HS2 Property Bond Cost Report · 2014-07-07 · HS2 property bond Cost report PwC 1 This document has been prepared only for the Department for Transport (DfT) and High Speed Two

www.pwc.co.uk

HS2 property bond

Cost report

Final Report

March 2014

HS2 property bond

Cost report PwC Contents

HS2 property bond

Cost report PwC 1

This document has been prepared only for the Department for Transport (DfT) and High Speed Two (HS2)Limited and solely for the purpose and on the terms agreed with High Speed Two (HS2) Limited in ourengagement letter dated 10 January 2014. We accept no liability (including for negligence) to anyone else inconnection with this document.

This document contains information obtained or derived from a variety of sources as indicated within thereport. PwC has not sought to establish the reliability of those sources or verified the information so provided.Accordingly no representation or warranty of any kind (whether express or implied) is given by PwC to anyperson (except to the DfT and High Speed Two (HS2) Limited) under the relevant terms of the Engagement) asto the accuracy or completeness of the report.

In the event that, pursuant to a request which High Speed Two (HS2) Limited has received under the Freedomof Information Act 2000 or the Environmental Information Regulations 2004 (as the same may be amended orre-enacted from time to time) or any subordinate legislation made thereunder (collectively, the Legislation),High Speed Two (HS2) Limited is required to disclose any information contained in this document, it will notifyPwC promptly and will consult with PwC prior to disclosing such document. High Speed Two (HS2) Limitedagrees to pay due regard to any representations that PwC may make in connection with such disclosure and toapply any relevant exemptions which may exist under the Legislation to such document. If, followingconsultation with PwC, High Speed Two (HS2) Limited discloses this document or any part thereof, it shallensure that any disclaimer which PwC has included or may subsequently wish to include in the information isreproduced in full in any copies disclosed.

This report does not necessarily represent the views of High Speed Two (HS2) Limited and the DfT. HighSpeed Two (Hs2)Limited and the DfT do not guarantee the accuracy, completeness or usefulness of theinformation contained within the report which was derived from a variety of sources as indicated within thereport; and cannot accept liability for any loss or damages of any kind resulting from reliance on theinformation or guidance this document contains.

Important notice

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Important notice 1

1 Introduction 3

2 Approach 4

3 Assumptions 6

3.1 Timeline for a property bond 6

3.2 Number of properties that are eligible 7

3.3 Value of eligible properties 8

3.4 Registrations for property bonds 9

3.5 Eligible property owners selling each year 11

3.6 Proportion of properties that fail to sell at protected value 13

3.7 Level of blight 17

3.8 Property management 19

3.9 Rental market 21

3.10 Property sales 22

3.11 Transaction costs 23

3.12 Administration costs 25

3.13 Other assumptions 27

4 Outputs 28

4.1 120m eligibility 28

4.2 300m scenario 30

4.3 500m scenario 31

5 Sensitivities 34

6 Model limitations 40

Table of contents

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1 Introduction

This cost report in relation to a HS2 property bond has been prepared in conjunction with PwC’s final report onthe implementation of a property bond scheme. It should be read alongside that document and reflects theassumptions that are contained within that report about how a property bond scheme would operate.

PwC has developed, in conjunction with DfT and HS2 Ltd, a cost modelling tool which allows for an assessmentof the potential cashflows associated with introducing a property bond based on a range of differentassumptions. These assumptions have been discussed with a number of professional organisations.

The cost model has been designed to provide a tool which is able to:

Provide an illustrative cost of implementing a property bond scheme based on given assumptions;

Calculate a range of potential Net Present Values/(Costs) for a property bond scheme based on thesame assumptions; and

Quantify the potential capital requirement (both total and within a certain year) associated withimplementing a property bond scheme based on the given assumptions.

The cost model has also been designed to allow for sensitivities to be run which show the impact of changingassumptions on the key model outputs.

This document sets out:

The approach that has been adopted in developing the cost model;

The assumptions that have been used in producing the illustrative results;

The illustrative outputs of the model using the base case assumptions;

The impact on the model outputs of changing the underlying assumptions of the model; and

The limitations of the cost model.

