The use of viability appraisals to test the ability of schemes to bear affordable housing and other infrastructure requirements sought by local planning authorities is becoming commonplace. Increasingly, where proposals do not comply, review mechanisms are included in section 106 agreements to ensure that a share of profit resulting from any improvement in viability is captured for public infrastructure.
How are review mechanisms used in London?
The mayor’s supplementary planning guidance, Homes for Londoners, adopted in August 2017, broadly contemplates two types of review mechanisms for schemes (there are alternatives for build-to-rent schemes).
First, where a scheme containing less than 50% affordable housing is not substantially implemented within an agreed period (often 12 or 24 months, depending on the scope of works required), viability must be reassessed (early review). This ensures that, in the event of surplus profits being anticipated, additional affordable housing provision on site is secured.
In practice, boroughs have different approaches for determining whether substantial implementation has taken place. At the extreme, evidence must be submitted of costs actually incurred for works done, before a meeting on site to check the scope of the development undertaken. Such an approach takes time and incurs further costs.
A late-stage review also applies where schemes have not met the mayor’s threshold for affordable housing provision on site without public subsidy, currently set at 35%, although it can be triggered by a failure to meet preferred tenure mix. The review applies on sale or letting of 75% of the units or as agreed with the borough. If viability has improved, there will generally be a contribution to affordable housing off-site.
Both reviews are upward only. There is no adjustment if the market changes, adversely affecting value, and/or costs substantially increase, resulting in the developer receiving less-than-expected profit. The guidance also raises the prospect of mid-term reviews for longer term, phased schemes or further reviews where schemes stall.
What is the scope of a review mechanism?
The scope of a review depends on the authority and site in question. Where viability is assessed at the application stage, the mayor’s guidance recommends a limited review of changes in development value and build costs, being the inputs most likely to change. If the change in value less the change in costs results in a positive figure, developer profit is deducted at the level used in the original viability, to calculate the surplus. Where viability is not assessed at the application stage, costs and values will be assessed at the point of review, with indices used to calculate changes since the date of permission.
In practice, however, some authorities require a review of all values and costs. The benchmark land value considered acceptable at planning application stage is compared to the residual land value on review to see whether a surplus arises. Indexation of the benchmark land value may be permitted to reflect inflation.
The proportion of any surplus payable to the authority can be contentious. Traditionally, it was considered that developers should be incentivised to generate a surplus and therefore it was not uncommon for developers to retain half or more of any surplus. The mayor’s guidance suggests the authority should receive 60% of any surplus.However, some authorities go further and seek to retain 80%. On early review, 100% of any surplus may be required to be used towards additional affordable housing.
Appropriate profit levels also need to be agreed, taking into account the commercial risk involved. Profits on residential development of 20% are not uncommon (around 6% for affordable housing). The inspector in a case study (see box) saw no justification for a developer profit level of 22.5%. The total amount of affordable housing required should be capped by reference to policy requirements. The mayor’s guidance caps off-site contributions by reference to the cost to the developer of converting market housing to affordable housing to address the shortfall in the scheme. However, some authorities consider that the overall percentage contribution to affordable housing should be judged on the total amount of housing being provided on and off-site – increasing the burden on the developer.
While standard approaches to review mechanisms are emerging, there remains significant variation across authorities in London.
The national approach?
Many authorities beyond London also seek review mechanisms, particularly on longer-term sites and where the infrastructure needed to release sites renders policy-compliant schemes unviable.
Current national planning practice guidance (PPG) allows for consideration of changes in the value of development and costs of delivery where a scheme requires phased delivery over the medium and longer term. While it does not specifically anticipate the need for review mechanisms, it does not preclude them.
In its revised guidance out for consultation, the government anticipates that development plans will be subject to detailed viability review, taking account of any proposed community infrastructure levy and section 106 obligation policies. It envisages the levy and section 106 obligations will be set at a level that generally enables policy compliance, limiting the need for further viability testing at application stage.
The government is optimistic. While the draft suggests strategic sites should be subject to detailed scrutiny at plan examination, authorities will not have the resources to test all sites in detail. Further, landowners and developers are unlikely to have assessed costs in sufficient detail. In any event, costs and values change over time. Fundamentally, it is unlikely authorities will set their requirements at such a level to render viability assessment largely redundant.
