For those returning from MIPIM, a blog on development viability testing may not be considered conducive to recovery. However, it is a serious business for the housing sector with far reaching ramifications for delivery.
We have viability testing because the UK is bad at tax making. This country should have a land value tax. However, where there is a painful trade off you can be sure our Westminster politicians will push it into the long grass. Look at the adult social care system.
The planning system has filled the gap whilst Westminster has looked away. It is now mandatory to undertake viability testing in some parts of the country, most notably London.
Theory and practice
The idea of viability testing is sound. It can protect against over speculation in the market and can ensure new developments offer appropriate community benefits that might not be possible immediately. Development is a long-term business and also one of many variables. A site’s value can be enhanced over time, but its present economics may prohibit offering what local policies might seek. Testing can offer a route to delivery. That was certainly how it operated in the early years.
Unfortunately, the present approach is complex and disputatious. It is driving capital out of the housing sector at a time when more investment is needed.
Litchfield Planning research found the average site requiring viability testing took almost five times the statutory period. In three quarters of cases, there were significant disagreements on the land value.
The approach taken by the viability system towards land valuation was also creating dispute. This was particularly apparent for smaller sites but applies across the board. The recent case of Holloway Prison where Peabody and Islington Council disagreed significantly on land value is a good example. Despite the applicant offering high levels of affordable housing, the Council pushed for an even greater contribution citing a £40 million + difference in development viability.
All these disputes take time to resolve, if they can be resolved, time which developers can ill afford to lose.
Three key changes
I don’t believe the viability system is bust but it needs some urgent surgery.
Firstly, the approach to valuing land for development is not realistic. Developers in the main are not landowners. They are manufactures and processors, land is their input. To drive land into their process they need to incentivise landowners with a premium. The current approach of existing use value with a premium of between 10-30% doesn’t offer an effective enough incentive. Most landowners are tax conscious. The premium they receive will be liable to capital gains tax and they will be expecting a significant gain to divest. Otherwise they will hold on.
The result has been a reduction in land supply and greater dispute in the system. There should not be a range of premiums which can be selected at discretion of the planning system. Instead, there should be one approach and if EUV remains the base a more realistic figure should be a 50% uplift.
Secondly, viability testing has taken to fiddling developer margins. Margins are the reward for undertaking complex activity and the developer’s only real contingency when things go wrong. In development a lot can and does go wrong so a sensible margin is important.
The GLA’s SPG on viability states: “The appropriate level of profit is scheme specific; evidence should be provided by applicants to justify proposed rates of profit taking account of the individual characteristics of the scheme, the risks related to the scheme, and comparable schemes.” The translation of this approach is many planning authorities taking differential margins across all sites. One council now sets out that small developers should be able to accept 10% profit margins as these sites are “low risk”. How can you price an investment if you do not know what position might be taken by the LPA.
My view is that we should work to set minimum margins for all development. This will give a clear signal for capital to come back into the housing sector rather than seep away to different sectors. Where there are cases for differentials, they should be to increase margins on more complex sites, not squeeze them in an effort by viability consultants to create more gain.
Finally, most developers would prefer not to do a viability test and deliver what’s required. There is a negative incentive to avoid viability testing which has proven to be quite strong. However, the positive incentive for doing more affordable housing is limited. If a developer offers to exceed minimum thresholds then there should be clear policy benefits. For example, if a developer chooses to do half the homes as affordable rather than say 35% there should be a gain in terms of the flexibility of mix and tenure across the homes delivered. This doesn’t exist.
All land is different. Contamination, ownership issues, light constraints to name just a few mean that universal planning policies cannot always be complied with, it would be naïve to believe otherwise. The viability system should be a pragmatic means of enabling developers and authorities to bring sites forward which cannot meet the high thresholds set by some local policies. Instead, it has grown around the housing sector like weeds in a flower bed. Left untended it is strangling the life out of what remains.