HS2 is a project that is without precedent in the UK. This means that there is minimal evidence on the impactthat an infrastructure project of this scale would have on the property market. Similarly, no property bondscheme of this type and extent has been introduced in the UK and therefore there is no empirical evidence ofthe market effects of implementing a property bond.

On this basis, many of the assumptions that have been made in developing the cost model are subjective andare based on a number of professional judgements. It is unlikely that the actual outcomes would mirror theassumptions that have been made in developing the cost model and any deviation between the assumptionsmade in developing the model and reality has the potential to have a significant impact on the model outputs.

The outputs that are generated from the cost model should always be reviewed in this context.

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2 Approach

2.1 Development of cost model

At the outset of our engagement, PwC prepared a cost model specification document which was shared andagreed with DfT and HS2 Ltd.

This document set out:

The objectives of the model;

The proposed model structure;

The input data requirement; and

The accepted limitations of the model (i.e. what is outside the scope of the model).

This cost model specification has been referred to throughout the development of the cost model and the finalversion of the modelling tool is in line with industry standards for modelling.

In particular, the cost model has been developed to conform to modelling best practice. In particular, the tool:

Has separate input, workings and outputs sheets;

Separates out time based and non-time based inputs;

Uses consistent formulae across rows;

Presents its workings in a transparent manner;

Has been reviewed by someone other than the original model developer (although has not been subjectto formal audit); and

Allows flexibility for different scenarios and assumptions to be easily run through the model.

PwC facilitated a workshop with DfT and HS2 Ltd where the functionality of the cost model was demonstrated.

In addition, the model has been developed to reflect the costs and structures that are assumed within PwC’sfinal report on implementing a property bond which sets out the administrative design of the scheme.

2.2 Development of assumptions

Section 3 of this report outlines the assumptions that have been used in the cost model in order to generate theoutputs that are set out in section 4. In addition, section 3 contains supporting information which documentsthe rationale behind specific assumptions.

Where possible, the model has been prepared on the basis of inputs and data sets which are based on empiricalevidence so a higher degree of confidence can be obtained over the input assumption. For instance, the numberof properties that are located within fixed distance bands from the line has been compiled over a number ofyears and we understand from HS2 Ltd that this data is comprehensive and is therefore unlikely to materiallyalter.

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However, many of the assumptions that have been required to develop the cost model cannot be based entirelyon empirical data and therefore involve making a number of subjective judgements.

Where these judgements have been required, a collaborative approach has been encouraged which has soughtto leverage relevant experience from other major infrastructure projects, HS2 Ltd’s existing property schemesand the professional judgements of a number of informed parties.

A series of workshops and meetings were facilitated with representatives from DfT, HS2 Ltd, VOA (ValuationOffice Agency), HMT and we have also met with professional organisations such as CBRE to draw upon theirexperience in refining the assumptions that are detailed in section 3 of this report. A number of refinementshave therefore been made to the assumptions as a result of these discussions. In addition, separate discussionshave been facilitated by DfT and HS2 Ltd with RICS, CML, CBRE and NAEA about specific assumptions andtheir views have been considered and reflected in the base case cost model inputs.

Given the subjective nature of a number of the inputs, a range of sensitivities have been run on the cost modelwhich demonstrate the impact on the model results from changing a specific assumption. Details of theseresults are included in section 5 of this report.

