Development Appraisal Report

Property: New build Residential/Retail on Greenfield.

Net Internal Area: 1790 sqm.

Gross Internal Area: 2175 sqm.

Rent Reviews: 2 Commercial Units at 5 years FRI, 18 Residential Units at 5 Years AST, 2 Residential Units “affordable housing” fixed rent.

Estimated Market Rent: £ 190.000 on similar terms.

Gross Development Value: £ 2.400.000.

Estimated Yields: Net Initial Yield 6,21%, ROA 6%, Annual Debt Service 6%, Development Yield 8,47%.

Situated and numbered: Chestnut Avenue and Holly Close, Manny Town, United Kingdom. Land Registry sheet 85, Parcel 58.

Prepared by: Dr. Roberto Garrone

Date: 21st April 2010

Index

1. Objective

2. Development Inception and Market Analysis

3. Planning and Development Site Condition

4. Construction and Letting

5. Outcome of Development

6. Sensitivity Analysis and Risk Management

7. Conclusion

8. References

Appendices

1. RLV

2. NPV of Project

3. Discounted Cash Flow

4. Stock Flow Simulation

5. Sensitivity Analysis

6. Terms of Engagement

7. Statistical Data

8. Cost Analysis and Development Program

9. Time Estimation with PERT simulation

10. Bootstrapping Yields Curves – SWOT Analysis

11. Site Location and Maps

12. Inflation

13. Process/Role Table and Risk Management Integration

1. Objective

In accordance with instructions received from General Developer plc and dated the 1st November 2009, we confirm that an inspection of the property was undertaken on the 25th January 2010 and we have pleasure in submitting the following Development Appraisal Report, prepared in accordance with our Standard Terms of Engagement (see appendix 7) and in compliance with the Practice Statements and Guidance Notes of the RICS Valuation Standards 7th Edition (the Red Book, 2012). This development appraisal report is prepared to assist a private sector house builder in evaluating the development scheme and improving its performances, identifying profits/losses of the development, carrying out a basic market analysis, providing a basic sensitivity analysis and advising on risk management.

2. Development Inception and Market Analysis

Location Analysis The site has the advantage of strategic location nearby the City of London. We found only a small number of local shopping facilities, suggesting the need for small scale retail units. Residential streets north of the property contain a mix of older homes and new infill development. Employment centers are accessible by car and public transport.

Market Area Definition Interviews with estate agents identify the primary market area (PMA) with the following places: Gloucester City, Audubon, Brookway and Oaklyn.

Housing Characteristics Homeowners occupy 70% of all housing units in the PMA, vacancy rates are between 3% and 5%.

Demographic Characteristics The suburb has a total resident population of 1.000.000.

Inflation and Interest Rates The Monetary Policy Committee has nominal target of 2% (medium term) for the CPI. The average loan for the construction market trade at 5%, but conditions may vary.

Employment/Unemployment The unemployment rate in the suburb rose to 2.9% in 2009 (4,5% national average), a 1.2% increase is partially offset by an increase in goods producing sectors.

New Construction Activity In most of the jurisdictions within the PMA, there are no new developments of similar units while the commercial sector is experiencing some growth.

Housing Supply We find an average price of £ 120.000 for 800 homes sold in the PMA with characteristics similar to the ones developed; we note a decrease in the last 6 months in all but two of the zip codes within the PMA mainly due to the tight conditions of the mortgage market.

Housing Demand We note an increase in the number of households, the need to replace obsolete units, shifts in tenure by renters in PMA becoming homeowners and changes in household income and in the prices of the units available. Affordable housing units will serve households with income ranging from £ 15.000 to £ 35.000, we estimate a capture rate of 2% of age and income qualified households. Market rate units, for which we estimate a capture rate of 5%, are targeted to the income band from £ 35.000 to £ 65.000.

Buyer Profiles and Home Features It is expected to serve first time buyers with a small percentage of senior households. While not provided in the units object of development, we note that surveys report the availability of additional storage area and energy saving features as characteristics that could command +8% on average prices.

UK Property Market The property market, especially the residential sector, had inflated from 1990 until 2008, with a rate of growth in prices that cannot be compared with the rate of growth of wages. In this moment, the mortgage banking sector is experiencing one of the longest period of tight liquidity.

