CITY OF LONDON LOCAL DEVELOPMENT FRAMEWORK CORE STRATEGY: DELIVERING A WORLD CLASS CITY AFFORDABLE HOUSING VIABILITY STUDY

Transcription

1 CITY OF LONDON LOCAL DEVELOPMENT FRAMEWORK CORE STRATEGY: DELIVERING A WORLD CLASS CITY AFFORDABLE HOUSING VIABILITY STUDY MAY 2010

2 CONTENTS PAGE EXECUTIVE SUMMARY 4 1 INTRODUCTION 5 2 METHODOLOGY 8 3 THE APPRAISAL EXERCISE KEY INPUTS TO VIABILITY ASSESSMENTS 10 IN THE CITY OF LONDON 4 APPRAISAL OUTPUTS 14 5 COMMUTED SUMS 19 6 CONCLUSIONS AND POLICY RECOMMENDATIONS 20 2

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4 EXECUTIVE SUMMARY This report tests the ability of a range of housing development sites throughout the City of London to deliver affordable housing to inform the development of affordable housing policy in the City of London Core Strategy. The study has been undertaken in accordance with the requirements of Planning Policy Statement 3 (Housing). It uses the GLA s Affordable Housing Development Control Toolkit (the Three Dragons Model) to assess the residual valuation of a range of typical housing schemes, assuming varying levels of affordable housing. The results provide guidance on the overall scale of affordable housing that can economically be provided through private sector housing development in the City of London. The Study considers the impact of affordable housing provision, at levels of 30%, 40% and 50%, on the residual value of housing developments of 10, 25 and 60 units within the City of London. It considers the impact of affordable housing provision on both new build schemes and those involving the change of use to residential. The City of London is the world s leading international financial and business services centre. As such the land use planning priority is ensuring that there is sufficient office space to retain the City s world leading position. The residential market in the City is small and largely concentrated in small clusters close to the City s boundaries. New residential development is located primarily within and close to these clusters, but still has to compete for sites with office and other development. Consequently, the residual values derived from residential development are compared against an alternative use value for offices. Following ten years of growth, the housing market throughout the United Kingdom is currently experiencing a severe correction with values falling in London by around 20% to 25% below their 2007 peak. The City of London is setting its affordable housing policy in its Core Strategy for a period up to 2026, during which market conditions will improve. The Study, therefore, includes some sensitivity testing, which assesses the implications of increases in residential values of 5%, 10% and 15%, alongside equivalent percentage increases in office land values. The result of the analysis demonstrate that there is consideration variation in the impact of affordable housing, depending upon the size of the scheme and whether it is delivered through new build or the change of use/conversion from another use. Taking account of a range of variables, the modelling suggests that on-site affordable housing at a minimum of 30% should be viable and, in some circumstances, a level above 30% could be viable. The results also indicate that it is unlikely that a reduction in the affordable housing threshold below the current 10 units will yield an increase in affordable housing supply, as developments at less than 10 units are unlikely to be viable. 4

5 1:. Introduction As part of the preparation of the Local Development Framework for the City of London an Affordable Housing Viability Study (AHVS) has been undertaken. The aims of the study are summarised as follows: a. To test the impact upon the economics of residential development of provision of affordable housing at the strategic affordable housing target of 50% set out in the 2008 London Plan. b. To test varying affordable housing percentages between 30% and 50%; c. To test the impact of affordable housing provision on typical residential development sites in the City of London; d. Consider the impact of changes in future values and costs on the deliverability of affordable housing. In terms of methodology, the study adopted standard residual valuation approaches to make appropriate comparisons and evaluations. The assessment was undertaken using the GLA s Affordable Housing Development Control Toolkit (the Three Dragons Model). However, due to the extent and range of financial variables involved in residual valuations, the results can only ever serve as a guide and a starting point for negotiations. In considering individual proposals, account must be taken of individual site characteristics and schemes will need to be considered on a site by site basis. 1.1 Policy Context National planning policy, set out in Planning Policy Statement (PPS) 3, makes clear that local authorities, in setting policies for the percentage of affordable housing sought must consider development economics and should not promote policies which would make development unviable. Paragraph 29 of Planning Policy Statement 3 (PPS 3) states that: In Local Development Documents, Local Planning Authorities should set an overall (ie plan-wide) target for the amount of affordable housing to be provided. The target should reflect the new definition of affordable housing in this PPS. It should also reflect an assessment of the likely economic viability of land for housing within the area, taking account of risks to delivery and drawing on informed assessments of the likely levels of finance available for affordable housing, including public subsidy and the level of developer contribution that can reasonably be secured. The application of paragraph 29 of PPS3 was tested in the Blyth Valley case (Blyth Valley Borough Council vs Persimmon Homes (North East) Limited, Barratt Homes Limited and Millhouse Developments Limited, Council Case number C1/2008/1319) which concluded that local planning authorities cannot rely on housing needs surveys alone in setting their affordable housing targets and should undertake viability assessments. The City of London Core Strategy policies must also be in general conformity with the London Plan. Policy 3A.9 of the 2008 London Plan requires local planning authorities to have regard to the London-wide affordable housing target of 50%. Draft Replacement London Plan (2009), Policy 3.12, seeks to maximise affordable housing provision, with targets being set locally to achieve this aim. The Draft Replacement Plan requires an affordable housing split of 60/40 (social rented:intermediate) to meet housing needs. The 5

