Finance costs and the assumed debt structure in viability

Finance costs in a viability appraisal are modelled, not taken from the facility the developer actually signed. The appraisal asks what a reasonable developer would have to pay to fund the scheme, applies interest to the running deficit across the cashflow, and adds the fees that come with borrowing. Finance costs in a viability appraisal therefore depend on three disclosed assumptions: the rate, the fee structure and the programme.

Hide any of those and the appraisal is not reviewable, which is the fastest way to have your figures discounted.

Why finance is modelled rather than taken from a facility

National guidance expects viability assessment to use standardised inputs so that one scheme can be compared with the plan's own viability evidence and with other schemes. A developer's actual facility reflects its balance sheet, its track record, its relationship with a lender and whatever else it had on at the time, none of which tells the authority anything about the site.

There is a second reason. Using the real facility invites the authority to ask for the facility agreement, the security arrangements and the group position, and most applicants would rather not open that door.

So the appraisal assumes a market-standard debt structure for a scheme of this type and scale. The applicant's job is to say what that structure is and to evidence the rate, and the authority's job is to test whether it is reasonable for the scheme rather than for the applicant.

Interest on the debit balance across the cashflow

The method that stands up is interest charged on the debit balance of the cashflow, period by period. Costs and receipts are placed in the periods they occur, the balance is rolled forward, and interest accrues only while the balance is negative.

The alternative that still appears in submitted appraisals is interest applied to total development cost for the whole development period, sometimes halved as a crude proxy. That overstates the figure, because it charges interest on money not yet spent, and an inspector who notices will discount it.

Three details change the output materially:

1. Whether the land payment sits at the start of the cashflow and is funded from day one, or is deferred.
2. Whether sales receipts are applied to the balance as they arise, which they should be, or held to the end.
3. Whether interest is compounded over the period used in the model, and whether that period is monthly or quarterly.

Say which convention you used. A reviewer rebuilding your cashflow with a different compounding assumption will get a different number and will assume the difference is yours.

Rate assumptions and evidence for them

Quote the rate as a margin over a stated reference rate rather than as a bare percentage, since a fixed figure quoted today ages badly and sterling facilities have been priced over SONIA since LIBOR was withdrawn.

Then evidence it. Published lender indications for development finance at the relevant loan to cost ratio, the plan's own viability study assumption, the rate accepted in a recent appeal decision on a comparable scheme, or a letter of indicative terms are all usable. A rate asserted with no source is the input most often adjusted downwards by an authority's reviewer.

Be clear about what the rate covers. Senior debt at a conservative loan to cost ratio prices differently from a stretched senior facility, and if the appraisal assumes high gearing it should say so, because the gearing assumption and the developer's return assumption interact.

Where the scheme has an affordable housing component with forward funding from a registered provider, the cashflow effect is substantial and should be modelled explicitly rather than absorbed into the rate. The same applies to any grant.

Arrangement, exit and monitoring fees

The interest rate is not the whole cost of money, and appraisals that stop at the rate understate finance by a meaningful margin.

The items to show separately are the arrangement fee on drawdown, expressed as a percentage of the facility, an exit fee where the lender charges one, a commitment fee on undrawn funds, the lender's legal and valuation costs, and the monitoring surveyor's fees across the build period. Each is a real cash item with a date, so each belongs in the cashflow rather than in a lump sum at the end.

Two of those are frequently missed. Monitoring surveyor fees run monthly for the whole construction period and are not trivial on a long programme. And an exit fee calculated on gross development value rather than on the facility is a much larger number than people expect.

Where the appraisal is being used to argue for a reduced affordable housing contribution, every one of these items will be examined, and an unevidenced schedule of fees weakens the whole case. Our note on affordable housing review mechanisms in section 106 explains how the same inputs get revisited later.

Sensitivity to programme length

Finance is the input most sensitive to time, which makes the programme assumption part of the finance case.

Model the programme explicitly: pre-start period, construction duration, and the sales or letting period with a stated absorption rate. Then run sensitivities. A six month extension to a two year programme adds interest on the full peak debt for that period, and on a scheme with a slow sales rate the carry on unsold units can exceed the construction interest.

State the peak debt and the month it occurs. It is a useful discipline, it tells the authority whether the assumed facility is even available at that size, and it exposes an appraisal where the cashflow has been smoothed.

Where a planning condition or a pre-start obligation delays the start, the finance consequence is a legitimate point to make, and it is more persuasive expressed as a number from the sensitivity run than as an assertion about risk.

Where finance overlaps with profit

The developer's return and the finance cost both price risk, and double counting between them is the error reviewers look for hardest.

The logic is straightforward. If the appraisal charges full debt interest on a highly geared structure and also applies a profit margin derived from equity-funded schemes, the same risk has been paid for twice. Conversely, an appraisal that assumes the scheme is funded entirely from the developer's own resources, with no interest at all, cannot then claim the higher return that gearing would justify.

Pick one coherent story. State the capital structure, the finance cost that follows from it, and a return assumption consistent with that structure, and explain the consistency in a short paragraph. A Viability Assessment that does this explicitly is far harder to pick apart than one that presents each input in isolation.

Inspectors do reopen these inputs, as our note on when an inspector reopens viability at appeal describes, and the finance and profit relationship is a standard line of questioning.

Presenting the assumption transparently

Put the finance assumptions in one table near the front of the appraisal, not scattered through the appendices.

The table should state the reference rate and margin, the loan to cost or loan to value assumption, the arrangement fee, the exit fee basis, the commitment fee on undrawn funds, the monitoring cost per month, the interest calculation method and compounding period, the drawdown and repayment assumptions, and the source for each. Then give the peak debt figure and the total finance cost as a proportion of development cost.

A reviewer who can reproduce your finance figure from that table will argue about the rate. A reviewer who cannot will argue about everything. Browse all 66 report types on PlanScope to see which documents a viability submission usually sits alongside, including the Affordable Housing Statement.

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