RESIDUAL METHOD OF VALUATION (NOVEMBER 2021)
RESIDUAL VALUATION OF LAND
Introduction
Residual valuation is the process of valuing land with development potential.
The sum of money available for the purchase of land can be calculated from the
value of the completed development minus the costs of development
(including profit).
The complexity lies in the calculation of inflation, finance terms, interest and
cash flow against a programme timeframe.
Development Costs
Development costs may include things such as:
 Building costs
 Professional fees
 Marketing and sales costs
 Financing
 Contingency
 Other ancillary costs
 Land acquisition costs
Building Costs
Building costs form the largest risk to the cost side of residual valuation.
MUWONGE RAPHAEL
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BY
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Class Hons) (MUK). Cert. IVS/IMSP (ISU). Cert. Land Tenure &
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In the UK, building cost information is published by organisations such as the
Building Cost Information Service (BCIS) every quarter (this is a subscriber only
service), giving details of historical cost information for a wide range of building
types.
This information is based on a national average of tender prices and is exclusive
of external works, fees and VAT. There are regional adjustments to be made
dependent on location. It is important to check whether cost information is based
on the gross external area, including common parts, or based on net lettable
areas. The difference can be as much as 20%.
Professional Fees
Design team and external project management fees generally vary from around
10% to 12%. Refurbishment and fit out fees are usually higher than new build
fees.
Other than standard design fees, ‘additional’ fees may be required for a wide
range of services, including:
 Landscaping
 Feature lighting
 Health and safety consultancy
 Acoustic consultancy
 Planning consultancy
MUWONGE RAPHAEL
STUDY NOTES
BY
M Sc. Management Science (IITC), B Sc. Land Economics. (First
Class Hons) (MUK). Cert. IVS/IMSP (ISU). Cert. Land Tenure &
Property Rights (USAID)
Research Fellow/Blogger/Real Estate
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RESIDUAL METHOD OF VALUATION (NOVEMBER 2021)
 Traffic modelling
 Interior design
 Site inspection
 Building Information Modelling (BIM)
 Environmental impact assessment
NB: Construction management fees are usually included as part of building costs.
Contingency
It is customary to apply a 5% to 7.5% contingency allowance based on estimated
building costs to allow for unforeseen circumstances and cost risks. Until
construction contracts are let, unforeseen risks can be mitigated by redesign, but
that flexibility is no longer easily available once construction contracts have been
placed.
Finance
Developers often use their own seed capital to fund the appraisal stage of
development, which might include any design work necessary to obtain a planning
consent.
However, with the appraisal and planning risks out of the way, terms for funding
loans are more advantageous and so they are likely to turn to banks or other
institutions to fund construction and perhaps the latter stages of design.
MUWONGE RAPHAEL
STUDY NOTES
BY
M Sc. Management Science (IITC), B Sc. Land Economics. (First
Class Hons) (MUK). Cert. IVS/IMSP (ISU). Cert. Land Tenure &
Property Rights (USAID)
Research Fellow/Blogger/Real Estate
Analyst/Valuer/Scholar
Mob: +256 704988430/+256 781437071
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RESIDUAL METHOD OF VALUATION (NOVEMBER 2021)
The agreed interest rate and draw down facilities will be encapsulated in the
funding or loan contract.
Interest rates might be fixed, variable and/or capped.
S-curves are used to predict expenditure in respect of cash flow against an
assumed programme.
Drawdown facilities (often on a quarterly basis) need to be more than sufficient,
and timed to meet contractor's monthly valuations. Often developers will base
residual value calculations on drawing down all construction and professional
payments by the two thirds stage of the building period to avoid any risk of
defaulting on payments.
Generally, 5% retention is kept from the contractor with half released at building
completion and the rest released at the end of a defects liability period.
The lender may wish to employ a professional team to carry out due diligence to
better understand project risk and police the loan agreement.
Marketing and Sales
Promotional marketing campaigns can cost as much as 1% of the development
value. Letting agents traditionally look for 10% of the first year’s rental income or
2% of sales revenue. On the major schemes there is an opportunity using
competition to negotiate these figures down.
MUWONGE RAPHAEL
STUDY NOTES
BY
M Sc. Management Science (IITC), B Sc. Land Economics. (First
Class Hons) (MUK). Cert. IVS/IMSP (ISU). Cert. Land Tenure &
Property Rights (USAID)
Research Fellow/Blogger/Real Estate
Analyst/Valuer/Scholar
Mob: +256 704988430/+256 781437071
Office Tel: +256 414 231302
RESIDUAL METHOD OF VALUATION (NOVEMBER 2021)
Other Ancillary Costs
Ancillary costs might include:
Void costs between building completion and achieving total rental income. This
might include: interest, insurance, rates, cleaning, maintenance, fuel, and
security.
Planning fees
Demolition and enabling works such as service diversions or site clearance.
Public consultations and exhibitions.
Planning conditions, planning obligations and the community infrastructure levy.
Third party fees, such as party wall surveyors or lawyers.
Topographical surveys.
Geotechnical investigation such as boreholes and trial pits.
Public utility charges.
Archaeology costs.
Site decontamination.
Legal costs on sales or leases.