6 Mayor s Interim Housing Supplementary Planning Guidance (2010) offers further guidance on the interpretation and implementation of the London Plan s housing policies and advises that affordable housing targets should be set based on need, capacity and deliverability. There is an acceptance from the Mayor that the 50% target in the London Plan is not a percentage that all local authorities must achieve on every site but rather a strategic Londonwide target for the region as a whole. In 2009, the Mayor agreed a three year target for the provision of affordable housing, which requires the delivery of 20 affordable homes within the City and 30 on sites outside of the City. The City of London is among the most expensive places to live in the country due to its position as the world s leading international financial and business centre. It is approximately one square mile in size and is predominately in office use, with housing occupying a small proportion of land (approximately 5%). Development costs are very high and it is therefore expensive to develop affordable housing. The City of London Unitary Development Plan 2002 and the draft Core Strategy place primacy on the use of land in the City for office development to maintain the City s role as the world s leading international financial and business centre. The City does not allocate land for particular uses as is common practice in most other local authorities. All housing sites are windfall sites and proposals must compete with alternative land uses, principally office use. The London Plan generally requires mixed use development, but within the strategically important cluster of business activity in the City, it promotes the concept of housing swaps or credits, whereby primacy is given to office development, with the off-site provision of housing and affordable housing elsewhere as part of a planning agreement. The 2008 London Plan requires the City of London to provide an additional 90 dwellings per year, against a residential stock of approximately 6,200 at April Within the City, planning policy seeks to concentrate housing development within broad clusters, generally on the City boundaries, with affordable housing usually provided in out of-city schemes. Funding for affordable housing comes principally from s106 planning obligations negotiated on commercial development in the City, with relatively small amounts coming from obligations on market housing schemes. The scale of contributions required from commercial developers is set out in the City of London s 2004 Planning Obligations Supplementary Planning Guidance. The SPG allocates 30% of planning obligations provided through commercial development to fund affordable housing schemes. The funding generated by commercial development and the small number of market housing schemes in the City funds affordable housing schemes in neighbouring boroughs in return for nomination rights to a number of units. 1.2 Development Context Developments in the City are diverse, ranging from the small scale conversion of redundant office space to residential tower blocks. This diversity reflects the mix of sites in the City where conservation and height restrictions apply and the existing urban grain is retained. Due to the small size of the City the appraisal assumes sales values and land values are constant across the City. In undertaking the appraisal, account has also been taken of past trends in the provision of housing in the City. The majority of new housing has been delivered on sites of under 10 units. Between 2007 and 2009, 75% of housing sites completed or with outstanding permission, were of 10 dwellings or less. Although there have been examples of larger scale housing developments, these are very few in number and not generally characteristic of housing development in the City. 6

