The IPD’s inaugural Development Report, launched earlier this in conjunction with property consultants Gerald Eve, reveals a number of trends relating to the development process
The IPD Development Report has studied the investment performance of developments undertaken over a 27-year period (1983-2010) and reveals average total returns of 6.7% for that period. This data might be seen to challenge assumptions that development is a high risk-high reward activity and suggests instead that it is a more often than not measured activity with relatively conservative rewards.
“One of the key themes to emerge from this research is perhaps that risk profiles change during the course of the development process, so the end returns have moved on from those that might have been predicted at the outset,” said Robert Fourt of Gerald Eve.
He continues: “There is no question that development is still a risky activity, but developers are skilled at de-risking as they go through the process, which has an inevitable impact on end returns,” he adds.
“Delivery of developments are exposed to a considerable number of variable factors throughout the development cycle, which in turn enhance the risk profile” Mark McIvor, Development Manager at IPD continued, “but we know developments can provide extremely high (and low) returns should these variables align favourably.
“The objective for a developer is to minimise and mitigate that risk, hence the need for detailed market analysis and appraisals. In the end developers must form their own judgement about the estimates that are made of the variable factors.
Another key trend to emerge from the report is that the shorter the development process, the higher the returns.
Over the course of the 27 year history of the research, developments that were completed in under 36 months outperformed those that took longer. Those completed within 24 months recorded 8.1% while those completed over a period of 36 months recorded returns of 7.8%.
McIvor continues: “One option available to developers is to seek to reduce the construction duration period, thereby reducing the time that a development is exposed to uncertainty. It stands to reason that as the construction duration increases, so too does the exposure to greater uncertainty. Thus any policies, and indeed measures, that seek to shorten the development process should be beneficial to the eventual returns if managed properly.”
Generally, the new National Planning Policy Framework has been welcomed by the commercial property sector, as it appears to reduce the time wasting complexity surrounding the all important planning permission stage.
Developments slow to a trickle in 2010
In 2010 there were only 44 completed developments, the lowest number in the history of the research. At an all developments level they returned -0.3%, considerably lower than the return supplied by the all commercial property average.
“The results for 2010 are counter intuitive to those produced over the full history of the research,” continued McIvor. “Returns for those in the shortest periods actually suffered, while those developments that took over 49 months were the best performing, with an IRR return of 7.6%”.
“This is partly due to the prevailing market conditions and the shortage of development finance which is limited to those major schemes in prime locations which still enjoy strong occupier and investment demand”.
Robert Fourt of Gerald Eve continued, “It is no secret that the development pipeline has been stalled for quite some time, with banks unwilling to provide capital unless the development has been pre-let. The retail sector has suffered considerably in this situation, in light of the difficulties surrounding high street shops at the moment, and as a result, retail returns were the lowest in the index, at -6.49%. Offices fared a little better, with an IRR of -1.12%, while industrial properties led with 1.88%.”
As in the commercial property market, the regional spread in returns was quite large. Over the 17 year history, returns in the City, Midtown and the West End were the highest, though Wales also saw a number of strong developments.