2.3 Scenarios

Based on the approach to developing inputs outlined above, for several assumptions it is believed to beinappropriate to only include a single assumption within the cost model as the actual outturn position is likelyto fall within a range and there is little basis for selecting a specific value relative to any other. Therefore, thecost modelling has been prepared on the basis of two scenarios:

‘Optimistic’ scenario – this assumes that a property bond achieves many of its objectives and arelatively viable property market is maintained. In particular, the presence of the bond limits thenumber of owners looking to sell their properties, there are lower levels of blight and most properties(other than those in close proximity to the line) are able to sell in the private market at an un-blightedvalue; and

‘Pessimistic’ scenario – this assumes that a property bond does not achieve all of its objectives andthe property market does not function as intended. In this scenario, we are assuming that a highernumber of property owners would look to sell their properties, blight levels would be higher and thereis limited demand in the private market to acquire properties at an un-blighted value, hence HS2 Ltdpurchase more properties,

It should be noted that these two scenarios do not represent all possible outturns and there is a possibility thatactual performance of the scheme would be outside the range captured by these two scenarios. In particular, the‘pessimistic’ scenario should not be considered to represent the ‘worst case’ scenario as this would reflect asituation where a very high proportion (90+%) of property owners look to sell under a property bond and thereis a material level of ongoing blight.

In addition to the ‘optimistic’ and ‘pessimistic’ scenarios, the cost model has also been prepared based on threepotential eligibility criteria. These are all distance based and consist of:

120m from the line in rural areas;

300m from the line in rural areas; and

500m from the line in rural areas.

Section 3 includes details of where the assumptions that have been adopted are assumed to vary based on thedifferent eligibility criteria.

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3 Assumptions

This section outlines the assumptions included in the cost model and used for generating the outputs that areshown in section 4 of this document. Alongside the current model assumption, the rationale for the assumptionand a summary of the available evidence is also provided.

The diagram below shows the main components of the cost model where assumptions have been developed inorder to produce output results.

Those assumptions which are circled are both particularly subjective and have a significant impact on theoverall output of the cost model and should be the main focus of sensitivity analysis.

In addition, a number of assumptions have to be made about the nature of the housing market during theperiod over which any property bond scheme operates as this will have a fundamental impact (alongside thelevel of blight) on the value at which HS2 Ltd can sell a property. Therefore, the cost model also includesassumptions about the levels of house price inflation and the average time to sell a property in the marketduring the period that any property bond scheme is active.

3.1 Timeline for a property bondThe cost model has been prepared on the basis of an assumed timeline for the project as documented in thetable below:

Date Assumption

Property bond introduced April 2015

Construction commencement 2017

Construction substantially complete 2024

Railway opens to passengers 2026

Commencement of statutory (Part 1) compensation 2027

What is donewith properties

acquired?

If leased, whatrevenuesreceived?

When areproperties sold?

What is thevalue at point of

sale?

Sale transactioncosts

Transaction volume

Costs and revenues of acquired properties

Design and set-up costs

Costs perregistration

Costs when saleprocesstriggered

Costs foracquisition

Ongoing internalcosts

Admin and internal costs

Number ofproperties that

are eligible

Number ofproperties that

register

Number ofowners that lookto sell each year

Number ofproperties thatfail to sell for

protected value

Number ofproperties HS2

acquires

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Between the completion of the majority of the construction works and the railway opening to passengers, weunderstand there would be a 12-18 month testing period. This period is likely to involve minimal constructionrelated disruption to property owners.

A number of the assumptions within the model (e.g. blight levels) are sensitive to the progress of construction.In the event of scheme commencement being delayed or construction of the railway taking longer thanenvisaged the assumptions contained within the cost model would require revisiting.

In addition, unless otherwise stated, all costs that are stated in this report have a base date of April 2014. Thisdate has also been used in NPV calculations.

3.2 Number of properties that are eligible

In line with the eligibility criteria outlined in PwC’s report on the implementation of a property bond, the costmodel has been prepared on the basis that:

Eligibility within rural areas would be distance based and scenarios based on a property bond boundaryof 120m, 300m and 500m from the line have been modelled; and

Within suburban areas, eligibility would be restricted to those properties that are within an 80mcorridor of the railway unless the line runs adjacent to existing rail/road infrastructure in which casethe properties are not included.

As instructed by HS2 Ltd, any property bond scheme, and hence our analysis would not include properties thatare above tunnels or in urban areas.

The table below shows the number of properties that are assumed would be eligible for a property bond,excluding those properties that are within the safeguarded area or already in the ownership of HS2 Ltd.

