Capturing planning gain (part 1)

Following Roger Jarman’s Red Brick post on reforming residential property taxes, Dave Treanor’s two-part post looks at capturing planning gain, taking acount of the Parliamentary inquiry into ‘Land Value Capture’ and this week’s revised National Planning Policy Framework. Today’s part looks at s.106 and CIL. Tomorrow’s will look at the level of compensation paid to landowners in a compulsory purchase.

---

By Dave Treanor

How much of the profit arising from public investment and planning decisions should go into the pockets of landowners and how much should be captured for the benefit of the community?

A new National Planning Policy Framework (NPPF) has just been published (July 2018) (Note 1). During consultation on the changes Parliament set up an inquiry into ‘Land Value Capture’.  The consultation invited evidence on whether planning gain contributions under section 106 and the Community Infrastructure Levy (CIL) are adequate measures for capturing increase in land value.  Do they bring sufficient money to local authorities to provide the infrastructure that developments often require? What new methods might be employed to achieve land value capture and what examples exist of effective practice in this area, including internationally?

The uplift in land value resulting from planning consents is £9 billion a year, of which less than £2.8 billion is captured by the Community Infrastructure Levy (CIL) and Section 106 (2).

Successive Labour governments since the war have legislated to capture at least some of these windfall gains for the benefit of the community. Each time it has been reversed by the next Tory government. When he was Communities Secretary (before promotion to Home Secretary) Sajid Javid declared his intention to tackle the hoarding of land by developers and make better use of the uplift from planning gain to support local infrastructure and development.  The Tories are alarmed at the fall in home-ownership, which they have always regarded as their best constituency.

S106

Section 106 of the 1990 Town and Country Planning Act was introduced by a Conservative government. It captures some of the increase in value when planning permission is granted to fund the inclusion of affordable housing in a development and improvements to schools, local transport and other infrastructure to deal with growth in the local population.  Despite some limitations it has been the single most effective mechanism for capturing planning gain, with a direct impact on the market price of land.

An extension of ‘permitted development’ in October 2015 provided automatic consent for offices and light industrial properties to be converted into housing, so they no longer make s106 contributions. Section 106 only applies on schemes with 10 or more units (now reduced to 5) making it harder to finance affordable housing in rural areas where developments are often small.

It is up to each planning authority to set out its own polices in planning guidance. Under the London Mayor’s Supplementary Planning Guidance, for example, the requirement is for 35% affordable housing, rising to 50% on regeneration of council and social housing estates.

The development of brownfield sites is inherently risky, and the value added by planning consents is sometimes insufficient to deliver the affordable housing. Section 106 provides flexibility so as not to prevent an otherwise beneficial scheme being built. Where it would not be economically deliverable at the levels expected in planning guidance the developer can negotiate a reduction in the affordable housing requirement to enable it to proceed using a Financial Viability Assessment (FVA).  The Inquiry heard evidence that this option was being abused resulting in reductions in affordable housing.

An FVA analyses future revenues that could be achieved with the new planning consent to assess a Gross Development Value (GDV). It includes sales receipts, the present value of future rents net of management and maintenance costs, and income from any commercial premises or community facilities.   These are compared with the costs of delivering the scheme, including clearing the site and compensating existing occupants, construction, and all associated fees and taxes. This is known as the Gross Development Cost (GDC). The Residual Site Value is then calculated as the GDV less GDC including a margin for developer’s profit.

A scheme is considered deliverable if the Residual Site Value is greater than the Benchmark Value, defined as the value below which a reasonable land owner is unlikely to release a site for redevelopment. Critically under Section 106 this excludes hope value arising from potential changes in planning consent to permit more profitable uses of the land. It should reflect policy requirements and planning obligations and, where applicable, any Community Infrastructure Levy.  Benchmark Value sets a cap on the land value a developer can use in a Financial Viability Assessment to justify a reduction in the affordable housing required.

A study by the RICS in April 2015 found that the ‘market value’ was not being applied correctly by valuers in assessing Benchmark Values, and ‘if market value is based on comparable evidence without proper adjustment to reflect policy compliant planning obligations, this introduces a circularity, which encourages developers to overpay for a site and try to recover some or all of this overpayment via reductions in planning obligations’. (3)

A High Court judgement in April 2018 (4) ruled that in assessing Benchmark Value under s106 the price paid by the developer or landowner is not necessarily relevant: if they had paid more than the site was worth based on current planning consents and planning policies this did not entitle them to negotiate a reduction in planning obligations. The judge also recommended that the widely used guidance on viability assessments by the RICS should be revised ‘in order to address any misunderstandings about market valuation concepts and techniques, the “circularity” issue and any other problems encountered in practice over the last 6 years, so as to help avoid protracted disputes of the kind we have seen in the present case and achieve more efficient decision-making.’

