Breaking the land bank

Land banking is the core business of any successful homebuilder. By means of shrewd land identification and acquisition land is drawn down from the land bank, once planning permission is obtained, and introduced into the short-term building cycle at a price in the region of 20% of projected selling price.

This is much less than the percentage represented by land purchase of the total sales price if land is purchased in the open market eg, at auction, when the land element usually represents a third or more of the total sales price.

Successful land banking helps to improve homebuilders’ profit margins. McCarthy and Stone, which relies heavily on its strategic land bank, shows the best margins in the industry of 32%. The table (right) drawn from results of public companies demonstrates its importance. The land bank is divided between the short term, usually with planning permission obtained and longer term land, which is located in strategic development areas, and usually controlled by means of an option to purchase from the landowner. Increasingly firms aspire to ensure that some 30-50% of short-term land is progressively drawn from the strategic land bank, so as to achieve the improvement in margins.

Because so much brownland appears on the land market at short notice, eg, closure of a commercial company, and is sold either by auction or sealed tender, most of the strategic land bank will be greenfield, usually farmland, with the farmer continuing to cultivate.

Pressures for change

During the last decade two forces encouraged homebuilders to build up land banks.

These were firstly the 1990 Planning Act which gave such prominence to the development plan. Homebuilders could no longer rely on processing land through by planning appeal and the emphasis on allocation in local plans meant that they could encourage landowners to option their land to them so that the homebuilder could then take on the responsibility of promoting the land through the successive stages of the development plan.

The second factor was the recession of the 1990s and the determination of homebuilders to try and control the price of their basic asset: land, in a fluctuating and cyclical housing market.

Following the dire events of the 1990s recession, homebuilding has recovered remarkably well and the published reports of the leading companies show financially sound companies, well capitalised, paying good dividends even if the dot.com obsessed stockmarket does not appreciate their value.

Yes, most company chairmen, in the introductions to their annual reports, have a moan about the planning system and planning delays, but they secretly admit to themselves that the shortages have not been bad for margins.

Now John Prescott’s PPG3 threatens to shatter the working method patiently evolved over the last decade.

PPG3’s new dimension

PPG3 brings two changes to the system that has evolved with potentially severe consequences for land banking.

The first concerns proposals to develop any larger greenfield land for housing. The criteria are: if in itself or as part of a wider but contiguous allocation for housing, the site is 5 ha or more, or comprises 150 dwellings or more regardless of size of site. In these cases, if the local planning authority resolves to grant planning permission, the scheme has to be notified to the Secretary of State before permission can be granted.

It is a fundamental change because ordinarily if proposals were in conformity with the development plan, for example, a planning application had been made on land allocated for residential development in the adopted local plan, then the proposals would not need to be notified to the Secretary of State. In this way the Secretary of State has the opportunity to call-in a planning application which the local authority would otherwise approve and gives the final word on whether or not it should be developed.

Secondly, the possibility of the non-renewal of outstanding planning permissions is canvassed. Planning permissions all have a time limit, usually five years, after which a new permission is needed. Ordinarily permissions have been renewed unless circumstances have changed radically. PPG3 advises “issues of sustainability mean that local planning authorities should review thoroughly all applications to renew permissions...

“They may, as a result, determine that some existing planning permissions no longer meet the requirements of current policy guidance and should not be renewed. Alternatively, where permissions for housing development are renewed, they should be revised to take account, for example, of the need for higher quality development which makes more efficient use of the available land. Where appropriate, conditions should be imposed accordingly.”

Brown battlefields

Government wishes to see 60% of new housing built on previously developed land. Analysing their company accounts, I would estimate that at best the major homebuilders are building about a third of their volume on previously developed sites. So they need to almost double completions on brownfield sites and as described, little of this can come from strategic land banks. Homebuilders will need to go into the market and buy land which is euphemistically described as ‘oven-ready’.

This is already happening and a glance through the property press any week will show the extraordinary range of former hospital, commercial, community buildings and breweries all being offered for homebuilding with or without permission. Government policy pronouncements have so encouraged vendors and their advisors that now land will be offered in the market even without residential planning permission in the confident expectation that this will be a formality. Most of us know that nothing is a formality in our planning system and I suspect we will see drawn out planning battles to do with brownfield sites, just as we have seen them on greenfield land releases.

What are homebuilders to do then with their strategic land banks? Do they treat them as a wasted asset and write down their value accordingly? The cynic would say that given the low capitalisation that the stockmarket puts on these companies, despite their extremely good profitability, now is the time to write off these assets. It is probably unlikely to make much difference to the share price as the market appears to have already fed into the market price its concerns about future uncertainties (which to date have not materialised). So now would be a good time to write down the assets.

Capitalisation is a matter for the companies and their own financial strategies but I would advise homebuilders to reposition their strategic land banks. In saying this, I am not obviously suggesting they rush out and buy land elsewhere, but that they look again at this land in the light of the criteria set out at PPG3. There are encouraging omens. John Prescott has refused to call-in a big greenfield (and also greenbelt) development on the edge of Newcastle upon Tyne as it is seen as part of a mixed-use scheme essential to the regeneration of the city. Greenfield therefore does not always equate to being bad.

Is land banking dead? The answer is not exactly, but existing strategic land banks will not be able to provide the assured 30-50% of short-term land business strategists originally envisaged. There will be an urgent need to identify that land in the strategic land bank that can meet sustainability criteria.

Land banking of brownfield land will be much more difficult, but alliances between larger homebuilding companies and holders of large tracts of brownfield land may be the answer. Brownfield will be no easier and no less expensive to promote than greenfield land and big budgets will be required.