Property development is essentially the act of combining the various factors of production (land, capital, labour and entrepreneurial skills, as you may remember from your study of economics).
It should be acknowledged that in terms of inputs and process, huge variations will inevitably occur dependent on the type of project and the business model of the developer, as well as on the locality in which a scheme is being undertaken. Some schemes might be completed in a very short time frame and others much longer. Some may never see fruition because of planning problems or changes in market conditions. This underlines the importance of getting the right land, in the right place, at the right time, at the right price, with the right building for the right market.
This first article starts by explaining different developer types. It then outlines the front end of the development process from initiation through to site acquisition.
Developer types
Before examining the processes of development, it is important to understand the range of developer type business models: they are not all the same. The typical range can be categorised as follows:
- Developer investors primarily develop property for others to use, but retain the underlying ownership as an investment to produce a rental return. The group also includes the rapidly growing residential private rented sector. Social housing developers operate in a similar fashion, but they are not-for-profit and let completed buildings at affordable rents.
i) Developer sellers build and sell to building users or property investors. This group includes both volume and small and medium enterprise housebuilders and commercial developers who build and sell office, factory and warehouse properties, etc.
ii) Owner-occupier developers are private and public sector organisations such as manufacturers, retailers, hotels, health trusts, etc, that wish to design and develop their own bespoke buildings.
iii) Land promoters are companies that buy land, get viable planning consents and then sell on to developers. As such, they are not really developers in the strictest sense, but they do acquire land and take sites along the initial stages of the development process.
Finally, it should be said some developers are big in terms of their financial worth and geographical reach, while many others are small – down to one-person businesses buying old houses, doing them up and then selling them on.
The start of the development process
If a developer decides that market conditions are appropriate, the process will begin with the identification of suitable search areas and a broad analysis of supply and demand. This would be judged against potential site availability, as well as site-specific planning allocations and related policies.
When the particular search areas have been chosen, sites may be identified by one of, or a combination of, three basic ways:
- Sites advertised for sale on the open market
- Sites introduced directly to developers by landowners or agents
- Sites not on the market but identified as of potential interest by desktop studies and field work.
Whatever the source, all potential sites should be seen and broadly evaluated as to their suitability for further examination.
This is likely to include preliminary discussions with planners, possible funders and, in particular in the case of 3, owners and/or their agents.
Sites in cases 1 and 2 above may or may not have a suitable planning consent and this could impact on a developer’s willingness to proceed, depending on their operating business model. In the case of 3, where an owner is interested in selling, discussions could take place to prepare and submit an outline planning application – or, in the case of housing in particular, try to promote the site for such development through an up-and-coming revision of a local plan.
Site surveys and evaluation
These would typically address:
- site location, size and area characteristics, including existing buildings and uses, topography, ground conditions, vegetation/biodiversity, etc
- any existing tenants and lease lengths
- measuring and determining net development areas of a site, ie what parts are developable and what are not
- current planning policies that pertain to the site and area, along with a relevant planning history of past applications
- market/sales data, the second-hand new-build market, competitors’ schemes and current capital and rental values
- building services connections and likely highway and drainage authority requirements
- design opportunities and options, possible building types, uses, floor spaces, possible sketch layouts, densities, site access and possible road layouts and any known/likely requirements of the local planning authority
- legal matters relating to the site, eg possible easements, restrictive covenants or boundary issues
- itemising and appraising likely costs and possible contingency provisions.
All of these matters would be brought together in an initial development appraisal. This would include a residual valuation setting out the estimated gross development value of a proposed scheme and all the expected costs and times that are estimated to be incurred, along with a contingency sum for possible unknown issues.
The residual land value would represent the most a developer would be willing to pay for a site. Thus, if a developer were able to purchase it for less, there would be more room to increase profits or possibly improve the specification. There will be circumstances where the selling price is fixed. If that is the case, a residual valuation would be run to see if an acceptable level of profit is achievable.
A development appraisal is not a one-off undertaking. It will be amended and updated from its first iteration all the way through the development process as new information and insights become available.
Development finance
Short-term finance is used to buy land and pay for construction work, while long-term finance is needed where a scheme is to be retained for investment or owner occupation. For developer sellers, short-term finance can be paid off as soon as a scheme is completed and sold.
Like all financing, the return on capital – interest to be paid – is inextricably linked to the level of risk exposure the lender is subject to: the higher the risk, the higher the interest rate.
Typically, short-term loans might be secured against the assets of the developer, but may not cover the full costs of the land purchased and construction work. Shortfalls will have to be met from a developer’s own funds and/or sought from an additional loan, likely at a higher rate of interest.
Site acquisition
1. Sites identified or introduced to a developer, but not on the open market
Having approached an owner or their agent, if there is an interest in selling, the method of purchase would normally be by private treaty. This means a purchase results following the parties negotiating an appropriate deal.
These negotiations could lead to
a) an outright purchase and agreed price
b) an option, where land is not purchased straight away but where a contract is entered into with a landowner giving developers the right to negotiate a purchase at any time up to an agreed date in the future.
c) a conditional contract whereby developers do not have to complete a purchase until some future condition has been fulfilled (eg securing a planning consent or a prelet).
In the case of a), developers will need to have resolved any doubts as to a site’s market suitability and planning position. In the case of b) or c), a site might have potential but not until the medium to longer term. Some residential developers build up land banks of sites held through option agreements.
2. Sites advertised on the market
The sale of land can again be by private treaty, but also through tender and auction.
Purchase by private treaty would be as described earlier, but it is up to the seller if they are willing to negotiate an option or conditional contract. Some developers will not proceed to buy sites unless they have secured planning permission – or have only agreed to do so subject to an option or conditional contract of sale.
Formal tenders require that a sealed offer be made before a fixed date stated by the seller. An informal tender is where informal offers are made at any time up to a given date. It is a mix of private treaty and formal tender.
If a sale is to be by auction, then a property will normally go to the highest bidder, though could be purchased before if a seller is willing or after if a reserve price is not reached.
The crucial thing about buying via formal tender and auction is that as much appraisal work and due diligence as possible must be undertaken before a bid is made.
Summing up
To conclude, it is worth reiterating the fundamental importance of getting the right land, in the right place, at the right time, at the right price for the right scheme, for the right market and end user – and at the same time meet society’s needs in terms of sustainability (more on that in parts two and three).
Further reading
- Information on a range of property development and construction matters is available at Designing Buildings, the Construction Wiki
- Development management, RICS guidance note (2009)
- Valuation of development property, RICS guidance note (2019)
- Land measurement for planning and development purposes, RICS guidance note (2019)
Paul Collins is the editor of Mainly for Students and teaches at Nottingham Trent University
An overview of planning, design, construction, marketing, sales/lettings and occupation will be explored in part two