7 Furthermore, given that the majority of new housing developments are small in scale, most take place through the conversion of existing properties, rather than through new build. The small number of new build schemes in the City tend to be larger schemes. Both the City of London UDP and the emerging Core Strategy seek to concentrate new residential development in existing clusters, generally on the City s boundaries. For the purposes of this study, it has been assumed that this policy position will be retained and that most new residential development over the period to 2026 will be provided in, or close to, existing clusters and that schemes will be wholly residential rather than mixed use. Although there is a presumption that development in the clusters will be residential, the office- based nature of the City is such that any schemes will need to be considered against the alternative use of the site for offices. Values for such alternative uses are set out later in this document, but office values have been assumed towards the bottom end of the current market. The exception is for schemes of 60 units which are likely to be new build and provided on sites that could deliver substantial amounts of office accommodation. Such sites are therefore likely to attract higher potential office values. 1.3 Economic and housing market context Following a ten-year trend of growth in the housing market, house prices reached a peak in the second half of 2007 and the market has now entered a period of correction. This correction of values gathered momentum during 2008, with the main commentators all reporting falls in values. The Halifax house price index showed an annual fall of 16.2% by the end of Similarly, the Nationwide showed an annual fall in prices of 15.9%. Prices of new build properties have fallen much further, with falls of up to 40% from peak 2007 values. The housing market has continued to be weak during 2009 and the early parts of 2010, but there are signs that the market is improving, with some indications that prices in parts of London had recovered to 2007 levels in early These price rises seem to reflect some easing in the availability of credit in recent months, the return to profitability of some sectors of the financial services industry and a shortage of supply as demand grows. Land Registry figures for the City of London show prices increased by just over 13% between the 1 st quarter of 2009 and the 1 st quarter of However, some caution needs to be attached to these figures, since they are based on a very small number of transactions. 7

8 2: Methodology This study uses the Three Dragons Model Toolkit to provide an assessment of the economics of residential development. This allows testing of the economic implications of different types and amounts of planning obligation and, in particular, the amount and mix of affordable housing. It uses a residual valuation appraisal approach which is the industry accepted approach. The Toolkit compares the potential revenue from a site with the potential costs of development before a payment for land is made. In estimating the potential revenue, the income from selling dwellings in the market and the income from producing specific forms of affordable housing are considered. The estimates involve (1) assumptions about how the development process and the subsidy system operate and (2) assumptions about the values for specific inputs such as house prices and building costs. These assumptions are set out in Section 3. The Toolkit used is the 2008/9 version. Where feasible, toolkit benchmark values for the City of London have been used. The exceptions are values for interest rates and house prices, which both reflect 2010 values, profit levels for housing developers, which reflect typical values currently used by developers and the higher level of risk inherent in the industry in current market conditions, and build costs for changes of use/conversion. 2.1 The Approach to Financial Viability The methodology can be summarised by the following equation: Completed Development Value minus Total construction costs minus Developer s profit equals Residual land value The Residual Land Value represents the sum potentially available to the developer for site purchase. It must be compared with existing or alternative land use values and, theoretically, if a proposal generates a sufficient positive value, it will be implemented. If not, the proposal will not go ahead, unless there are alternative funding sources to bridge the gap, such as affordable housing grant funding from the Homes and Communities Agency or a regeneration body such as the London Development Agency. Recent appeal decisions suggest that viability appraisals should be based on current values and costs (i.e. at the time of appraisal for policy, or the time of application for individual schemes), rather than values and costs at completion. Nevertheless, the appraisal methodology can only ever be a broad guide to viability. Policy based assessments, in particular, cannot take on board site specific costs and revenues. Key difficulties include: 8

9 Residential sales values are largely dependent on comparable evidence which requires sufficient new development in the locality of a similar size and type, to provide a realistic value base. The small size of the City and low annual levels of residential development (the London Plan requirement is for the City to provide an additional 90 dwellings per year), together with the current uncertainty in the residential market mean that any assessment of values must be based on a relatively small sample and, principally, a sample based on the second hand rather than the new housing market. Development costs: the convention in policy based viability studies is to use generic development cost values, normally from the Building Cost Information Service (BCIS), and based on national and local monitoring of trends. This presents difficulties for the City due to the small size of its residential market and new build residential programme. Although benchmark values are available it is difficult to say how accurately they reflect the specific costs within the City. Since all development in the City is on previously developed land, there will be additional costs, for example for demolition and archaeological investigation, which will vary substantially according to individual site characteristics. Finally, most new residential development in the City is through the conversion or change of use of existing properties. Such costs are very difficult to determine on a generic basis as much will depend on the nature of the existing building and the standard of construction used in the new residential accommodation, but generally they will be lower than new build. Viability assessments present information at a given point in time, yet policy looks forward often 15 to 20 years in the future. To ensure that policy based appraisals provide a robust assessment of viability going forward, it is necessary to undertake some form of sensitivity testing. There are a wide range of variables that can change over time, but the principal concerns are changes in residential sales values and changes in existing or alternative land values. It is likely that as the economy recovers from recession, not only will residential sales values increase, but also office rents and land values will also increase. It is impossible to predict which of these variables will be strongest, reinforcing the need for assessment of schemes on a site by site basis within the broad parameters set by policy. 9

