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 Neal Hudson
limiting the rate of new home building can be traced back to the pricing and availability of Associate Director
land for residential development. 07590 531150
nhudson@savills.com
The availability of development land is constrained by the planning system but also by other
@resi_analyst
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 Residual Land Value
the formula opposite shows. =
When in competition with other developers and assuming discipline on appropriate profit Gross Development Value
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 Development Costs
(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 Profit
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 buyers 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-to-
100 Buy Equity Loan

90
80
Index (2007 peak = 100)

70 Savills Greenfield
60 Land Index

50
Modelled Using New
40 Build House Prices Valuation Office
Agency
30 (discontinued)
20
10
0
Q1 1985
Q1 1986
Q1 1987
Q1 1988
Q1 1989
Q1 1990
Q1 1991
Q1 1992
Q1 1993
Q1 1994
Q1 1995
Q1 1996
Q1 1997
Q1 1998
Q1 1999
Q1 2000
Q1 2001
Q1 2002
Q1 2003
Q1 2004
Q1 2005
Q1 2006
Q1 2007
Q1 2008
Q1 2009
Q1 2010
Q1 2011
Q1 2012
Q1 2013
Q1 2014
Q1 2015

Source: Savills using VOA and Nationwide

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4 June 2015
Housing Market Note
Other Factors
At first sight, the models 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 developers 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.

Planning issues will Fig 2 House Builder Production Constraints

always be a valid go-to 100 Planning delays
complaint for developers
90
% considering factor a 'major

but recent evidence Materials

suggests that the 80 Land availability
availability (and cost) of availability/prices Development
70
materials and labour has finance
60
constraint'

been a bigger constraint

over the last couple of 50
years. 40 Labour
availability
30
Survey responses from
the HBF survey suggest 20
these issues are declining 10
in importance but remain 0
high relative to recent
Q1 2000

Q1 2001

Q1 2002

Q1 2003

Q1 2004

Q1 2005

Q1 2006

Q1 2007

Q1 2008

Q1 2009

Q1 2010

Q1 2011

Q1 2012

Q1 2013

Q1 2014

Q1 2015
years. The uncertainty
around future build cost
inflation will inevitably limit
land prices to some
degree.
Source: Home Builders Federation
Fig 3 Build Costs Compared to Nationwide New Build House Price

Prior to 2001, indicators 160

Nationwide
for build costs suggest 150 New Build
Real price indices (Q4 2001=100)

that they generally 140 House Price

matched the trend in
130
house prices.
120 ONS
That relationship broke 110
down between 2001 and 100
2007 when house price Holmans BCIS
90
inflation substantially
80
outpaced build costs.
70
BIS
The relationship has 60
resumed post recession 50
and the recent house
Q4 1973
Q4 1975
Q4 1977
Q4 1979
Q4 1981
Q4 1983
Q4 1985
Q4 1987
Q4 1989
Q4 1991
Q4 1993
Q4 1995
Q4 1997
Q4 1999
Q4 2001
Q4 2003
Q4 2005
Q4 2007
Q4 2009
Q4 2011
Q4 2013

price rises have been

matched by increases in
build costs.

Source: Nationwide, Holmans, BIS, ONS, BCIS

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 th
4 June 2015
Housing Market Note

Fig 4 Development Land Value & House Price Change From 2007 Peak
The performance of local
land values since the 40%
market peak in 2007

House price change from 2007 peak

broadly reflects the 35% London
underlying performance of Cambridge
the local housing market. 30%

25% Oxford
There are exceptions that
highlight local approaches 20%
to development and land
release. Cambridge has 15% Sevenoaks
seen similar or higher Reading/Bracknell
house price growth than 10%
Milton Keynes
other markets yet land
values are lower relative 5%
Norwich UK
to peak. This reflects the
0%
local approach where Lincoln
more land has been made -5%
available, including some
from the Greenbelt, and -10% Telford
there is clarity on the level -60%
60% -40% -20% 0% 20% 40%
of affordable housing Land value change from 2007 peak
required.
Source: HM Land Registry, Savills
Although not directly Fig 5 Land Values & Housebuilding 1892 to 1969
relevant to the above 1,000,000 450,000
analysis, the chart
opposite shows the trend Housebuilding 400,000
in land values between (rhs)
1892 and 1969. 350,000
100,000

Annual housebuilding
Price per acre (log)

The substantial premium 300,000

Commercial
for commercial land
across the period and the 250,000
divergence in value 10,000
200,000
between residential and Industrial
agricultural land from the 150,000
1930s are both interesting Residential
features and reflect the 1,000
100,000
importance of location in Agricultural
land values. 50,000

Care should be taken in 100 0

1890
1894
1898
1902
1906
1910
1914
1918
1922
1926
1930
1934
1938
1942
1946
1950
1954
1958
1962
1966
1970

reading too much into any

single year given the data
collection periods. Source: Bank of England, EA Vallis, Estates Gazette (1973), DCLG
Previous Issues
Peak Loneliness Size Matters Housing Delivery Pension Reform
http://sav.li/43c http://sav.li/3z8 http://sav.li/3wo http://sav.li/3ul

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