eres2010_130_Henneberry_MODELLING_THE_RELATI(8)

The paper describes the development and application of physical-financialmodelling techniques to the analysis of relations between development design –covering the broad characteristics of a scheme, such as land use mix, developmentdensity and built form – and financial viability. It is divided into two parts

The Financial Analysis of Design Changes

The financial analysis of a development proposal and of changes in its design is undertaken on a spreadsheet. The residual valuation technique is adopted and both profit and land value residuals may be estimated. The developer’s profit is derived by assessing the end value of the scheme and then deducting the costs of producing it, including land costs, construction and finance costs and professional fees. The land value is derived by substituting a minimum developer’s profit for the land cost and then subtracting the costs associated with land acquisition, such as legal fees.

The structure of the spreadsheet mirrors that of the residual valuation method. There are separate sheets for land costs (based both on development value and on existing use value); construction costs (for site works and buildings); and the value of the scheme (covering both space for sale and rent, using unit price and rent/yield comparables, respectively, and applying specified net/gross ratios). The gross development value and the land and construction costs are then incorporated into an appraisal sheet that estimates the various finance costs and fees before calculating the developer’s profit (absolute and proportionate [percentage of total costs])

The traditional residual approach thus described has many shortcomings. The final result is dependent on the estimation of many variables that, because of site idiosyncrasies, requires the extensive exercise of expert judgement. Because of gearing, minor adjustments to key input variables can result in large changes to the residual. In order to mitigate these issues, data must be gathered and treated with caution. In addition, the traditional residual is, essentially, a cross-sectional approach. It does not deal with time. This causes some significant problems: finance costs can only be approximated; no indication can be given of the financial position during the development period; the method cannot deal with phased developments or with changes in variables during development (Isaac, 1996; Havard, 2008). Finally, the treatment of interest charges as development costs raises the question of how the developer’s profit should be interpreted (Crosby et al, 2008).

For these reasons, the spreadsheet incorporates a cash flow residual. This allows selection of the unit period and the definition of cash flow patterns for the costs and/or incomes associated with each element of the scheme (site works, [parts of] buildings and fees). Period-by-period, net terminal value and discounted cash flow calculations are performed. The internal rate of return (IRR) and the net present value (NPV) are the measures of return that are generated. There is also a facility for undertaking sensitivity analysis of the input scheme.

However, the novel aspect of the appraisal spreadsheet is its linkage to SketchUp – and, therefore, to Simmetry3d and the Rave studio - that allows the relation between design quality and development viability to be analysed3. The physical dimensions of the design are transferred from SketchUp into the first sheet of the spreadsheet. The 3 At the time of writing (June 2010), we were aware of only one other attempt to explore this link: the StrateGis Urban Developer software package (for information, see <>). This is based on SketchUp and provides financial and other analyses of project performance, although it is not linked to more sophisticated visualization systems. However, we have not yet been able to undertake a detailed technical comparison of the two approaches.