10 3: The Appraisal Exercise Key Inputs to Viability Assessments in the City of London 3.1 Notional Development Sites Seventy five percent of new residential development since 2007 has come forward on sites of 10 or less dwellings, within a context of a policy requirement of 90 additional dwellings per year. There are consequently few sites coming forward in the City above the 10 dwelling threshold to provide a basis for the detailed assessment of notional or typical development sites. However, an analysis of completions and permissions in the City suggests that, for the purposes of setting policy, it would be appropriate to examine the implications of affordable housing provision on 3 different site typologies: 10 units 25 units 60 units. In addition, the study has assessed the implications of affordable housing provision on a site of 5 dwellings to determine whether there is scope to reduce the current policy threshold of 10 dwellings. 3.2 Affordable Housing Percentage Requirements The study has looked at a the viability of continuing to require 50% affordable housing as set out in the 2008 London Plan, as well as lower levels at 30% and 40%. 3.3 Affordable Housing Tenure Mix The study has considered an affordable housing mix of 70:30 social rented:intermediate housing, in line with the findings of the City of London Housing Needs Study 2004 and the City of London Affordable Housing Strategy This mix is also in line with broad guidance in the 2008 London Plan. The draft Replacement London Plan 2009 indicates the Mayor s desire to see the affordable housing tenure mix across London as a whole change to 60:40 social rented:intermediate. The City of London is working with the East London Housing Partnership to prepare a Sub- Regional Housing Market Assessment (SHMA) which will provide updated housing need figures for the City and suggest an appropriate tenure mix. The final SHMA report was not available at the date of this study (May 2010), but initial findings suggest that the overall level of housing need in the City, and the tenure breakdown of this need, has not altered significantly from the 2004 study. Consequently, the City of London considers that the appropriate tenure mix should remain at 70: Residential Sales values: Residential sales values in the City fell during 2008 and 2009, although there are now signs that prices are beginning to recover. The small size of the residential market in the City of London means that there is limited information on new build housing costs available. Further, a number of the more recent new build schemes have been of a high specification, seeking to achieve values well in excess of typical values on the second hand market. It is therefore difficult to identify robust evidence of new residential values in the City. There is, however, a much higher level of second hand transactions and more reliable and robust data on second hand sales values. Values have therefore been based on average second hand values being sought within the City of London at March 2010, as advertised on the Rightmove website. These figures have then been inflated by 10% to provide a new build premium. Values are all for flatted accommodation, rather than housing, reflecting the predominance of this type of accommodation within the City. 10