Draft guidance therefore recommends that plans should set out the circumstances in which review mechanisms may be required. It states that such mechanisms can be used to amend developer contributions to help account for significant changes in costs and values over the lifetime of a development and to re-apportion or change the timing of contributions – to help deliver sites that would otherwise stall. It remains to be seen whether authorities will accept an approach that provides flexibility that could work in favour of the developer or landowner.
Will review mechanisms result in more affordable housing?
It is too early to say whether a tighter approach to viability assessment and review, as per evolving practice in London, will result in the provision of more affordable housing. The expectation is that land value will adjust to reflect more stringent policy requirements given that overpayment for land (where purchasers fail to take into account policy requirements) will not be taken into account in viability appraisals or on review.
Planning reform has a habit of producing unintended consequences. Where existing use values are high, there is an increasing risk that landowners will not be incentivised to release land for development. An inflexible approach to benchmark land value may fail to reflect that landowners value their land differently – a farmer with one field for development might be keener to sell than a landowner taking a long-term view.
Review mechanisms may ultimately act as a disincentive to developers to generate a surplus beyond the base affordable requirement. In order to compete for sites at above benchmark land value but maintain viability, developers may seek to cut costs. How will practice evolve once data grows on how standardised inputs compare to actual costs? The debate on viability is not going away.
Claire Fallows is a partner at Charles Russell Speechlys
Image ©PHOTOFUSION/REX/SHUTTERSTOCK
Case study: Parkhurst Road Ltd
The High Court has recently considered the issue of viability in the context of planning decisions in Parkhurst Road Ltd and Secretary of State for Communities and Local Government and the Council of the London Borough of Islington [2018] EWHC 991 (Admin); [2018] PLSCS 80.
A planning application for a residential scheme had been refused by Islington (LBI) and was then refused on appeal. A reduced scheme suffered the same fate. A key issue was whether the developer had justified its affordable housing offer as being the maximum reasonable amount required by policy. The developer sought to challenge the decision of the inspector on the second appeal.
At the heart of the judgment is the difficulty of setting an appropriate benchmark land value for viability assessments. National planning practice guidance indicates that the most appropriate way varies, but three principles should be reflected. First, land value should reflect policy, section 106 and community infrastructure levy requirements. Second, it should provide a competitive return to willing developers and landowners. Third, it should be informed by comparable, market-based evidence wherever possible.
However, if market-based evidence does not reflect policy, circularity can arise. While the parties’ positions as to land value evolved, the inspector on the second appeal supported LBI’s assessment of £6.75m, against a purchase price of £13.25m.
Unusually, the existing use value of the site was agreed to be “negligible”. There was no basis for any alternative use value other than the appeal scheme. In establishing land value, the developer relied on the original bid process and purchase price, a Red Book valuation, an unsolicited, unconditional offer and comparable transactions.
The inspector rejected the developer’s approach. He noted the difficulty of finding truly comparable sites, the “vast” adjustments needed to allow comparison and the impossibility of assessing comparability without sufficient relevant information. Simply ignoring transaction bids significantly above the market norm was not sufficient. He concluded the absence of evidence of the assumptions of the developer and other bidders underpinning their bids and comparative site information meant that the market evidence needed to be treated with caution.
Following a rolled-up hearing before Holgate J in March, the inspector’s decision was upheld. While the judge found the analytical approach of LBI’s expert to comparing sites was flawed, he concluded the error did not taint the inspector’s conclusion that the developer had not discharged the policy requirement to provide the reasonable maximum level of affordable housing.
The case illustrates the burden arising in establishing that market-based evidence is truly comparable and reflective of planning policy. However, the judgment also reminds practitioners that application of policy should be informed by the market. Realism is required.
After lengthy scrutiny of valuation evidence at the High Court, the judgment ends with a plea by Mr Justice Holgate for RICS and others to address misunderstandings about market valuation concepts and techniques and “circularity” , to avoid protracted disputes and achieve more efficient decision-making.