This judgment is expected to lower landowner’s expectations of how much a site is worth, based on speculative pricing achieved elsewhere. It means the Existing Use Valuation plus a premium sufficient to make it worthwhile for the landowner to sell (EUV+) takes precedence over the price paid for the site or any market comparisons in assessing the Benchmark Value.

The appropriate level of premium is perhaps the hardest element to judge, and this lack of clarity can be exploited by expensive lawyers and consultants.

The lack of clarity on the likely outcome of planning gain negotiations leads to uncertainty and undermines its impact on the market price of land.

To make matters worse, planning authorities are required to publish their calculations while the assumptions and calculations used by developers in their financial viability appraisals were treated as commercially confidential.  The case for this was incredibly weak since the owner of the land is not in competition with anyone, and only they can benefit from the negotiations. Planning authorities, including the London Mayor, are now making transparency a condition of applying for planning permission.

In a significant change, the new NPPF (para 57) reinforces the expectation that developments must comply with affordable housing requirements and downgrades the role of viability assessments, removing confidentiality from them.  ‘Where up-to-date policies have set out the contributions expected from development, planning applications that comply with them should be assumed to be viable. The weight to be given to a viability assessment is a matter for the decision maker, having regard to all the circumstances in the case, including whether the plan and the viability evidence underpinning it is up to date, and any change in site circumstances since the plan was brought into force. All viability assessments, including any undertaken at the plan-making stage, should reflect the recommended approach in national planning guidance, including standardised inputs, and should be made publicly available’.  This puts the onus on the developer to demonstrate that local circumstances affecting their scheme have changed since the affordability requirements were assessed, justifying a reduction.

For the transparency to be effective the information has to be provided in a way that enables the assumptions to be benchmarked.  Larger sites are invariably developed in phases over as much as fifteen years. Separate appraisals are carried out for each phase and each type of housing on offer, and then consolidated to produce an overall appraisal.  The costs and charges on which these are based are first assessed at current prices and extrapolated into the future based on expected levels of inflation in each of them. That is how financial appraisals are constructed (5).

Unless transparency requires development costs and future revenues to be quoted at current prices it becomes impossible to compare them with other schemes to test how realistic they are.  Expectations of growth in each type of revenue and cost and the years over which they extend should also be benchmarked and are relevant to the overall viability assessment.  But the precise phasing of individual costs and revenues has a relatively small impact in judging viability, and in any case will be optimised and adjusted in response to market conditions as the scheme progresses.

There is a strong case for setting up a benchmarking club for local authorities on s106 which can analyse trends in land pricing, construction costs and associated fees, providing evidence planning authorities can use to challenge the assumptions behind Financial Viability Appraisals presented to them by developers. The added transparency should have a direct impact on land valuations.

It is always easier to negotiate with a competent partner, and delays and confusion from local authorities in dealing with s106 can cost developers money. Developers sometimes accuse planning authorities of using this as leverage in negotiations.

Barratts claim to deliver target levels of affordable housing in most of their developments with only 15% requiring negotiations on viability. But a study by the Campaign to Protect Rural England (CPRE) in 2017 presented a less optimistic view, reporting that around 48% of affordable homes in rural areas had been obviated by means of viability assessments (6).

Clarifying the rules would be in everyone’s interests, except those most adept at gaming the system.

CIL

The Community Infrastructure Levy (CIL) is intended to ensure that infrastructure costs incurred in supporting the development of an area are funded wholly or partly by owners or developers of land in a way that does not make development economically unviable.  It was introduced by the Planning Act 2008 as part of the Labour government’s response to the Barker Review of Housing Supply. Where implemented it applies to any development creating more than 100 square metres of additional floor space or a new dwelling.

CIL is charged per square metre of gross internal floorspace at rates set out in charging schedules published by the planning authority. The rates can differ according to the type and size of development. Social housing is often charged at zero or reduced rates. Unlike s106 there is no discretion to vary it to suit the circumstances of a particular development.  But there is scope to agree what infrastructure will be funded by the charge to support a particular development.