Certain policies such as the Bank of England’s Fund ing fo r Lend ing scheme and the government’s Help to Buy scheme are helping to increase the demand for housing. In the rental market conditions are little changed over the past months with landlord instructions more or less stable and moderate growth in tenant demand. Rent expectations are estimated to grow by 1.7%. See Appendix 1 and 8 for further details. [SAV],[RICS],[RED],[BOE],[OECD]

3. Planning and Development Site Condition

Property: Undeveloped Land Owner: Bamboos Consulting ltd Developer: General Developer plc Land Area: 500 sqm Existing Building: None Proposed Development: Development of Residential & Small Retail Site Address: Chestnut Avenue and Holly Close, Manny Town, United Kingdom

We have not inspected those parts of the property which were covered, unexposed or inaccessible and such parts have been assumed to be in good repair and condition. We have not tested any of the drains or other services and we have assumed that they are all operating satisfactorily. We have not arranged for any investigation to be carried out to determine if any deleterious or hazardous materials have been used in the construction of the property or have since been incorporated. We have assumed that such investigation would not disclose the presence of any such materials to a significant extent and that the property is considered to be in perfect conditions. See appendix 12 for pictures and maps. [RICSVIP]

Location and site The property is situated at the junction of Chestnut Avenue and Holly Close, in the second residential (medium and low level) suburb area North East of London, registered as a single parcel at the local Land Registry. The area consists of a roughly rectangular plot of land with the shortest border of 16,7 mt and the longest of 30 mt. The lot is oriented to north with the shortest border and is not confining with other buildings. There is no evidence of archaeological features and presence of channels or other water sources, but we recommend proceeding with geological research to understand the risk of future flooding or other relevant hydro geological and geotechnical issues. The subject property was considered to be free from any matters that may result in excessive abnormal costs from development perspective and it was and it is free from party wall, boundary and rights of light, rights of way, easements, encumbrances, overhead power lines, tunnels, water or mineral extraction rights, etc. The property is in order with waste management obligations. The subject property is considered to be in keeping with its surroundings where no significant adverse

environmental factors have been noted. The property has been measured in accordance with the RICS Code of Measuring Practice. [RICSVIP]

Infrastructure All main services, namely water, electricity, gas, telecommunications and drainage were accessible from the plot without the need of substantial expenditure. The capacity of the services met the requirements of the development and all the service runs were not interfering with the physical development. All the permissions to access services have been granted and examined. [RICSVIP]

Roads & Access The property is situated on a main road, made up and adopted, maintainable at the expense of the Local Communal Authority. It has been verified with highway authorities that the traffic generated by the development was acceptable and that no road alterations were required. [RICSVIP]

Planning The property forms part of an area where we have verified that there is no adverse town planning, Local Authority or other proposals/regulations which would be of direct detriment of the project as specified in this document. All the appropriate planning consents and permissions to build have been examined and observed to be in order and without time limit or expirations (development consent, environmental assessment, listed building consent). The local plan reports the correct classification for the intended use of the property. Planning history has been examined without revealing notable facts; the site does not belong to conservation areas and does not require sustainability statements. As a Section 106 (TCP 90) agreement, 10% of the flats are to be retained in the rented sector. [RICSVIP]

Building Regulations The Building Control office of Manny Town assessed health and safety requirements (CDM plan), approved plans prior to and during commencement and certified the building on completion.

Title The freeholder of the property was a small real estate and consulting company, named Bamboos Consulting ltd, with registered address in St. John Street, London, United Kingdom. We have inspected the documents of Title and verified with the Lands Tribunal that the subject of interest is unencumbered and free from any unduly onerous or unusual easements, restrictions, outgoings, covenants, mortgages, leases, offers to sell or rights (of way, grazing, etc). Bamboos Consulting ltd agreed the sale of the land for £ 100.000, to be paid at the end of the development period, or one year after the contract was entered into, whichever occurred sooner, with a monthly penalty of £ 1.000 in case of delay. For the purpose of valuation, the client agreed with the valuer to report the full details and to consider the contract as signed. [RICSVIP]

Environmental Matters and Contamination We have not been provided with an Environmental Assessment and our comments are based upon our knowledge of the area and our superficial inspection of the property and the immediate environs. We are not aware of the content of any environmental audit or other environmental investigation or soil survey which may have been carried out on the property and which may draw attention to contamination or the possibility of any such contamination. We have therefore assumed that none exists. [RICSVIP]

