Setting your building budget right at the outset is no different to any other capital purchase and all the same principles apply. In fact the arithmetic is quite straight forward; how much hard cash have you got from savings, what level of equity do you have in your existing home and what sums could you reasonably afford to borrow through a recognised mortgage product? Add the whole lot together and that gives you your overall budget which, for the avoidance of any doubt, should include everything including any financing costs, professional fees and exceptional items.
It’s important to look at at how the cash flow works and what challenges lie ahead regarding the release of equity and the purchasing of your land. But, for now, most folks need to understand what the component costs will be in completing a house build so that you won’t end up being one of the few, newsworthy TV stories, where the budget was all spent half way through the project!.
Some people still refer to the law of thirds, where one third of your house-build project should be the land cost, one third the physical build and the remaining third your profit. However, in truth this is out-dated and every project will have its own discrete metrics depending on where it is in the country. The reason for this is due to the broad range of house price valuations with the influencing element being the value of the land itself rather than the physical building costs. Of course, building labour costs will vary throughout the country, where a carpenter or bricklayer may expect to earn more if they are based in the South East when compared to the North East. But these variances are less severe than the regional spread of house prices which will be the main determining factor in how building plots are priced.
In theory a local agency would choose to value a building plot based upon two traditional methods; First would be the comparative method, whereby comparative examples would be used to benchmark evidence of successful activity and, second, would the residual method, where price is determined by reducing the proposed end value by the cost of the physical build.
However, ‘value’ is only ever an opinion of price, with evidence to demonstrate some professional logic, but a parcel of land may be ‘worth’ an entirely different figure to a prospective purchaser due to a range of more emotional responses including opportunity, desire, impatience, fatigue etc. Which is why, lumped on top of the above two valuation methods, there could be an additional premium due to an overall scarcity of supply.
So how does this help you in deciding how much you can afford to pay for your plot? In truth one needs to act a bit like a developer and work backwards from an end valuation. For the purposes of providing an example, therefore, let us make our first assumption that our overall budget, as described above, is £300,000 all-in. Let us then make our second assumption that we have (or will secure) planning consent for a 4-bedroomed 2-storey house of 1,650ft² or 153m². We’ll also assume that this is someone’s side garden in an urban location and that all the main services are relatively accessible from the main road.
The generic understanding for valuing new housing brought to market would be by using the comparative method in conjunction with the size of accommodation provided. Thus, there will be a prevailing rate per ft² or m² for new speculatively delivered housing upon which minor variations will be applied based upon location, amenity, specification etc. Let us make our next assumption, therefore, that our prevailing rate in our example is £200/ft² or £2,150/m². This means our completed house should have a market value of £330,000.
So, starting with our end valuation of £330,000, let’s start taking off the costs of building our house in very broad and simplified groups. To do this we need to make our next assumption which is that we are a family with normal weekly commitments and between us one and half full time jobs plus kid’s football at the weekends! We’re going to need a main contractor who’ll give us a fixed price leaving us to possibly do the decoration and a bit of external landscaping (over time!). We need to apply a rate ft² or m² for this service adding on top a 10% contingency.
At £100/ft², our costs are going to be £165,000 which, by the time we have added a 10% contingency will take us to £181,500. Plus we might have a garage, obviously some external works, professional & legal fees, financing costs and taxes in the guise of the new Community Infrastructure Levy and Stamp Duty Land Tax. And we should also deduct some of the developer’s profit as you are, in effect, now the developer and might want to factor some initial equity in return for your efforts.
I believe the model, therefore, looks a bit like this:
Interestingly the proportional value of the land compared to the final value of the house in this example is 21% demonstrating that the rule of thirds does not apply here. However, if you run the above model in a location where the prevailing sale price for a new house is closer to £250/ft² then the proportional value of the land becomes 35% at a cost of £144,000 for the plot and subject to a 1% SDLT charge. Although the temptation might be to increase the 10% profit margin which, assuming build costs remain constant, would then suppress the target land value.
Some folks will proceed without deduction of some profit for themselves and others will omit their contingency which, using the above example, would enable you to increase your bid price for the land from £70,000 to about £120,000 although your overall budget would have to increase accordingly. I can’t condone the removal of a contingency, however, as in my experience, everyone needs one!
Many will question the indicative building rate of £100/ft² which will be massively affected by the complexity of your design, the specification that you choose and the geographical location of your build. Those that choose to self project manage should make savings on this figure through their organisational efforts and those with more complex designs and higher specifications will see this rate increase and, most probably, along with their professional costs.
The CIL charge is subject to much debate in Westminster and there is the possibility that one off houses may be given a reprieve. But generally Councils are looking to gain a contribution to local infrastructure from all new development either through CIL or section 106 agreements and so you should check this out with your Council before finally making your land purchase. CIL rates should be published based upon local calculations of need but not all Councils have formalised this yet.
So, one thing is for sure, all of you will have different financial equations, your motives for building will vary, not all of you will be looking to make money from the exercise and your choices of build management will vary widely from a ‘hands-on’ approach to the appointment of independent project managers, professionals and main contractors.
Crafting this early budget will help you to profile your own individual metrics in an informed and less impulsive way.
This article was written by Tim Doherty, and originally published for Build It Magazine. Tim is the Director and Principal Surveyor of Dobanti Chartered Surveyors, a building surveyors based in Tunbridge Wells, Kent. Get in touch for more information about Dobanti’s property and building services, or read more online now. Further articles and blog posts can be found here.