value until that planning decision is given, so keeping each entity in a separate vehicle helps to limit the group risk and the overall liability of the business and directors.
Letting out your completed development
Some developers choose to sell and take their profit at the point that planning permission is obtained, leaving the buyer to build out the development. Alternatively you can choose to build it out after you get the planning. The next consideration is whether to sell the completed but still vacant development or find tenants. Obtaining tenancies with good covenant will put you at peak value and in a position to sell to potential acquirers interested in the site for its long term investment potential. Alternatively you might prefer to retain the site as an investment yourself, but in those circumstances be wary – a change of use from development to investment can have onerous tax consequences and advice should be sought before taking that step.
Whilst good tenant covenant does have a positive impact on valuation, there can be a downside. Large corporate “blue chip” tenants have historically been regarded as having excellent covenant but we have seen examples in recent times (those examples being, unsurprisingly, Covid-19 related) whereby those tenants will demand a permanently reduced rental on a non-negotiable basis, with the alternative being to vacate. Whilst such demands might be in clear breach of the lease terms, large corporate tenants may have deep pockets and expensive lawyers. You may be left without much leverage in these situations and forced to take the pragmatic view that some rent is better than none.
There will always be external conditions that you cannot plan for, such as fire, flood, damage from extreme weather and, of course Covid-19. A report issued by The Actuary Magazine in July 2021 suggests that commercial insurance premiums have risen by 15% globally. However, the property sector in particular has been impacted by the 2017 Grenfell tragedy. Insurance premiums for all involved – developers, investors, contractors and architects – have increased rather more than 15% and in many cases by some multiples. For longer term projects commenced around or shortly after 2017, the budgets and consequent valuations have been impacted accordingly.
Green credentials can make things more marketable. By adding in sustainable elements like solar power or electric car charging points, you are effectively future-proofing the development. These green features could be mandated in future legislation, and it may well cost you more to retrofit these new green-compliant items at a later date.
2. Value for investment companies
As with development companies, the fundamental value of the business comes from the property assets on your balance sheet. The surveyor’s valuation will take into account matters beyond simple bricks and mortar, with specific attention being given to the tenancies as mentioned above.
Subject to the factors already mentioned, when comparing investment to development there is generally less inherent risk since many of the “unknowns” present at the outset of a development project have been resolved by the time that a property is ready to be regarded as an investment vehicle.
Other considerations that can affect the end value
Things like complying with green guidelines and providing more sustainable features to tenants could add latent costs and could affect the value. Buyers are willing to pay for more for this, as will end tenants, if they know it helps them drive their green strategy.
Return will be a major factor in the value of your properties, where return is measured as the annual rental income expressed as a percentage of the total property value. Typical returns for residential properties will be around 4% and commercial properties something between 6% to 10%, depending on the nature of the property (warehousing/office space/high street retail) and the strength of tenant’s covenant.
The property outlook for 2022 and beyond
There have been notable ups and downs over the past two years in the property sector, so anticipating how the market may affect your end value now is an important consideration. External conditions can be tricky when it comes to the project management of any construction project, but the supply chain issues that the building industry has been experiencing shouldn’t materially affect the fundamentals of the site. It might take longer, but the project will get built.
The major challenge for those currently contemplating property development is the rising costs of construction, which may be up significantly (20 to 25%) against the pre Covid-19 era. Sites that made commercial sense before the pandemic might now be more marginal.
The Covid-19 pandemic certainly had an effect and, with the worst hopefully behind us, that effect lingers. Some landlords have been hit hard. Those holding retail units have seen tenants go under, not least those with small outlets in the hospitality and entertainment sector, whilst my landlord clients that hold office space are seeing their tenants reconsider their requirements with the increased tendency to home working. In the commercial sector, warehouses may retain their demand for 2022 and beyond. Large manufacturers and delivery companies will always need warehouse space, and online retail businesses will increasingly need logistics centres.
However, development potential remains. For those with the requisite experience there is always another site (and indeed, the next “up and coming” postcode) out there with potential, and that influx of money, businesses and the ever burgeoning coffee shops can quickly change the market value of your property, so it’s worth keeping an eye on fashionable and potentially fashionable areas.
On the whole, things look more positive than not. With the pandemic and the associated panic now hopefully behind us we are seeing some calming in the market.
The benefits of working with an adviser
Working with an external adviser gives you a second set of eyes and a much wider view of the current property market.
At Haines Watts North London, we work with a wide range of different property clients, so when you work with us, you reap the benefit of that wider knowledge. We know the opportunities and threats to consider and can show you the most beneficial ways to enhance the value of the business prior to a valuation and sale.
If your property business has ambitious plans for 2022 and beyond, whether it’s expanding your portfolio or selling up and exiting, understanding your market value is going to help both your decision-making and planning for the new year and beyond.
Come and talk to us about a valuation and let’s see what we can do to deliver the best possible end value for your development or investment business.