A lengthy consultation process is required to amend the charge rates, so once set they are rarely changed. That certainty is helpful in having a predictable impact on land prices but means there is little opportunity to fine-tune the rates. If they are set too high that could have an adverse impact on more marginal developments in run down areas. If too low there may be insufficient money to fund the infrastructure needed. CIL has only been implemented in 43% of local authorities, largely because outside the high demand areas there may be insufficient added value to tap into, and a fear that it might further discourage investment.

Local Plans

The NPPF put Local Plans at the centre of the planning process so that it is plan-led.  The latest edition (July 2018) requires them to be reviewed and updated every five years.   ‘Plans should set out the contributions expected from development. This should include setting out the levels and types of affordable housing provision required, along with other infrastructure (such as that needed for education, health, transport, flood and water management, green and digital infrastructure). Such policies should not undermine the deliverability of the plan’.

Policy levels of affordable housing should be viability tested in drawing up the plan.  The GLA’s ‘London Plan Viability Study’ published in December 2017 in support of the London Mayor’s Supplementary Planning Guidance is a good example (7). The Inquiry suggested that on larger sites covered by a local plan the planning authority should seize the initiative and not wait for proposals from developers before commissioning its own viability assessment, so that it starts from a well-informed position (8).

Town and Country Planning Association (TCPA) pointed out that ‘some of the most successful land value capture models are accompanied by powerful public-sector bodies that act as the master developer.  They work in concert with the private sector, which delivers most of the development, but you have that oversight from a master developer.  The Dutch, Austrian, German and Danish models all, to some degree, work on that basis’. 

Stephen Ashworth, a solicitor from the planning team at Dentons summarised this position: ‘A local planning authority can afford to be firm if it has development plan policies in place that provide a stronger justification for a decision to refuse a scheme that is not of an adequate quality of development, that does not provide an appropriate public realm or that does not provide the affordable housing.  However, if it has development plan policies in place that very clearly signal that those are its requirements, then it should be able to expect the Secretary of State’s support on appeal and it should be able to have a robust debate with a developer or landowner about what is going to be provided, and it ought to win that argument.

To date, we have suffered considerably from local plan policies that have been hedged and caveated, and the Department needs to take some responsibility for that because they used to go around saying, “You ought to add qualifying wording into planning policies.  You will normally have 35% affordable housing or you will have public realm subject to viability”.  That should be excised.  There is no place for that.  Particularly if you are moving forward with a plan policy that is properly viability-tested, there is no need for that sort of qualifying wording because the moment you put that in, you offer the opportunity for debate and, if you have that sort of debate, some local authorities will, on a number of occasions, be persuaded to lower their standards in order to be able to grant a consent and see some development.  In practice, I suspect they could say no, if the local plan policy supports them, and still get the development’.

In other measures the new NPPF tightens the Delivery Test, putting additional pressure on planning authorities to identify sufficient sites where they have previously failed to meet new housing targets. Social housing is included in the definition of affordable housing. There is a requirement for 10% of all new housing to be low-cost home-ownership, with exceptions for professionally managed build for rent with tenures of at least 3 years.

Part 2 of this review will look at the level of compensation paid to landowners in a compulsory purchase. The inclusion of the ‘hope value’ arising from potential future uses for the land put an end to self-funded new town development.  How is that justified and could it be reversed?

NOTES

[1] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/728643/Revised_NPPF_2018.pdf

[2] https://progressive-policy.net/2017/03/estimating-land-value-capture-england-updated-analysis/

[3] Para 3.48 of ‘Homes for Londoners: Affordable Housing and Viability Supplementary Planning Guidance’, Mayor of London 2017

[4] Islington v Parkhurst Land Limited: In this case the developer had bid £13.25 million for a site that was only worth £6.75 million once the planning obligation for affordable housing was taken into account.

[5] I can vouch for that having designed the software social housing organisations use for their financial viability appraisals https://www.m3h.co.uk/products/development/m3pamwin-lite  For many years I also ran a Benchmarking club on development appraisal assumptions.

[6] http://www.cpre.org.uk/media-centre/latest-news-releases/item/4602-developers-renege-on-affordable-homes-as-countryside-faces-housing-crisis

[7] https://www.london.gov.uk/sites/default/files/london_plan_viability_study_dec_2017.pdf

[8] See for example the Old Oak and Park Royal Development Corporation’s viability study at https://www.london.gov.uk/sites/default/files/50._whole_plan_viability_study.pdf