Land Acquisition Costs
MUWONGE RAPHAEL
STUDY NOTES
BY
M Sc. Management Science (IITC), B Sc. Land Economics. (First
Class Hons) (MUK). Cert. IVS/IMSP (ISU). Cert. Land Tenure &
Property Rights (USAID)
Research Fellow/Blogger/Real Estate
Analyst/Valuer/Scholar
Mob: +256 704988430/+256 781437071
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RESIDUAL METHOD OF VALUATION (NOVEMBER 2021)
Land acquisition costs should include taxes and any compensation necessary to
achieve vacant possession.
Development Value
Gross development value is calculated by multiplying annual rent by the ‘year
purchase’ at a yield appropriate to the type of property proposed in a given
location. A rent of £500,000 and a yield at 7.5% provides a year purchase of 13.33
and so a capital value of £6,665,000.
Net development value is calculated by deducting purchaser’s costs such as
stamp duty and legal fees from the gross figure.
Other Considerations
Development Timescale
In calculating residual value a view has to be taken on how long the project is
going to take from the point of incurring costs to the time when the full projected
rental stream has been achieved, or sale is completed. The programme will have
an effect on all aspects of cost, including finance charges.
Large-scale speculative commercial and retail developments may suffer a
substantial void period before attracting tenants, and landlords sometimes offer
rent free periods to entice tenants into the building. In property market downturns
building development might only proceed with pre-letting agreements in place to
MUWONGE RAPHAEL
STUDY NOTES
BY
M Sc. Management Science (IITC), B Sc. Land Economics. (First
Class Hons) (MUK). Cert. IVS/IMSP (ISU). Cert. Land Tenure &
Property Rights (USAID)
Research Fellow/Blogger/Real Estate
Analyst/Valuer/Scholar
Mob: +256 704988430/+256 781437071
Office Tel: +256 414 231302
RESIDUAL METHOD OF VALUATION (NOVEMBER 2021)
avoid the risk of void costs and also reducing marketing costs.
Many larger projects can take far longer in the planning stages than in
construction. Terminal 5 at Heathrow Airport, which was subject to a public
enquiry, took thirteen years to get to the construction stage, but just four years to
build.
Discounted Cash Flow
Where costs and revenue are being incurred over a very long period it is usual to
prepare a cash flow business plan, mapping out income, expenditure and cash
flow position on a quarterly basis over the given period.
The cash flows are discounted back to the present rather than having interest
added. The income is projected alongside projections of rental growth and
discounted back to net present value (NPV) using an appropriate discount rate.
Providing NPV is greater than total development cost the scheme is considered
viable. The discount rate allows for a margin of profit reflecting the likely risks and
rewards.
PARRY’S VALUATION AND INVESTMENT TABLES
These tables are commonly used in valuations. They allow for either rental income
being received annually in arrears or quarterly in advance. The essential inputs
are:
MUWONGE RAPHAEL
STUDY NOTES
BY
M Sc. Management Science (IITC), B Sc. Land Economics. (First
Class Hons) (MUK). Cert. IVS/IMSP (ISU). Cert. Land Tenure &
Property Rights (USAID)
Research Fellow/Blogger/Real Estate
Analyst/Valuer/Scholar
Mob: +256 704988430/+256 781437071
Office Tel: +256 414 231302
RESIDUAL METHOD OF VALUATION (NOVEMBER 2021)
 Net income received
 The period over which net income will be received
 The required yield
 A good knowledge of the letting and investment market is required to
provide these inputs.
RISK MITIGATION
A sensitivity analysis should be carried out to highlight those variables with the
highest impact on the development appraisal. The revenue income is normally a
higher risk than the costs, the latter being slightly easier to predict than future
national and local property market movements.
A £2 per square feet difference in projected rent on a 100,000 square feet office
block has a significantly greater effect on calculations than the cost of unforeseen
ground obstructions or an increase in steel prices. From such analysis and an
assessment of the likelihood that the risk will occur, a mitigation strategy can be
developed.
Risks can be retained, shared, transferred or insured. As a general rule risk is
best placed with the party that has greatest ability to control it. For example,
ground risks might be placed with a contractor (albeit at a price). Incentives can
also be used, for example, target cost contracts can be used with both consultants
and contractors to share risk.
MUWONGE RAPHAEL
STUDY NOTES
BY
M Sc. Management Science (IITC), B Sc. Land Economics. (First
Class Hons) (MUK). Cert. IVS/IMSP (ISU). Cert. Land Tenure &
Property Rights (USAID)
Research Fellow/Blogger/Real Estate
Analyst/Valuer/Scholar
Mob: +256 704988430/+256 781437071
Office Tel: +256 414 231302
RESIDUAL METHOD OF VALUATION (NOVEMBER 2021)
Market risks can be mitigated by pre-selling at a discounted price. Joint ventures
and overage deals with land owners can also be adopted as a form of shared risk.
TOOLKITS FOR RESIDUAL VALUATION
Most developers have their own software for development appraisal with built in
formula that allow them to choose variables and undertake sensitivity analysis.
Assumption about interest rates, investment yields, and timescales can
significantly alter the outcome, as can the projected rent per square feet.
Furthermore the criteria can shift during the course of the project, for example, net
to gross calculations can only be fully determined when the design is complete.
MUWONGE RAPHAEL
STUDY NOTES
BY
M Sc. Management Science (IITC), B Sc. Land Economics. (First
Class Hons) (MUK). Cert. IVS/IMSP (ISU). Cert. Land Tenure &
Property Rights (USAID)
Research Fellow/Blogger/Real Estate
Analyst/Valuer/Scholar
Mob: +256 704988430/+256 781437071
Office Tel: +256 414 231302