Area Up to 40mfrom line(suburbanonly)

Up to 120mfrom line1

Up to 300mfrom line

Up to 500mfrom line

London Metropolitan 22 n/a n/a n/a

BirminghamMetropolitan

39 n/a n/a n/a

Country (South) n/a 265 1,133 2,930

Country (North) n/a 83 541 1,820

TOTAL 61 409 1,674 4,750

These numbers have been provided by HS2 Ltd and we understand that they have been prepared on thefollowing basis:

1 CBRE has provided data that demonstrates there are 586 properties within 150m of the line. HS2 Ltd hasinformed us that there are 561 properties that are within 120m of the line. These 561 properties have been splitbetween the two rural areas in line with the apportionment shown in the CBRE data and the number ofproperties that are within the safeguarded area or in the ownership of HS2 Ltd removed from the totals.

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property count data that has been provided by CBRE to HS2 Ltd;

the property count has been cross-checked by HS2 Ltd against a desk-top survey they have undertaken;

any properties that are within the ownership of HS2 Ltd have been removed from the totals; and

any properties that are within the safeguarded area have also been removed.

Properties within the safeguarded area have been removed from the count used within the model. Whilst theseproperty holders would be eligible for a property bond scheme, the additional payments that they would receivethrough the safeguarding process means it is unlikely that an eligible property owner would choose to use abond scheme.

In addition, it is proposed that any property bond would only be intended to be available to owner occupiers (orthose who have been forced to become landlords due to personal circumstances) rather than professionallandlords. The numbers in the table above include all residential properties.

Therefore in order to obtain the number of properties that are eligible for a property bond any residentialproperties that are owned by professional landlords need to be excluded. DCLG’s ‘English Housing Survey 2011to 2012’ shows that nationally 65.3% of households are owner occupied.

However, the rural nature of the vast majority of eligible properties would suggest that these properties aremore likely to be owner occupied than the national average which is influenced by areas like London where the2011 census showed that 50.4% of people in London live in rented property.

A desktop exercise assessing the amount of rental properties in the areas affected by HS2, alongside discussionswith HS2 Ltd’s officials who are operating existing property schemes and have an understanding of the localmarket would suggest that only c. 5% of eligible properties are likely to be held by professional landlords. Thisassumption has been used in the cost model.

Assumption Model level

Proportion of homes that are owneroccupied

95%

Any increase in the proportion of rented properties would reduce the number of properties that would beeligible for any property bond.

3.3 Value of eligible properties

Alongside the number of eligible properties, the cost model has been developed based on assumptions aroundthe average un-blighted value of properties within a particular property bond area.

CBRE has undertaken a number of valuation exercises for DfT and HS2 Ltd in relation to the HS2 project. Weunderstand that these have used a range of different approaches in order to establish valuations for differentpurposes.

For the cost model we have been instructed to use the average valuations that are set out in the table below. Weunderstand that these are:

Average valuations based on detailed valuations (which have included site visits) that CBRE has carriedout on properties that fall within 100m of the line;

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These averages have then been assumed to apply consistently to properties that are outside the 100mboundary; and

Are at a base date of July 2013 and reflect un-blighted (i.e. no-HS2) valuations.

Other than where required in relation to specific transactions under one of HS2 Ltd’s existing propertyschemes, we understand that HS2 Ltd has not undertaken any detailed valuation exercise across a sample ofproperties that are not within 100m of the line.

However, analysis of actual valuation data provided by HS2 Ltd from the administration of statutory blightnotices and the Exceptional Hardship Scheme (EHS) shows that the average value of completed purchases toJanuary 2014 is £600k with an average in the Country (South) area of £651k and in the Country (North) area of£561k.

This compares to the average valuation under the CBRE data of £586k to £631k per property (depending whicheligibility criteria is adopted) across the potential property bond area which is c. 5% higher than the propertiesthat have been purchased under the EHS. In addition, the EHS data shows that values within the Country(South) area are significantly lower (c. £124k) than in the CBRE data but those properties within the Country(North) area are significantly higher (c. £136k).