11 Table 1: Residential Sales Values 2nd hand New Build Studio/bedsit 280, ,000 1 bedroom 360, ,000 2 bedrooms 530, ,000 3 bedrooms 1,100,000 1,100,000 Source: Rightmove. NB: New build price = 2 nd hand price x 10% - rounded to nearest 10k 3.5 Residential Density Residential densities in the City are very high as the majority of housing schemes are multistory with no outdoor space or car parking provided. In this appraisal densities between 909 and 1200 dwellings per hectare have been used to reflect the average residential densities which have occurred in the City in recent years. The appraisal assumes that developments will take place either in, or close to, existing residential clusters and will be purely residential with no mixed uses. 3.6 Base construction costs (New Build): The appraisal uses a base construction cost ranging from 1,764 per sq m for new build low story flats to 2,402 per sq m for higher rise flats. These figures are benchmark figures provided by the Three Dragons model for the City of London for 2008/9. Since this period, BCIS reports that build costs fell slightly in 2009 and there is expected to be a small increase in 2010/11 1, suggesting that the 2008/9 benchmark figures remain valid. Information from the City of London Surveyor s Department also indicates that the benchmark figures are also broadly in line with current build costs. 3.7 Base construction costs (Conversion) The Three Dragons model does not provide benchmark figures for base construction costs for conversion of properties to residential, noting that such costs may need to be assessed on a site by site basis. Much of the residential development in the City is in the form of conversions, so it is necessary to use specific, City of London, figures. The City of London Surveyors Department considers that build costs for conversions are approximately 15% below base costs for new build. For the purposes of this assessment, therefore, costs of 1,499 per sq m for under 5 storey schemes, and 2,042 per sq m for schemes over 5 storeys have been assumed. 3.8 Contributions from Planning Obligations Unlike most other boroughs in London, the City does not seek planning obligations from residential developments for community facilities. Obligations which may arise from residential development are negotiated on a site by site basis. However, the City does require a contribution towards archaeological investigations to be carried out where it is believed there is archaeological potential underneath the site. Although the level of this contribution will be determined on a site specific basis, a cost of 1,000 per scheme has been assumed in the appraisal. 3.9 Exceptional Development Costs Exceptional development costs include the cost of building to Lifetime Homes standard and Code for Sustainable Homes level 4 (which affordable housing will have to achieve from 2012). 1 BUILDING COSTS UPDATE, QUARTER , GVA GRIMLEY 11

12 A number of studies have looked at the costs of building to Lifetime Homes standards, concluding that costs range from 545 to 1,615 per dwelling 2. For this purposes of this assessment, it has been assumed that costs will be approximately in the middle of this range, i.e. around 1,000 per dwelling. The Department for Communities and Local Government has published research in to the costs of delivering the various code levels for Sustainable Homes, providing figures for the additional cost over base 2006 building regulations. This research suggests that, for flats, the additional cost of achieving Code Level 4 would lie in the range of 5,500 to 6, For the purposes of this study, a cost in the middle of this range of 5,900 per dwelling has been assumed Developer s profit For a developer to bring a site forward a reasonable assumption must be made of the return to the developer on his investment in the scheme, i.e. profit. Within standard residual valuation models, including the Three Dragons model, profit is treated as a legitimate cost on the development. Developer profits are based on an assumed percentage on gross development value. The level of profit is closely correlated with the perceived risk of residential development - the greater the risk, the greater the profit level necessary to mitigate against this risk and to make the scheme sufficiently attractive to external funders. In 2007, profit levels were generally assumed to be in the range of 15% to 17% of Gross Development Value. However, with the impact of the credit crunch and the collapse of interbank lending and the various government bailouts of the banking sector, profit margins have increased. The minimum generally acceptable profit level is now around 20%, while the banks will require some riskier schemes to show a higher profit level, of perhaps up to 25%. For the purposes of this appraisal, a level of 20% has been assumed Affordable Housing Values Affordable housing values are the amount that a Registered Social Landlord would be prepared to pay for a completed unit of affordable housing. Due to the City s small housing market and high land values, most affordable housing schemes have been developed with no social housing grant to date. This appraisal therefore assumes no social housing grant is available Existing Use Value / Alternative Use Value Existing Use Value / Alternative Use requires particular attention as there is a point where the Residual Land Value that results from the development appraisal (the amount available to the developer for land purchase) may be less than the land s existing or reasonable alternative use value. Subject to planning permission, the potential development site may be capable of being used in different ways business rather than residential for example or a different mix of uses. The City of London is the world s leading international financial and business centre and offices are the primary land use within the City. Planning policy in the emerging Core Strategy retains this primary focus on office use, providing for an additional 1,500,000 sq m of office floorspace over the period to Consequently, any development in the City must be appraised against the potential for the alternative use of the site for office accommodation. Information from the City of London Surveyors Department suggests that, at March 2010, average office values ranged between 1,200-2,000 per sq ft COST ANALYSIS OF THE CODE FOR SUSTAINABLE HOMES, CLG, JULY

