Each affordable home loses sales revenue but also needs less profit and no marketing: net, the land value falls by a fixed amount per unit that the appraisal can measure.
Affordable housing reduces residual land value by a fixed amount per affordable unit: the revenue lost against a market sale, less the developer's profit and sales costs the unit no longer needs, divided down for land costs and land finance. On a fictional 80-unit scheme, each affordable home costs 73,850 of land value, so 30 per cent affordable halves the land value from 3,535,628 to 1,763,234. Against a 2,500,000 benchmark, the scheme can carry 17.5 per cent.
Worked in full in The Real Estate Development Manager by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
An affordable home sold to a registered provider at 55 per cent of market value loses 45 per cent of its revenue. The land value does not fall by that much, for two reasons. The developer needs a lower return on a unit that is pre-sold with no market risk, so less profit comes off the top. And the unit carries no agency or marketing cost. What remains is then shared with the costs of buying the land, because a lower residual also means less stamp duty, fees and interest on the land. The residual appraisal handles all three if it is set up correctly; the arithmetic below shows each piece.
| Input | Value |
|---|---|
| Units / market price a unit | 80 / 350,000 |
| Affordable transfer price, % of market value | 55% |
| Build cost a unit, same for both tenures | 170,000 |
| Professional fees / contingency, on build | 10% / 5% |
| Other statutory contributions | 600,000 |
| Sales costs, market units only | 2.5% |
| Developer's profit: market / affordable GDV | 20% / 6% |
| Finance rate / land acquisition costs | 7.0% / 6.8% |
| Benchmark land value (the owner's minimum) | 2,500,000 |
The margins and transfer price are illustrative; they vary by market, tenure and the provider buying the units.
| Line | Amount |
|---|---|
| Market GDV, 56 × 350,000 | 19,600,000 |
| Affordable GDV, 24 × 192,500 | 4,620,000 |
| Gross development value | 24,220,000 |
| Less sales costs, 2.5% of market GDV | −490,000 |
| Build, fees, contingency and contributions | −16,240,000 |
| Build finance: 16,240,000 × 7.0% × 2 years × 0.5 | −1,136,800 |
| Profit: 20% of 19,600,000 + 6% of 4,620,000 | −4,197,200 |
| Residual for land | 2,156,000 |
| Land value: 2,156,000 / (1.068 × 1.072) | 1,763,234 |
The blended profit is 17.3 per cent of GDV. With no affordable housing the same scheme has a GDV of 28,000,000, a residual of 4,323,200 and a land value of 3,535,628.
Lost revenue = 350,000 × (1 − 55%) = 157,500
Less profit no longer required = 20% × 350,000 − 6% × 192,500 = 58,450
Less sales costs saved = 2.5% × 350,000 = 8,750
Net cost to the residual = 90,300; to land value, 90,300 / 1.2228 = 73,850 a unit
Excel: =(Price*(1-TP) - (Price*PMkt - Price*TP*PAff) - Price*Sales) / ((1+LandCosts)*(1+Rate)^2)
Because build cost is the same for both tenures, the cost is linear: 590,798 of land value for every 10 points of affordable housing, 59,080 a point. That linearity is useful in a negotiation. Each extra affordable home asked for has a price, and it can be stated before the meeting.
| Affordable share | Affordable units | GDV | Land value | Per unit of scheme | vs no affordable | vs benchmark |
|---|---|---|---|---|---|---|
| 0% | 0 | 28,000,000 | 3,535,628 | 44,195 | 0.0% | 1,035,628 |
| 10% | 8 | 26,740,000 | 2,944,830 | 36,810 | −16.7% | 444,830 |
| 20% | 16 | 25,480,000 | 2,354,032 | 29,425 | −33.4% | −145,968 |
| 30% | 24 | 24,220,000 | 1,763,234 | 22,040 | −50.1% | −736,766 |
| 40% | 32 | 22,960,000 | 1,172,436 | 14,655 | −66.8% | −1,327,564 |
| 50% | 40 | 21,700,000 | 581,638 | 7,270 | −83.5% | −1,918,362 |
A GDV that falls 13.5 per cent between 0 and 30 per cent affordable takes half the land value with it, the gearing that runs through every residual. Solving for the share at which land value equals the 2,500,000 benchmark gives 17.5 per cent, 14 homes. A policy asking for 30 per cent would need a viability argument, or a better transfer price.
The transfer price is the other lever. At 45 per cent of market value, the 30 per cent scheme supports only 1,117,478 and the viable share falls to 12.8 per cent; at 65 per cent it supports 2,408,990 and the viable share rises to 27.6 per cent. Ten more points on the provider's offer buy about ten points of policy; ten fewer cost about five, because each affordable home then loses more.
The common mistake is to apply the market profit margin to the whole GDV, affordable units included. At 30 per cent affordable that takes profit to 4,844,000 and land value to 1,234,264, understating it by 528,970, and moves the viable share down from 17.5 to 13.5 per cent. The landowner sees a lower bid than the scheme justifies; the planning authority sees a viability case that overstates the burden. Either way the appraisal has charged a market risk premium on homes that carry no market risk. The opposite error, forgetting that affordable units still cost the same to build, is rarer but just as costly.
The residual method itself is set out in how to calculate residual land value, and a blank version is in the residual land valuation template. The Real Estate Development Manager runs its own residual with four stress tests and the two break-even numbers it says belong on the front page; the workbook is among the free companion files for the book.
Per affordable unit, take the revenue lost (market price less the transfer price), subtract the developer's profit and sales costs no longer required, and divide by one plus land acquisition costs and land finance. On the fictional scheme 157,500 of lost revenue, less 58,450 of profit and 8,750 of sales costs, leaves 90,300, which is 73,850 of land value per unit.
Usually a lower margin than on market housing, because the units are pre-sold to a registered provider with little sales risk. Illustratively 6 per cent of affordable GDV against 20 per cent on market GDV. Using the market margin on affordable units as well understates land value at 30 per cent affordable by 528,970 on the fictional scheme.
The share at which residual land value falls to the benchmark land value the landowner will accept. On the fictional 80-unit scheme with a 2,500,000 benchmark that is 17.5 per cent; if the registered provider pays 65 per cent of market value rather than 55, it rises to 27.6 per cent.
This article is one calculation from The Real Estate Development Manager. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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