4. Construction and Letting The development scheme, realized with a traditional procurement route, consists of 10 storey residential building with retail space at the ground floor. It consists of a NIA of 1790 sqm, excluding 160 sqm of common areas and a total GIA of 2175 sqm. The retail NIA is 170 sqm (2 shops of 70

sqm and 120 sqm respectively) and the residential NIA is 1600 sqm. It has 235 sqm at floor 0 and 190 sqm at each subsequent floor (including stairs and lift). The remaining 40 sqm of the common areas are destined to the small terrace on top of the building. [COMM], [CPD]

Building Shape and Orientation The building design shape is traditional and with two main views, North and South. The orientation has been choose to optimize costs and parking facilities.

Structural Design Concept The total building height is 35 mt, we measure internally 3,60 mt for the retail and 2,80 mt for the residential. Traditionally built, external walls are painted.

Car Parking Bay Design Concept It complies with the Council's transportation policies and objectives; it is provided in the land around the property and it consists of 15 common car park bays.

Lettable Area Retail 11%. Residential 80%. Residential (as statement 106) 9%.

Land The payment for land, £ 100.000, will be deferred one year or at project’s end, whichever will occur sooner, with a monthly penalty of £ 1.000 in case of delay.

Finance Short-term finance covering 80% of building costs has been granted on the following conditions: 6% year rate, 12 months interests only, Optional conversion to permanent loan, 20 years term.

Rental Rate and Units’ Price Rents and values for residential and retail units have been estimated from comparables properties (see appendix 1) assuming contracts 5 yrs FRI for the shops and 5 yrs AST for the apartments. Two units will be rented at reduced price as required by the statement 106 (affordable housing).

Operational Expenses All the costs have been estimated in £ 43.680 yearly (see appendix 1).

Professional Fees and Development Team Fees are estimated as a fixed percentage of the planned construction costs: 0,5% for planning, 2,5% for architect, 1,5% for project management and development direction, 1,5% for engineer. For simplicity included in construction costs. All the professionals were employed as external consultants. Tax Aspects and Transaction Fees The Council Tax for the developed property is in band 3 with a figure of £ 6.500. In the valuation we have assumed an Income tax of 33% and a transaction fee of 5% (paid totally by the buyer) but the tax burden depends mainly on the kind of transaction and legal nature of the parties in transaction. The customer agreed to not account for VAT in the valuation.

Construction Costs, Developer’s Profit and Contractor Estimated in £ 1.000 per sqm. Developer’s profit has been estimated at 10% of construction costs, slightly reduced due to UK economic conditions. The developer opted for a simplified single stage selective tendering.

Timing and Phasing Timing has been estimated in 6 months for planning, 12 months for construction and 6 months for letting. All the permissions have been collected in the estimated time. The construction time has been 14 months, delayed of two months because of issues with the removal of wild animals (with a

sanction of £ 10.000) from the construction site, thus the sale/lease-up phase shifted of two months. The latter could be shortened to three months but lasted four because of post construction issues (leaks in 2 units, the delay caused a reduction in price of £ 10.000). A proper phasing and staging managed process was not adopted on developer’s assumption that the size of the project did not require it. [RED], [CPD]

Sales and Letting All the activities have been outsourced to a chartered surveying firm partnered by a local commercial agent charging the developer a total commission of 5% of the transacted value.

• 6 residential units sold in month 16 for £ 594.000

• 6 residential units sold in month 17 for £ 582.000

• 6 residential units sold in month 18 for £ 570.000

• 2 residential units sold in month 19 for £ 110.000

• 2 commercial units sold in month 19 for £ 515.000

Risk Premium We assume a positive but cautious medium term outlook, and we start from a 2,5% risk premium for residential/retail sector.

