Development appraisals: these are increasingly used in planning decisions, and developers must demonstrate that schemes offer value and quality. But issues remain to be clarified.

Profitability is more crucial than ever when starting, lending or foreclosing on development. Issues relating to economic feasibility are also vital to the credibility of proposals for historic assets and the use of compulsory purchase powers, arguments for competing forms of development and planning gain decisions. The use of toolkits heralds a more transparent, but not necessarily informed, approach. This article explains some of the legal and practical issues that arise from the growing use of development appraisals in planning decisions and suggests ways of achieving a consistent approach.

Viability matters

Without the lure of a realistic profit, investors will not help to get projects off the ground. The return of loan-tovalue as the basis for lender due diligence (from the boom-time loan-to-cost approach) underlines the need for robust development appraisals. Deliverability is also embedded in the planning system:

  • compulsory purchase powers should be available only if the underlying scheme is demonstrably viable
  • harm to historic assets must often be justified by evidence that no appropriate and viable alternative use can be found
  • applicants for out-of-centre retail schemes must assess the viability of alternative sites.

Planning policy also recognises that schemes may be unable to meet the totality of policy requirements but still be economically viable. Circular 05/2005 (Planning Obligations) recommends that "in such cases, and where the development is needed to meet the aims of the development plan, it is for the local authority and other public sector agencies to decide what is to be the balance of contributions made by developers". http://www.egi.co.uk/Articles/Article.aspx?liArticleID=649839PPS 3 (Housing) requires local authorities to ensure that affordable housing policies are based on "an informed assessment" of economic viability. The community infrastructure levy (CIL) will also have to be set so that it is, in broad terms, viable.

Four cases illustrate the pitfalls. In Croydon, the local authority (and its development partner) failed to convince an inspector that compulsory purchase powers should be used in connection with a stadium scheme that would have displaced the owner and its more deliverable scheme: see APP/L5240/V/06/1198485.

In Trent Vale, the inspector found that Tesco had failed to satisfy the PPS 4 sequential test requirements because it did not supply viability evidence to support its claim that its floorspace proposal was the minimum required to compete effectively with other retailers: see APP/M3455/V/10/2122016.

Affordable housing policies are set for the development plan period and do not have to be viable at each and every point in time - see Barratt Developments plc v Wakefield Metropolitan District Council [2010] EWCA Civ 897; http://www.egi.co.uk/Articles/Article.aspx?liArticleID=721463[2010] PLSCS 216 - but they must be based on a proper assessment of the effect on viability. In Blyth Valley Borough Council v Persimmon Homes (North East) Ltd [2008] EWCA Civ 861; http://www.egi.co.uk/Articles/Article.aspx?liArticleID=686661[2008] PLSCS 225, the court accepted that they were not and quashed the policy.

 Rules of engagement

Developers and local authorities face complex pressures, requiring the economics of development to be dealt with in a structured and transparent way. Viability assessment considers whether the value likely to be received after paying all development costs would represent a reasonable developer's profit. That usually entails calculating whether the value after costs and profit would be less than either the value of the land in its existing use (existing use value) or the value if used for another, permitted, purpose (alternative use value).

The evidence submitted to local authorities (often to justify a discount against affordable housing requirements) varies in terms of complexity and reliability. Rather than using a different methodology for each site, standard toolkits are now commonly used. These can be "open book" (using certified data and detailed cash flow analysis), but are usually generic (using standard assumptions on financing and development costs). They are superficially straightforward models, but rely on complex assumptions as to how much development will cost and how much parts of it can be sold for (and when). Toolkits should be treated with caution and assessed by a professional valuer (see box).

The quality of evidence used to inform policy making is equally uneven. Local authorities must therefore exercise caution, since building a policy on inadequate evidence can be costly, as was confirmed in Blyth Valley.

The lack of detailed national policy guidance is a barrier. Commentary by the Homes and Communities Agency has been helpful, but is necessarily limited (see http://bit.ly/e71sta). The RICS is preparing guidance that will help lay members and planning professionals.

Protocol helps

Whether planning permission is justified with a discount from adopted policy requirements is, depending on the development plan, a matter of planning judgment regarding the essential balance between benefits and costs.

An acknowledgment of viability constraints does not mean that permission should be granted. The crucial issue remains whether it is in the public interest for the scheme to be approved below a certain threshold of quality or contribution (having regard to long- as well as short-term factors). Applicants should not assume that they have an inherent right to build and local authorities should avoid the danger of debates over viability inputs becoming a proxy for genuine planning judgments. Until the CIL comes into effect, authorities also cannot treat development value as betterment to be taxed at source.

Adopting a clear and consistent approach should free planners from sterile debates on viability assumptions and enable real choices to be made (see Protocol box). Local authorities should maintain an up-to-date protocol giving clear guidance to applicants, officers, members and the public. Applicants are often encouraged to maximise the quality and demonstrate the value of their proposals.

Protocol

  • Clearly identify the established policy requirements (and their purpose).
  • Consider whether the applicant has presented a technically robust and convincing case for variation.
  • Review the implications of variation (including whether site is a one-off) and acceptability in the light of the scheme’s importance to development plan goals.
  • Fully understand the specific benefits, if any, of the proposals and the timing of their delivery, which may warrant viability being given more weight in some cases than in others. 
  • Recognise that significant relaxation or abandonment of policy requirements should arise only in exceptional cases
  • Understand the minimum threshold below which, say, no affordable housing provision will be acceptable.
  • Consider mechanisms for limiting public sector risk (see Robust Mechanisms).

