Value Of Land

4th June 2015
Housing Market Note
Residential Research
THE VALUE OF LAND
A Leveraged Bet On House Prices?
Land is the fundamental ingredient in the construction of new homes. Many of the issues
limiting the rate of new home building can be traced back to the pricing and availability of
land for residential development.
Neal Hudson
Associate Director
07590 531150
[email protected]
@resi_analyst
The availability of development land is constrained by the planning system but also by other
factors. Land is generally an appreciating asset and many landowners’ price expectations
will be firmly set. Even if planning regulations were eased further, there are limited incentives
for landowners to sell at a faster rate than they are currently as that might compromise the
price they achieve. That is particularly the case where the land is already generating an
income through other uses.
Development land is typically valued using a residual approach with reference to comparable
transactions. A developer assesses what new build house price is achievable in that location
with reference to prices and sales rates in the second hand market and on nearby
comparable new build sites. At a very basic level (assuming no affordable housing, S106 or
CIL), multiply that new build house price by the number of homes to be built on the land and
you arrive at the gross development value (GDV) of the site. The underlying value of the land
is then the GDV less the cost of development and less an appropriate allowance for profit as
the formula opposite shows.
Residual Land Value
=
Gross Development Value
Development Costs
Profit
When in competition with other developers and assuming discipline on appropriate profit
margins, the winning bidder will typically be the one that pushes for a combination of the
highest new build price, the highest density (subject to planning) and the lowest build cost
(unless one offsets the other). With land typically bought up front, this approach sets the
target new build house price in stone. Developers will then only build and sell homes at the
rate dictated by market demand for this target new build price. It is through this mechanism
that the 10 to 1 ratio between overall housing market transactions and private housing starts
is thought to arise.
We can demonstrate the link between house prices and land values using a simple model. It
uses Nationwide new build house prices as a proxy for GDV and the only input. It is based
rd
on an old land buyer’s rule of thumb: land is 1/3 of GDV. Therefore the modelled land value
rd
is 1/3 of the house price. The volatility in land prices is accounted for by assuming that the
rds
remaining 2/3 (effectively costs and profit) are sticky and do not fall. Therefore land values
absorb the full impact of any falls in house price and the full benefit from any rises while
house prices are below their previous peak. The model output (red line) does a reasonable
job of tracing actual land values up until two years ago.
Fig 1 – Residential Development Land Values
110
Start of Help-toBuy Equity Loan
100
Index (2007 peak = 100)
90
80
70
Savills Greenfield
Land Index
60
50
Modelled Using New
Build House Prices
40
Valuation Office
Agency
(discontinued)
30
20
10
Source: Savills using VOA and Nationwide
Q1 2015
Q1 2014
Q1 2013
Q1 2012
Q1 2011
Q1 2010
Q1 2009
Q1 2008
Q1 2007
Q1 2006
Q1 2005
Q1 2004
Q1 2003
Q1 2002
Q1 2001
Q1 2000
Q1 1999
Q1 1998
Q1 1997
Q1 1996
Q1 1995
Q1 1994
Q1 1993
Q1 1992
Q1 1991
Q1 1990
Q1 1989
Q1 1988
Q1 1987
Q1 1986
Q1 1985
0
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4 June 2015
Housing Market Note
Other Factors
At first sight, the model’s output suggests that there is substantial room for uplift in land values.
However, the model is oversimplified by intention and the reality is more complex and varies by
local market. Calculating actual land values has to account for a mix of property use classes; a mix
of tenures; site remediation; infrastructure and CIL; affordable housing contributions; and other
costs. It will also include forecasts for rates of sale, house prices and construction costs. These will
then be balanced against the developer’s required rates of return. This all adds a degree of
uncertainty to the calculation.
Many developers and housebuilders will remain cautious despite the current strength of the new
build sales market. Housebuilders’ profit margins may be returning to pre-recession levels but
there are other potential economic, political and market risks that warrant some caution. Build cost
inflation and labour availability have been top of the constraints list recently and explain some of
the underperformance. The need to absorb CIL and the lower value of affordable housing will
continue to contribute to the gap between the model and actual land values in some markets. With
large scale Government support of the housebuilding sector through the likes of Help-to-Buy, there
will be political uncertainty created by the election cycle and a lack of long-term cross-party
strategic planning for the provision of new homes.