13 In using this figure within appraisals, it has been assumed that alternative office values will be at the lower end of this scale for smaller sized residential schemes (under 25 units). Such schemes are most likely to be located within existing residential clusters where the opportunity for office development will be less and will need to consider the potential impacts on residential amenity. For schemes over 25 units, a level of 1,600 per sq ft has been assumed, reflecting the fact that such sites are more likely to be on the edge of residential clusters or in established office areas, where competition from office uses will be greater Interest Rate In bringing forward development, a developer will typically borrow funding to cover development costs over the period of construction and sales, incurring an interest charge. Historically, appraisals have used an interest rate based on the Bank of England Base Rate plus 2%, or the 3 month Libor Rate plus 2%. However, even though the base rate is at an historically low figure of 0.5%, the perceived risk in lending to residential developers and the generally tight credit markets following the recession of 2008/9, means that interest rates charged are significantly above this figure. Actual rates will vary quite widely from developer to developer, depending on the perceived level of risk and the financial status of the developer, but for the purposes of this study, a figure of 7% has been assumed, based on advice from the City of London Surveyors Department and evidence from affordable housing viability appraisals undertaken elsewhere in London to support policy during 2008 and Residential Unit Sizes The residential unit sizes adopted in this study are based on the benchmark figures given in the Three Dragons model and experience of the size of dwellings provided in the City of London. The sizes adopted do not include the very small, or micro, units that have been provided in some parts of the City in recent years, but rather reflect the minimum sizes generally required by the Homes and Communities Agency for affordable housing: Studio/bedsit (30 sq m) 1 bedroom (46 sq m) 2 bedroom (66 sq m) 3 bedroom (86 sq m) 3.15 Housing Mix The mix of residential units within the modelling has been determined by reference to the requirements identified in the City of London 2004 Housing Needs Survey and 2006 Affordable Housing Strategy, and evidence from planning applications over the past 3 years, about the sizes of private residential units provided. The mix used is: Studio/bedsit 25% 1 Bed 50% 2 Bed 15% 3 Bed 10% 3.16 Other Costs, Values, Fees etc For other costs and values, benchmark figures provided by the Three Dragons model for the City of London have been used. 13

14 4: Appraisal Outputs The modelling has been based on a number of assumptions about likely revenues and costs. In general, it is assumed that if the residual value of a particular scheme exceeds the reasonable alternative use value, then the scheme will be viable and will, in principle, proceed. The modelling is intended to give a broad indication of viability to provide the basis for policy setting. Individual development schemes should be assessed against a bespoke viability assessment which can cover the values and costs applicable to a specific site and a specific developer. 4.1: 10 Unit Scheme Figure 1 summarises the results of the viability modelling for a 10 unit residential scheme in the City, comparing the residual value of schemes at varying levels of affordable housing requirement and for conversion and new build schemes. Figure 1: Residual Value 10 unit residential scheme, City of London 300, , ,000 Residual Value ( ) 0-100, ,000 Conversion New Build -300, , ,000 30% 40% 50% Affordable Housing % The modelling suggests that up to 40% affordable housing could be viable in a conversion scheme, but that affordable housing at percentages much above 30% for a new build scheme would not be viable. 14

15 4.2: 25 Unit Scheme Figure 2 summarises the results of the viability modelling for a 25 unit residential scheme in the City, assuming the same affordable housing percentages as for the 10 unit scheme and comparing conversion and new build. Figure 2: Residual Value 25 unit residential scheme, City of London 400, ,000 0 Residual Value ( ) -200, , , ,000 Conversion New Build -1,000,000-1,200,000-1,400,000 30% 40% 50% Affordable Housing % The modelling suggests that affordable housing provision at 30% would only be viable on a 25 unit scheme which involved the conversion or change of use of an existing building. Above an affordable requirement of 30%, conversion schemes of 25 units would not be viable. The additional costs incurred in new build schemes suggests that a requirement for 30% affordable housing would render the scheme unviable. 15