CBRE has undertaken a desktop analysis of values of properties up to 500m from the line based on council taxbandings but they believe that the more detailed valuations they have on properties that are within 100m of theline represents the most robust data set that they have available.

Area Average un-blighted value as providedto PwC (July 2013 base date)

London Metropolitan £450,000

Birmingham Metropolitan £125,000

Country (South) £775,000

Country (North) £425,000

The numbers in the table above are used as the base values for the purposes of the cost model.

In order to get greater certainty about the average value of properties further from the line (say 300m-500m),

HS2 Ltd could consider commissioning a further valuation exercise to review a sample of properties and

establish their un-blighted value.

3.4 Registrations for property bonds

As outlined in the PwC report on implementing a property bond, there are a number of measures that HS2 Ltdshould consider in terms of managing the number of registrations for a property bond.

For the purposes of the cost model, the following assumptions have been adopted:

HS2 Ltd seeks to encourage people to obtain a property bond;

the application process is transparent and simple; and

all eligible property owners are able to apply for a bond from day one with no registration fee beingcharged.

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In addition, when considering the likely rate of bond registrations a number of factors have been taken into

account. These include:

the Council of Mortgage Lenders (CML) is likely to advocate that its members encourage eligible

property holders to obtain a bond which would prompt people to acquire a property bond;

registering for the bond entitles the potential bondholder to have their property valued at nil cost to the

owner;

the level of response to property consultations has demonstrated a high level of interest in this area

which could lead to large numbers of early registrations; and

an eligible property owner who looks to sell their home is likely to register for a bond prior to marketing

their property and estate agents would advise as such.

Set against these factors suggesting a high level of take-up, the response rate for voluntary schemes that have

been run across the public sector is not universal. For instance, on HS1 we understand that over 300 referrals

were made to the Lands Tribunal (now the Upper Tribunal Lands Chamber) in respect of subsoil acquisitions as

a result of eligible parties failing to complete paperwork which entitled them to £550.

Based on the various considerations identified above, in all scenarios we are assuming in the base case of the

cost model that registrations would have the profile shown in the graph below. Notably this includes:

a peak in take-up (c. 35% of eligible property owners) at the outset of any scheme;

this declines over time as more properties obtain a bond during the start of the construction works;

post 2019, any registrations are assumed to relate to property owners who decide to sell who had not

previously registered for a bond; and

over the life of a bond, c. 95% of property owners are expected to register.

The rate and total quantum of registrations does not have a material impact on the cost model as the actual

costs incurred with registering a property bond would be relatively small.

An understanding of likely take-up is most relevant to the operational design of a property bond administrative

structure as this vehicle would need to be able to process the anticipated volume of cases.

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3.5 Eligible property owners selling each year

A material assumption in the cost model is the number of eligible property owners who would look to sell their

homes each year.

The timing of transactions would be both dependent on, and be influenced by, a number of other assumptions

that are contained within the cost model. For instance, the level of blight at a given point in time is likely to lead

to an increase in eligible property owners looking to sell whilst one possible cause of blight might be if a large

proportion of property holders decided to move in a short time period.

There are a number of different considerations that would influence the property market to deviate from its

normal pattern as a result of HS2 and a property bond. These include:

it is generally accepted that a number of properties would experience disruption during the

construction works;

a property bond potentially makes it easier for property owners who have decided to sell to do so when

compared to normal market conditions, but may also provide certainty to property bond holders and

therefore discourages ‘panic’ selling; and

the costs (financial and non-financial) associated with moving are significant and many homeowners

are unlikely to want to move unless there is significant disruption or blight on their property.

For the purposes of the cost model, it has been assumed that:

Without HS2 or the existence of a property bond, the average property owner would be likely to sell

their home once every 20 years (i.e. 5% per annum). This is based on DCLG’s ‘English Housing Survey

2011 to 2012’ which shows that the mean average for owner occupiers living in their current residence is

17.1 years. In rural areas, the average time between house sales tends to be higher and therefore an

assumption of a non-HS2 baseline of 20 years is assumed.