Our house view is more balanced and suggests that the full uplift in land values will only be
realised in markets with high housing demand and constrained land availability. There are
currently a relatively high number of consents coming through the planning system compared to
new housing starts although they are unevenly distributed across the country. Where starts exceed
planning consents, this could lead to increased demand for land and an associated rise in land
values. Thanks to the mechanisms detailed in this note, higher land values could then limit sales
rates in markets unable to absorb higher new build prices. This approach means that developers
and housebuilders will continue to build homes at a rate dictated by how fast they can sell them
based on the price they had to pay for the land. The need for more land to be released is apparent.
100
Planning delays
90
Land
availability/prices
80
70
Materials
availability
Development
finance
60
50
Labour
availability
40
30
20
10
Q1 2015
Q1 2014
Q1 2013
Q1 2012
Q1 2011
Q1 2010
Q1 2009
Q1 2008
Q1 2007
Q1 2006
Q1 2005
Q1 2004
Q1 2003
Q1 2002
Q1 2001
0
Q1 2000
Survey responses from
the HBF survey suggest
these issues are declining
in importance but remain
high relative to recent
years. The uncertainty
around future build cost
inflation will inevitably limit
land prices to some
degree.
Fig 2 – House Builder Production Constraints
% considering factor a 'major
constraint'
Planning issues will
always be a valid go-to
complaint for developers
but recent evidence
suggests that the
availability (and cost) of
materials and labour has
been a bigger constraint
over the last couple of
years.
Source: Home Builders Federation
ONS
Holmans
BCIS
Q4 2013
Q4 2011
Q4 2009
Q4 2007
Q4 2005
Q4 2003
Q4 2001
Q4 1999
Q4 1997
Q4 1995
Q4 1993
Q4 1991
Q4 1989
Q4 1987
Q4 1985
Q4 1983
Q4 1981
Q4 1979
BIS
Q4 1977
The relationship has
resumed post recession
and the recent house
price rises have been
matched by increases in
build costs.
Nationwide
New Build
House Price
Q4 1975
That relationship broke
down between 2001 and
2007 when house price
inflation substantially
outpaced build costs.
160
150
140
130
120
110
100
90
80
70
60
50
Q4 1973
Prior to 2001, indicators
for build costs suggest
that they generally
matched the trend in
house prices.
Real price indices (Q4 2001=100)
Fig 3 –Build Costs Compared to Nationwide New Build House Price
Source: Nationwide, Holmans, BIS, ONS, BCIS
2
th
4 June 2015
Housing Market Note
Care should be taken in
reading too much into any
single year given the data
collection periods.
London
Cambridge
30%
25%
Oxford
20%
15%
Sevenoaks
Reading/Bracknell
10%
Milton Keynes
5%
UK
Norwich
0%
Lincoln
-5%
-10%
-60%
60%
Telford
-40%
-20%
0%
Land value change from 2007 peak
20%
40%
Source: HM Land Registry, Savills
Fig 5 – Land Values & Housebuilding – 1892 to 1969
£1,000,000
450,000
400,000
Housebuilding
(rhs)
350,000
£100,000
300,000
Commercial
250,000
£10,000
200,000
Industrial
Residential
£1,000
150,000
100,000
Agricultural
£100
Annual housebuilding
The substantial premium
for commercial land
across the period and the
divergence in value
between residential and
agricultural land from the
1930s are both interesting
features and reflect the
importance of location in
land values.
35%
50,000
0
1890
1894
1898
1902
1906
1910
1914
1918
1922
1926
1930
1934
1938
1942
1946
1950
1954
1958
1962
1966
1970
Although not directly
relevant to the above
analysis, the chart
opposite shows the trend
in land values between
1892 and 1969.
40%
House price change from 2007 peak
There are exceptions that
highlight local approaches
to development and land
release. Cambridge has
seen similar or higher
house price growth than
other markets yet land
values are lower relative
to peak. This reflects the
local approach where
more land has been made
available, including some
from the Greenbelt, and
there is clarity on the level
of affordable housing
required.
Fig 4 – Development Land Value & House Price Change From 2007 Peak
Price per acre (log)
The performance of local
land values since the
market peak in 2007
broadly reflects the
underlying performance of
the local housing market.
Source: Bank of England, EA Vallis, Estates Gazette (1973), DCLG
Previous Issues
Peak Loneliness
http://sav.li/43c
Size Matters
http://sav.li/3z8
Housing Delivery
http://sav.li/3wo
Pension Reform
http://sav.li/3ul
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