16 4.3: 60 Unit Scheme Figure 3 summarises the results of the viability modelling for a 60 unit residential scheme in the City. The opportunities to develop a larger scheme of this size within existing residential clusters is limited in the City. A scheme of this size is more likely to be provided close to existing clusters on a site in direct competition with office floorspace. Consequently, it is assumed that such a site would attract a higher alternative use value than the smaller sites considered above. For the purposes of this modelling, therefore, an alternative site value of 1,600 per sq ft has been assumed. Figure 3: Residual Value 60 unit residential scheme, City of London 1,500,000 1,000, ,000 0 Residual Value ( ) -500,000-1,000,000-1,500,000-2,000,000 Conversion New Build -2,500,000-3,000,000-3,500,000 30% 40% 50% Affordable Housing % The modelling shows that, for a larger residential scheme in the City, affordable housing provision at 30% is only viable where it is delivered through the conversion or change of use of an existing building. However, given the overall scale of the expected values from a scheme of this size (overall residual value is estimated at 8.5m), it is possible that a developer would proceed with a new build scheme, with 30% affordable housing, even though the modelling suggests a marginally negative value against potential office use. 4.4 Sensitivity Testing The viability modelling undertaken has been based on values and costs at March The intention is that policy derived from this modelling work will provide guidance for the period up to 2026, during which time there will be fluctuations in the values and costs of residential development, fluctuations in the values and costs of alternative office development, changing housing need requirements and affordability requirements, as well as changes in the costs and availability of development finance. It is not possible to model the potential implications of all the permutations in values and costs, but some sensitivity testing has been undertaken to look at the potential implications of changes in house prices and changes in alternative office values upon the viability of affordable housing provision. 16

17 Figures 4 and 5 illustrate the implications of varying sales values by 5%, 10% and 15%, and varying office land values by similar proportions on a scheme of 25 residential units involving a change of use to residential. Figure 4: 25 unit conversion scheme, 30% affordable housing % increase in office land value Viable Viable Not Viable Not Viable % increase in residential sales value 5 Viable Viable Viable Not Viable 10 Viable Viable Viable Viable 15 Viable Viable Viable Viable Figure 5: 25 unit conversion scheme, 40% affordable housing % increase in office land value Not Viable Not Viable Not Viable Not Viable % increase in residential sales value 5 Not Viable Not Viable Not Viable Not Viable 10 Viable Viable Not Viable Not Viable 15 Viable Viable Viable Not Viable Generally, the figures indicate that increasing residential sales values have a positive effect on overall scheme revenue, bringing previously unviable schemes into a viable position. Thus, increasing residential values by 10% or 15% will mean that it would be possible to deliver 40% affordable housing on a 25 unit conversion scheme, whereas currently such a scheme would not be viable. Increases in office land values have the opposite effect, making residential schemes with an affordable housing element less viable. Thus, an increase in office land values of 10%, would render unviable a conversion scheme with 30% affordable housing. The analysis suggests that the viability of residential schemes is much more sensitive to changes in residential sales values than changes in office land values and that a return to a prolonged period of high house price inflation would make the provision of higher proportions of affordable housing viable within the City. 17

18 There are inherent difficulties in predicting changes in values over the period to Changes in values also have to be considered alongside changes in other modelling variables. For example, higher rates of house price inflation are likely to be accompanied by higher interest rates to counter inflationary pressures which, in turn, will depress the residual value of residential development. This serves to highlight the need for bespoke development appraisals to be undertaken for individual schemes, which can reflect the economic and other market conditions at the time of application as well as any specific abnormal development costs. 4.5 Impact of Affordable Housing on Schemes of less than 10 units A significant proportion of new housing development in the City is provided on sites of less than 10 units. Monitoring suggests that up to 75% of new residential units come forward on these smaller sites. Within this total, a further substantial proportion is delivered through schemes of 1 or 2 units. To test the impact of affordable housing on smaller sites, a series of appraisals have been run assuming a site size of 5 units. Experience suggests that such schemes are principally the result of a change of use of small office units into residential, often outside of the defined residential clusters. The results of the appraisal indicate that provision of affordable housing at 30% on sites of 5 units in the City would not be viable, with the residual value potentially achievable from such a scheme being nearly 10% below the alternative use value for offices. To deliver affordable housing on sites of this size, then the policy will need to be set at a lower level of 20% or less. Provision at this level is, in turn, likely to incur much higher management and maintenance costs and may not be economic for an RSL to maintain on an ongoing basis. 18

