An unconditional price has to carry the planning risk; a conditional contract moves it to the landowner, and the gap between the two headline prices is far wider than the gap in what the landowner can expect.
Price land subject to planning by weighting what it is worth with consent and without it by the chance of getting consent, discounting over the planning period at a rate that reflects the risk, and deducting the planning costs you will spend at risk. On an illustrative site with a residual land value of 4,000,000 once consented, a 60 per cent chance of consent in 18 months and 300,000 of planning costs, the unconditional price today is 1,808,272. Under a conditional contract the developer can pay up to 3,383,381 on the grant of consent.
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 →
The residual appraisal gives a land value on the assumption that the scheme has consent. Before consent, the land is worth that figure only if planning is granted, and its existing use value if it is not. Who carries that risk decides the price. Buy unconditionally and the developer carries it, so the price has to be an expected value. Buy under a conditional contract and the landowner carries it, so the price can be close to the full residual, less only what the developer spends to get consent and the return it needs on that spend.
| Input | Value |
|---|---|
| Residual land value with consent, at the date of consent | 4,000,000 |
| Existing use value if refused | 500,000 |
| Probability of a satisfactory consent (judgement) | 60% |
| Planning period | 18 months |
| Planning costs, spent at risk at the start | 300,000 |
| Developer's required return on at-risk capital | 15% |
| Landowner's discount rate | 8% |
The residual already carries the developer's profit on the scheme. The 15 per cent is the return on money spent before anyone knows whether there will be a scheme, which is why it is higher than the cost of development finance.
1. Expected value at the decision date = 60% × 4,000,000 + 40% × 500,000 = 2,600,000.
2. Discount over 18 months at 15%: factor 1.151.5 = 1.2332, so 2,600,000 / 1.2332 = 2,108,272.
3. Less the planning costs: unconditional price = 2,108,272 − 300,000 = 1,808,272, 45.2% of the consented value.
4. Conditional: the developer pays the price only on consent but spends 300,000 either way. Break-even: 60% × (4,000,000 − C) / 1.2332 = 300,000.
5. C = 4,000,000 − 300,000 × 1.2332 / 60% = 4,000,000 − 616,619 = 3,383,381, 84.6% of the consented value.
Excel: =(p*RLV+(1-p)*EUV)/(1+r)^t-Costs and =RLV-Costs*(1+r)^t/p.
The deduction in the conditional price is the planning cost grossed up twice: once for time, from 300,000 to 369,971, and once for the chance of failure, to 616,619. Every successful application has to pay for the ones that fail.
| Offer | Headline price | Expected value today at 8% |
|---|---|---|
| Unconditional, paid now | 1,808,272 | 1,808,272 |
| Conditional, paid on consent; land kept if refused | 3,383,381 | 1,986,895 |
| Difference | +87.1% | +9.9% |
The conditional headline is 87.1 per cent higher; its expected value to the landowner is 9.9 per cent higher, and that is only because the landowner discounts at 8 per cent where the developer needs 15. Both offers are the same developer's maximum. A landowner comparing them on headline price is comparing a certain sum with a 60 per cent chance.
| Probability | Unconditional today | Conditional on consent | Conditional, owner's expected value |
|---|---|---|---|
| 30% | 956,854 | 2,766,762 | 1,051,373 |
| 40% | 1,240,660 | 3,075,072 | 1,363,214 |
| 50% | 1,524,466 | 3,260,057 | 1,675,054 |
| 60% | 1,808,272 | 3,383,381 | 1,986,895 |
| 70% | 2,092,078 | 3,471,470 | 2,298,735 |
| 80% | 2,375,883 | 3,537,536 | 2,610,575 |
| 90% | 2,659,689 | 3,588,921 | 2,922,416 |
The unconditional price moves almost in proportion to the probability; the conditional one barely moves, because the probability only scales the planning cost. That is the case for a conditional contract when planning is uncertain: the developer's judgement of the odds, which nobody can prove, matters far less to the price. Below a 13.9 per cent chance of consent, the unconditional price falls under the existing use value and no unconditional deal is possible at all.
Time works the same way. With 60 per cent odds, a 12-month planning period supports 1,960,870 unconditionally and a 3-year one 1,409,542; the conditional price only moves from 3,425,000 to 3,239,562.
The book's worked scheme, in which the appraisal comes in well below the conditional contract price already agreed, is in the free workbooks for this case; the residual itself is worked in how to calculate residual land value.
A purchase that completes only if a satisfactory planning consent is granted, with the price paid on completion. The developer carries the planning costs; the landowner carries the risk of refusal and keeps the land if it happens. On the illustrative site the developer can offer up to 3,383,381 on consent, against 1,808,272 unconditionally today.
Not by as much as the headline suggests. On the illustrative site the conditional price is 87.1 per cent higher than the unconditional one, but weighted by the 60 per cent chance of consent and discounted at 8 per cent over 18 months it is worth 1,986,895 to the landowner, 9.9 per cent more than the 1,808,272 paid today.
It moves the unconditional price almost in proportion and the conditional one far less. On the illustrative site, from a 40 to an 80 per cent chance of consent the unconditional price rises from 1,240,660 to 2,375,883, while the maximum conditional price moves only from 3,075,072 to 3,537,536.
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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