At the point of introducing any property bond there is an expectation that there would be an initial

increase in the number of property owners who decide to sell above the long term norm.

(i) In all scenarios, it is assumed that a number of property owners who would ordinarily have sold in

the years immediately prior to any property bond being enacted have delayed their decision to sell

until after a property bond is introduced; and

(ii) in the pessimistic scenarios, the introduction of a property bond alongside general fears about the

impact of HS2 and perceived blight prompts some property owners to decide to sell (in the 120m

scenario c. 7.5% of owners) who in a normal market would not have moved.

Both of these factors are more prevalent in the scenarios that involve the tightest eligibility boundary

criteria as it is assumed that the closer the proximity of properties to the line the more likely it is that

property owners would experience blight and have greatest concerns about the impact of the railway.

Once construction commences, it is assumed that more property owners would look to sell than in

normal market conditions due to the inconvenience that is caused by construction activity and a

property bond providing home owners with a tool that assists them in selling their homes. This increase

is anticipated to stay constant throughout the construction period recognising that whilst there would

be localised spikes in construction activity on average the pattern across the entire route is likely to be

relatively constant.

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The increase above normal market levels of activity would be most prevalent in the 120m pessimistic

scenario where the cost model has been prepared on the basis of twice as many owners as normal

deciding to sell during the construction works.

As any property bond expires and its benefits to property owners expire and be replaced by less certain

statutory compensation, it is assumed that there would be a spike in owners looking to sell their

properties at the end of the scheme (in 2025). The level of any spike at the back end would be linked to

the level of blight at that point in time and the extent to which perceived blight is greater than the costs

(both financial and non-financial) associated with moving. It is assumed that the closer a property is to

the line, the more likely that the level of blight would justify a decision to move as the end of any

property bond scheme approaches.

The graphs below show the profiles used in the base case cost modelling assumptions that have been developed

in conjunction with HS2 Ltd based on the factors outlined above. The graphs show the proportion of eligible

property holders (i.e. those that still have a property bond in place) who could look to move each year.

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The proportion of eligible property holders who may look to sell each year has a material impact on both the

overall cost of a property bond and the capital budget required to finance acquisitions within a specific year.

The effect of changing the assumptions from the levels shown in the graphs above is shown in section 5 of this

report.

3.6 Proportion of properties that fail to sell at protected value

The cost model takes the number of properties where the owner decides to sell each year (in line with the

assumptions outlined in 3.5 above) and then calculates what proportion of those properties HS2 Ltd is likely to

acquire each year as a result of properties failing to sell for their protected value.

In order for HS2 Ltd to avoid acquiring a property, a purchaser would need to be willing to pay the protected or

un-blighted value for a property on the basis of a property bond being in place. There is no empirical data

available which evidences the willingness of buyers to pay an un-blighted value given the presence of a similar

property bond to that proposed.

Purchasers would be most likely to buy a property at its protected value if:

they believe that the time limited guarantees offered by a property bond would have a value equal to the

value of any blight;

the purchaser perceives there is no (or minimal) blight associated with a property as a result of the HS2

railway;

the security of having a purchaser of last resort in the government is attractive to the purchaser; or

a potential purchaser has a strong personal motivation for wanting to live in a certain area.

Notwithstanding the factors identified above, we consider it unlikely that there would be strong demand for

properties that have been blighted but marketed at a protected value based on a property bond being in place.

This reflects experience from other schemes where there has often been a pool of buyers still willing to purchase

properties but that the number of buyers in a certain market usually contracts at the point that disruption (e.g.

major infrastructure works) commence. If this follows there would therefore be fewer purchasers in the market

likely to pay a full protected value for properties.