• The tenant risk class: unemployment is increasing -> +0,4%

• The lease risk class: slightly below average, upwards increases, 5+5 yrs -> +0,3%

• The building risk class: new -> +0,2%

• The location risk class: no planning restrictions, positive reclassification -> 0,14%

Summing up we have a real estate risk premium of 3,54%. [BAUM], [LING]

5. Outcome of Development To analyze the development we start from the net rent, obtained from comparables, and the realized sale’s value. Given the risk premium, which for simplicity we assume to be the same for the residential and commercial part, we find a corresponding opportunity cost of 4% reflecting the tight condition of the mortgage market. Since inflation in the last 10 years averaged 2%, the 6% construction loan less inflation and opportunity cost calculate a 0% lender development premium. Thus, we can conclude that the financial costs are of difficult improvement. In appendix 11 we have bootstrapped different yield curves to obtain estimates of the previous financial environment:

• with a lower opportunity costs we find corresponding property values that may or may not represent the real market value but that in some way point to the expected value that the RE market will adjust to.

• It is when demand in the RE market is growing that lenders start to support the property cycle.

We provide a simulation of a similar behavior with the stock flow model in appendix 5 for the purpose of qualitatively reassume the argument. We use traditional and modern methods to valuate: RLV, SFFA and NPV of project to assess the initial viability of the scheme, DCF to analyze and appraise the real development. The main difference between DCF and the other models relates to the timing and extent of cash out flows since different patterns of expenditures have a strong impact on financial costs. The capitalized value is obtained with the growth explicit equated yield model, using the 6,21% all risk yield as a capitalization’s rate. Vacancy has been characterized as a fixed percentage of rent instead of including it in the all risk yield. From our initial analysis of the scheme we obtain a required rent of £ 120/sqm and a maximum supportable

cost by loan of £ 1.800.000, requiring thus an additional £ 480.000 equity to be provided by the developer and alerting us that the NOI seems to be insufficient (see appendix 1 and 2). This clearly implies that margins are reducing and requiring intervention. From the RLV we obtain a negative figure (£ -190.000) as well as solving for discounted profits (£ -280.000). Finally evaluating the NPV of project and assigning different risk factors to each phase (development, lease-up and operational, represented in appendix 3) we obtain another negative figure (£ -90.000, not including developer’s profit). Assessing the real development using a DCF approach identifies the loss in £ -250.000 (see appendix 4). The DCF accounts for three streams of money: Cash Flow from Operations (or after construction costs), Cash Flow after Financing, and Cash Flow after Taxes. This approach has been chosen to take in consideration the impact of financial leverage, taxes and construction costs. [WU], [POOR], [SEGEL], [RED], [RICS2], [WHEAT], [RICSRP], [CPD]

6. Sensitivity Analysis and Risk Management In appendix 6 we provide a simulation, using triangular distributions, to demonstrate how the main variables of the RLV can affect profitability. The same simulation can be applied to any of the proposed valuation approaches. Looking at the summary statistics, in particular to variance, can confirm the negative outlook but the result is heavily dependent on distributions and ranges of the input parameters. Experience, good estimation and forecasting abilities are essential and confirm that risk management need to be integrated in all the business processes of the company to be effective. When this is not possible and risk must be managed, it could be better to switch to integrated procurement strategies like package deals. For each variable below, we provide suggestions to manage and reduce risk in case of unexpected fluctuations. [CPD]

• Rents/Values: pre-let/pre-sale contracts are a common strategy but at the price of reduced profits. While this variations should be always taken in consideration there is little to do a part to quantify the risk and to estimate the probability. Other strategies include early letting agent appointment and aggressive marketing and advertising. In the case in object, we suggest to increase the quality of the product in order to compensate the decrease in demand with greater margin, for instance adopting the features reported in the last paragraph of chapter 2. [CPD]

• Interest Rates and Finance Costs: usually the impact of interest rates on finance costs could be reduced with fixed rate loans or financial instruments that will edge the risk of fluctuations in interest rates (swaps, collars and caps). A change in interest rates usually point to a wider movement of the whole economy and thus it can have an effect on demand, substantially changing the assumed rent/values and opportunity cost. In small projects a second and reduced design could be an option; generally we suggest monitoring interest rates and demand, to plan for a worst case scenario and to carefully evaluate if the development should not be started. Project linked debt, which requires the sale of a scheme prior to completion, could reduce further the developer’s profits and increase the risks in the lease-up phase. The option to convert the construction loan to a permanent loan allows to decrease the outflow of money in the worst case and to change development strategy (for instance retaining part of the development as an investment). [CPD]