19 5: Commuted Sums As a general principle the City recognises that seeking on-site provision of affordable housing is desirable. This position is consistent with national guidance in Paragraph 29 of PPS3 which states: In seeking developer contributions, the presumption is that affordable housing will be provided on the application site so that it contributes towards creating a mix of housing. However, where it can be robustly justified, off-site provision or a financial contribution in lieu of on-site provision (of broadly equivalent value) may be accepted The Mayor s Interim Housing SPG (April 2010) suggests that off-site provision may be acceptable in the boroughs in the Central Activities Zone if it would provide more units than is possible on the principal site, or where on-site provision would compromise broader planning objectives such as securing strategically important clusters of economic activities. In negotiating commuted sums in-lieu of on-site provision of affordable housing, the City currently seeks a contribution of 151,584 for each unit of affordable housing required. This figure is based on the previous Housing Corporation Total Cost Indicator for the City, adjusted for inflation. It is an indicative figure, subject to review in the light of inflation and costs of provision of affordable housing in and around the City. The viability modelling which underpins the Core Strategy on-site affordable housing requirement can also be used to calculate the appropriate level of affordable housing which should be provided off-site. In making this calculation, the City has taken into consideration the increased return to any housing developer, in the form of a greater number of market units and higher residual value that will accrue from not providing affordable housing on site. The additional revenue accrued from not providing affordable housing on site can be calculated as the difference between the open market value of the units provided and the affordable housing value (i.e. the amount of money that a Registered Social Landlord can reasonably pay a developer for units). Within a high cost area like the City of London, the difference between these two amounts can be substantial, particularly for social rented housing. Table 2: Calculation of Proportion of Off-Site Affordable Housing Provision Scheme (units) OMV AHV ( ) Est No. affordable units 1 % of total units provided on site , ,974, ,817, ) Difference between OMV and AHV, divided by 151,584 Table 2 shows that the potential contribution that could be made to affordable housing will vary according to the overall size of the site and the open market value of the scheme. For the purposes of setting policy in the Core Strategy, an average across the range of housing sites is proposed, suggesting an off-site requirement of 60%. Adopting a requirement for 60% off-site is also in line with the City s established policy approach to off-site provision, which currently requires 50% affordable housing on-site, or 100% off-site. 19

20 6: Conclusions and Policy Implications The modelling indicates a wide range in potential viability between the different size of residential schemes considered, and between whether they are conversions of existing buildings or new build. For schemes of 10 units involving the change of use or conversion of existing buildings, affordable housing at levels of up to 40% may be viable, but for larger schemes of 25 units and 60 units, affordable housing provision at levels beyond 30% do not appear to be viable. For new build schemes, the modelling suggests that affordable housing at 30% may be viable for a 10 unit scheme and a 60 unit scheme, but not for a scheme of 25 units. For schemes of under 10 units, the modelling suggests that provision at 30% would not be viable and that a lower requirement would be necessary. On a site by site basis provision of a single isolated affordable unit is likely to incur additional maintenance and management costs and may well be uneconomic for an RSL to provide in the longer term. Sensitivity testing has demonstrated that viability will vary with increases in values and costs, with viability more sensitive to changes in residential values than to equivalent changes in alternative office land values. To provide clear policy guidance for the City of London Core Strategy, avoiding the complications of different policy guidance for different sized schemes and for new build vs conversion, a minimum percentage requirement of 30% is proposed, on sites of 10 or more units. This will provide a degree of certainty as to the base level of affordable housing required in the City, whilst at the same time providing scope for higher levels where justified by individual site circumstances. Where a developer seeks to provide the affordable housing off-site through a commuted sum payment, the level of the payment must have regard to the increased revenue accrued to the developer through providing 100% market housing on site. Taking account of the likely additional revenue from a market housing scheme, the modelling suggests that policy should require an off-site contribution equivalent to 60%. The analysis has indicated that there will be site-specific circumstances where achievement of the affordable housing proportions discussed may not be possible. This should not detract from the robustness of the overall targets but the City will need to take into account specific site viability concerns when these are justified. If there is any doubt about viability on a particular site, it will be the responsibility of the developer to make a case that applying the City s affordable housing requirement for their scheme makes the scheme unviable. 20