The impact of blight is likely to be highest in properties that are closest to the railway. Therefore, in the 120m

scenario it is assumed:

in the ‘optimistic’ scenario, c. 20% of property transactions take place on the open market during the

construction period where blight is at its highest. From 2023 when construction is completed in certain

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areas, it is assumed that the property market would begin to recover and purchasers would be more

willing to buy properties at protected value; and

in the ‘pessimistic’ scenario, a similar profile is assumed albeit the higher levels of blight initially (40%

as detailed in section 3.7) means that almost no open market transactions would occur on properties

that are within 120m of the line and therefore HS2 Ltd ends up purchasing all properties.

When the eligible boundary criteria is extended to 300m and 500m, it is assumed that properties further away

from the railway would exhibit different market dynamics than those closer to the railway. In particular, the

extension of eligible boundary criteria means that a number of properties would fall within the scope of any

property bond scheme but may not suffer material blight due to HS2 (e.g. a property that is 450m away which is

not on a route used by construction traffic and which sound contours show would be unaffected by the railway’s

operations).

On this basis, in the 300m and 500m cases it is assumed:

In the ‘optimistic’ scenario, a proportion of the market would continue to function as normal and prior

to 2023 HS2 Ltd would be required to purchase:

(i) Any additional properties that come to the market as a result of more property owners selling each

year than would be the case in a no HS2 environment. (i.e. the assumptions for the supply side of

the market suggest that there would be an increased supply which is unlikely to be matched by an

increase in purchasers willing to pay protected values to provide the increased demand to match

the increased supply).

(ii) A proportion of the properties that in normal market conditions would have sold but have failed to

sell as a result of HS2. This is based on the assumption that, compared to a non HS2 environment,

fewer purchasers would be willing to pay the protected value and therefore there would be a drop

in demand below normal market conditions.

Determining the extent of this reduction in demand is subjective and no empirical evidence is available

on which to base an assumption. Key to influencing the behaviour of purchasers would be the level of

confidence that they place in any property bond in protecting the value of the properties they are

considering acquiring. For modelling purposes, in the 300m scenario a reduction in the number of

purchases (relative to normal market conditions) of 40% is assumed and in the 500m scenario a decline

of 20% is assumed.

The table below sets out a worked example based on a situation where in normal market conditions 100

properties would be sold and purchased each year (i.e. there are 100 purchasers and sellers in normal

conditions).

Scenario (A) Number ofproperties

sold each yearwithout

HS2/PropertyBond

(B) Number ofproperties

marketed eachyear with HS2Property Bond

(C) Number ofproperties

bought by HS2due to increasein supply (B-A)

(D) Assumed dropin demand relativeto normal market

(E) Number ofproperties bought

by HS2 due todecrease in

demand(A*D)

300m 100 150 50 40% 40

500m 100 150 50 20% 20

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This shows that:

The impact of HS2 and a property bond could increase the number of sellers to 150 each year;

This is 50 more properties than would be marketed in a no scheme world and it is assumed that there is

no increase in purchasers. Therefore, it is assumed that HS2 Ltd would be required to purchase all 50

of these properties;

In addition, it is assumed that there would be a reduction in the number of purchasers from the 100

purchasers who would be present in a normal market. In the 300m scenario, this reduction is 40% so

the assumed number of purchasers is reduced to 60. HS2 Ltd would be required to purchase the 40

properties where there are no longer purchasers; and

In the 300m example, HS2 Ltd is assumed to acquire 90 properties of the 150 properties that are sold

each year.

In the ‘pessimistic’ scenario, it is assumed that there would be a more pronounced impact on the demand side

of the market and HS2 Ltd would be in a position where it is acquiring almost all of the properties that have

been blighted. The proportion of properties that HS2 Ltd acquires is lower as the eligibility boundary criteria

extends and as construction completes to reflect the fact that fewer properties would be blighted and therefore

able to sell on the open market.

To provide a more robust case for the extent of this reduction in blight as the distance from the railway

increases it would be necessary to obtain a better understanding of current blight levels based on a substantial

data set which would provide evidence about the level of correlation between blight and distance. At this point

in time, this data has not been collected or analysed.

In all cases, the state of the property market at a particular point in time would have a material impact on the

number of market sales that occur. In a weak market where values are declining or stagnant it is likely that HS2

Ltd would be required to purchase an increased number of properties that are brought to the market.