• Construction Costs: site investigation and design works completion (including drawings and bill of quantities) are the key factors to reduce risk, proper estimates and analysis of cost variations should be available together with some factual proposals (alternative designs or construction techniques) to resolve or avoid the issue. Always require a tender price appraisal from a quantity surveyor; preferably use JTC standard contracts and warranties or insurances. In appendix 9 we provide an example of a traditional cost analysis, more modern techniques like BIM integrate the cost analysis at design time and provide a pre-tender estimation. [IBBC], [CPD]

• Development Time: the main effects are on finance costs, project management techniques like Pert simulations help in the estimation and optimization of development

time. In appendix 10 we provide a simulation that confirms the estimated development time of 12 months. The delay of two months (to remove wild animals from the site) could be avoided requiring an environmental or site assessment and could be scheduled as a parallel process in the initial site works. Thus, since it seems to be more a process problem than a time management one, we propose an example process/role’s responsibility table with integrated risk management (see appendix 14). [CPD]

• Post Development Issues: we suggest the use of insurance covers and/or retainage through contracts. The reduction in price caused by leaks could be avoided requiring quality controls and inspections before final payments and integrating risk management as reported above. [CPD]

• Inflation: we summarize the effects of inflation in appendix 13 and we suggest the use of contracts to limit the increases in the costs of labour, material and money, to trade off with pre-let/pre-sale contracts and to use insurance covers for leases. [COMM]

• Yields: lease structure, commonly AST for residential properties and FRI for commercial properties, reflects the main properties of the two markets in terms of length (1-3 year renewable for residential, 6+6 years for commercial), rent review (usually upward and agreed at periodic time in the commercial, at re-let and prevailing market conditions in the residential), security of income (more governed by tenancy turnover rates for the residential), vacant possession (the income stream generated by a commercial property for the investment market is strongly related to low vacancy while vacant dwellings for owner-occupier market usually have higher values) and capital growth (residential property value as an investment is more related to its vacant possession value and market expectations, while commercial is more related to the wider market place). [RICSRP]

• Team: Always require terms of engagement and professional indemnity insurance to correctly identify responsibilities of the members of the development team and to avoid any cost connected to failures in meeting their professional requirements. [RICSRMS], [CPD].

7. Conclusion Using the SWOT analysis reported in Appendix 11 we provide a list of suggestions that could improve the profitability of the scheme and reduce the losses of the development:

• Planning: obtain permissions from the Planning authority avoiding statement 106. This will increase profitability of the whole complex since affordable housing “could” introduce users of different social classes and income.

• Strategy: hold the commercial part of the development as an investment. Converting the short term finance in permanent loan should cover the losses of the development (including the value of the shops), we estimate the rent sufficient to cover permanent loan’s costs.

• Value: add features highly requested by potential buyers: sanitary options, ecological materials, etc. Offering a wider project in term of sqm, kind of residential and retail units, common and recreational areas can drive up profits. Increase efficiency and total sales area (NIA), consider a loading design factor for future extension up to 15 floors.

• Sustainability: acquire funds or reliefs adopting green or energy saving policies, search for some kind of Tax relief for remediation of polluted areas, promotion of sites or job creation.

• Verticalize services: direct sale of apartments and shops, maintenance and management, sale of furniture (kitchens, living rooms, etc.) and other additional services can increase profits up to £ 8.000 per unit (5% agent’s fees + 10% of operating expenses + 20% margin on furniture, etc.).

We mention some factors that may allow for development even in the case of a negative final figure: forecasted increase in yields for residential property, a developer’s company with a structure of costs that need to be sustained, a reduction in the amount of taxes to be paid or a probable strong increase in inflation (see appendix 13). Furthermore we underline the importance of choosing the right use for the site and the right time (see appendix 5 and 11) to implement the development scheme.

8. References Baum, Mackmin, Nunnington, (2011), Income Approach to Property Valuation, Chapters 6,10, EG, [BAUM].

Geltner, Miller, (2002), Commercial Real Estate Analysis and Investments, Chapter 29, Thomson SouthWestern, [COMM].

Miles, Berens, Weiss, (2001), Real Estate Development, Chapters 17,20, ULI, [RED].

Osbourn, Greeno, (2007), Introduction to Building, Image on pg. 118, Pearson Ed., [IBBC].