Planning appeal decisions are often relied on as part of a viability rulebook. Although they can show how a fair approach can be applied to complex facts, they often demonstrate the limitations of a prescriptive approach. Assumptions about the cost of land are especially controversial. It is often suggested that historic land values cannot be used without inappropriately subsidising developer risk (and that schemes must be judged viable if residual land value exceeds existing use value). This is only partly true and illustrates the need to balance consistency and common sense:

  • First, if residual valuations are appropriate, allowance must be made for the uplift above existing use value necessary to make it worthwhile for the owner to sell. This will vary significantly between brownfield and agricultural land.
  • Second, there should be no bar to using historic land costs if the price paid was not excessive in the purchase year (assuming a reasonable developer's profit and the full suite of planning obligations at the time). This approach was accepted in the Jericho Boatyard appeal decision (APP/3110/A/04/1152062), and the secretary of state's contrary verdict regarding Clay Farm, Cambridge (APP/Q0505/A/09/2103599) should be approached with caution, since, there, the requirement for residual valuation was embedded in the adopted development plan and the applicant had offered no catch-up mechanism.

Dealing with uncertainty

Where applicants seek a discount on the basis of current conditions, they should offer (or be prepared to accept) robust mechanisms to make up the slack should the market improve (see box below).

In Robert Hitchins Ltd v Secretary of State for Communities and Local Government [2010] EWHC 1157 (Admin), a multi-phased scheme in Lydney was dealt with at appeal on the basis that only 13% affordable housing could be offered throughout the development period. The inspector objected on the basis that the development appraisal was a snapshot of market conditions and, without a mechanism to allow for change in those conditions, the scheme did not comply with policy. The judge on the applicant's appeal upheld the inspector's approach. The secretary of state had previously accepted such mechanisms for large schemes (see Flemmingate APP/E2001/V/08/1203215) and refused to approve those where the applicant had failed to offer any catch-up or deferral mechanism.

Accepting properly drafted cascade or deferral mechanisms should complement, not constrain, the ability to form a view on whether the benefits of a scheme warrant the risk to the public interest that such mechanisms entail. A Court of Appeal decision sheds light on the difficulties in practice. In Kensington and Chelsea Royal London Borough Council v Secretary of State for Communities and Local Government [2010] EWCA Civ 1466; http://www.egi.co.uk/Articles/Article.aspx?liArticleID=727855[2010] PLSCS 321, the local authority's challenge to an inspector's decision - that viability evidence was polarised but overall provided no firm grounds to require affordable housing provision - was initially upheld by the High Court.

The developer (Vannes) had applied for permission to convert an empty hotel into nine luxury flats. Contrary to policy, it refused to provide any affordable housing or contribution (because this would render the scheme unviable). In determining Vannes' appeal against refusal, the inspector was presented with two appraisals with a profit difference of around £18m. He decided that he had "no basis" on which to determine the reliability of Vannes' build costs or to prefer the local authority's assessment. Giving no weight to the viability evidence, he accepted Vannes' position and concluded that there were "no firm grounds to require affordable housing provision". The local authority challenged the decision and the secretary of state accepted that it should be quashed. Vannes contested the claim. The High Court held that the inspector had failed to reach a clear conclusion on essential evidence concerning a "principal important controversial issue" and had erred in law.

The Court of Appeal rejected that approach. It found that it was open to the inspector to conclude that no contribution was appropriate despite the lack of robust data either way. It held that the principal issue was whether affordable housing should be required (of which viability was only a component).

Unusually, although the judgment refers to the need to "have regard to" the development plan, it does not refer to the requirement (under section 38(6) of the Planning and Compulsory Purchase Act 2004) for decision makers to determine applications "in accordance with" that plan unless material reasons militate against it. Although the relevant local plan policies had expired, the inspector had proceeded on the basis that policy 3A.11 of the London Plan "normally" requires affordable housing in such schemes. The issue for the inspector was whether a departure from this requirement was merited. In the absence of reliable evidence either way (and any catch-up mechanism - see box below), it is hard to see how he could properly have concluded that there were grounds to accept the applicant's failure to include an affordable housing provision.

Robust mechanisms

  • Short-life consents: 18 or 24 months to achieve practical completion may be appropriate where short-term constraints are relied on.
  • Bounce back: Longer-life permissions can be combined with a reversion to the policy-compliant level of provision after the sell-by date for the appraisal.
  • Catch-up: deferred payments and reverse cascades: Section 106 agreements can include mechanisms to ensure that realised sales values or changes to profitability are reflected in future phases or in deferred payments.

Development is not a given

As the coalition's unfolding planning agenda suggests, there is no inherent right to develop. Unless schemes serve a useful purpose, and are of sufficiently high quality, the fact that planning policies render them unprofitable, undeliverable and/or commercially undesirable is unfortunate, but not impermissible. It is therefore essential to demonstrate the quality and value of a scheme.

Equally, local authorities must assess the consequences of policies that will affect the economics of provision and adopt them only where they will not thwart development. Whether the proposed national planning framework will clarify matters remains to be seen, but making the case for appropriate development will continue to merit careful thought.

This article appeared in Estates Gazette, 12 February 2011.