Havard, (2002), Contemporary Property Development, Chapters 1,2,3,4,5,6,7, RIBA, [CPD].

Wu, Segel, (2012), Note on Financial Leverage in Real Estate, HBR, [WU].

Poorvu, (2003), Financial Analysis of Real Property Investments, HBR, [POOR].

Segel, (2013), Real Estate Finance: a Technical Note based on “Bonnie Road”, HBR, [SEGEL].

Ling, Naranjo, (1997), Economic Risk Factors and Commercial Real Estate Returns, -, [LING].

Di Pasquale, Wheaton, (1998), Urban Economics and Real Estate Markets, Chapter 10, Prentice Hall, [WHEAT].

RICS, 01/03/2008, Valuation Information Paper No. 12, 11/03/2014, www.rics.org, [RICSVIP].

RICS, -, Cash Flow Forecasting, 11/03/2014, www.rics.org, [RICS2].

RICS, -, Valuing Modern Residential Property Designed to be Rented, 21/04/2014, www.rics.org, [RICSRP].

RICS, 01/11/2013, surveys, 11/03/2014, www.rics.org, [RICS].

RICS, -, Risk Management Strategy, 11/03/2014, www.rics.org, [RICSRMS].

Savills, 01/11/2013, Research, 11/03/2014, www.savills.com, [SAV].

Bank of England, 01/11/2013, Inflation Report, 11/03/2014, www.boe.com, [BOE].

OECD, -, Statistical Profiles, 11/03/2014, www.oecd.org, [OECD].

9. Appendix

1. Project Estimations

2. RLV

3. NPV of Project

4. Discounted Cash Flow

5. Stock Flow Simulation

6. Sensitivity Analysis

7. Terms of Engagement

8. Statistical Data

9. Cost Analysis and Development Program

10. Time Estimation with PERT simulation

11. Bootstrapping Yields Curves – SWOT Analysis

12. Site Location and Maps

13. Inflation

14. Process/Role Table and Risk Management Integration

Appendix 1. Project Estimations.

Appendix 2. RLV.

Appendix 3. NPV of Project.

Appendix 4. Discounted Cash Flow.

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Appendix 5. Stock Flow Simulation.

Appendix 6. Sensitivity Analysis.

Appendix 7. Terms of Engagement.

Identification of the client: General Developer Plc.

Purpose of valuation: Evaluate the development scheme and improve its performances, identify the profit/loss of the development.

Subject of valuation: Only the property, and its development, situated at the junction of Chestnut Avenue and Holly Close, Manny Town, UK.

Interest to be valued: Residential/Small Retail development of the land plot identified above.

Type of asset: Development on Freehold property

Basis: Market Value.

Valuation date: 21st April 2010.

Valuer: Dr. Roberto Garrone.

Disclosure of Involvement: Given the valuer’s interest in the property he declares that any conflict that may arise, in past, present or future, has been resolved in a satisfactory way.

Currency: British Pound.

Investigations’ Extent: All the investigations required by the client have been done with the diligence required, with considerations to the Letter of Instruction.

Third party Information’s: All the relevant information provided has been verified personally by the valuer. Statistical data is provided “as is” and with no warranty.

Restrictions on publication: No reproduction’s right is granted to the client, except for internal use.

Valuation’s Standard The valuation complies with the RICS Valuation - Professional Standard (2012).

Professional skills: The valuer declares to have knowledge, skills and understanding to undertake the valuation competently.

Fee: 0,75% of the sale’s price when sold or £ 3.000 plus vat before sale.

Institution’s Monitoring: It is possible that the valuation may be investigated for compliance with these standards.

Assumptions: Some assumptions are made in Appendix 1,8 and in chapters 2,3,4. Please note that forecasts of any type may or may not represent real values.

Valuation approach: Comparables, NPV of Project, Residual Land Value, Discounted Cash Flow.

Appendix 8. Statistical Data.

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N.B.

Since the difficulty to obtain local data we analyze national data and assume to proportionally adapt the conclusions.

Appendix 9. Cost Analysis and Development Program.

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Appendix 10. Time Estimation with PERT simulation.

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Appendix 11. Bootstrapping Yields Curves – SWOT Analysis.

Appendix 12. Site Location and Maps.

Appendix 13 Inflation.

Appendix 14. Process/Role Table and Risk Management Integration.