Conversely, in a particularly buoyant market it is likely that there would be greater demand from purchasers

and HS2 Ltd would be required to acquire fewer properties.

RICS’s research suggests that the typical duration of a property cycle ranges from 4-12 years with an average

duration of 8 years (although other research has suggested a longer duration to a typical property cycle). This

would suggest that during the life of any property bond scheme a full property market cycle would occur.

It should be noted that whilst the properties that are eligible for any property bond share a similarity in their

proximity to the proposed HS2 line, they are spread across a large geographical area. Therefore, rather than the

property market viewing all properties with a bond in place as being a homogenous market, the market is more

likely to compare bonded properties with other properties without a bond in a localised market.

A high level review of the available data, suggests that properties eligible for a bond in the 500m scenario would

make up no more than 0.5% of the total number of properties within the local authority districts which have

properties that would qualify for a bond. Whilst the precise proportion of a local market that would be included

within any bond scheme area varies along the route, this demonstrates that the conditions of a local market (as

well as the bond) would have a significant impact on purchaser and seller behaviour in different geographies

and at different points in the life of any property bond scheme.

The graphs below summarise the cost model inputs in the different scenarios:

HS2 property bond

16 PwC Cost report

The extent to which a property market continues to function and purchasers are willing to buy bonded

properties at a protected value would have a material impact on the number of properties that HS2 Ltd acquires

and the overall and peak cash requirement of the scheme. Results of sensitivities showing the impact of

changing this assumption are shown in section 5.

HS2 property bond

17 PwC Cost report

3.7 Level of blight

The level of blight experienced by property owners during the construction and operation of HS2 is important

in determining the overall cost of a property bond as well as influencing a number of other assumptions.

The blight assumptions have been developed based on:

anecdotal evidence around the level of blight that exists in the current market as a result of HS2. It

should be noted that this tends to be based on a very small sample size and involving properties that are

not typical of the properties that would be captured within any potential scheme;

drawing on the experience of other professional advisers (including CBRE who prepared a December

2010 Blight Study for the HS2 scheme) around the available evidence in respect of blight on HS1 and

other major transport schemes; and

considering the available academic literature on the nature of blight and the shape of the ‘blight curve’.

It should be noted that the unique characteristics of HS2 mean that datasets which might be considered

comparable are, on closer examination, not to be relied upon to accurately project the level of blight around

HS2. For instance:

HS1 was predominately constructed adjacent to existing road and rail corridors and the sound

mitigation measures that HS1 introduced meant that for many property owners the introduction of HS1

actually led to a reduction in transport related noise;

HS1 included intermediary stations which meant that many of the communities that had the potential

to experience the greatest blight as a result of HS1 were also able to benefit from improved transport

connections and this has led to house prices increasing faster than the regional market in some areas

such as Ashford;

similarly to HS1, road schemes generally provide a benefit to those living near the scheme from being

able to use the improved transport network which can offset other forms of blight; and

other infrastructure schemes where local residents do not benefit from improved amenity but

experience blight tend to include airport expansions and nuclear power stations. In the case of nuclear

power stations, these tend to be sited in remote areas where comparatively few properties experience

blight. In addition, nuclear power stations tend to employ large numbers of people and therefore can

significantly increase housing demand in a local area. Airports similarly employ large numbers of

people and therefore can increase demand for property in the proximity. In addition, the limited

development of aviation facilities in the UK in the last 20 years means that no project comparable to

HS2 has been undertaken where blight patterns can be observed.

In the absence of robust data from other schemes, the blight levels for Phase 1 HS2 have been prepared based

on the following assumptions:

experience shared with us when consulting other professional bodies suggests that for other transport

projects, generally the highest level of blight experienced is in the region of 35-40% and can be lower;

blight was highest on HS1 for high value properties where the number of potential purchasers is lower

and their perception of value tends to be most affected by large infrastructure projects. HS2,

particularly in the Country (South) section of the line contains properties with an average value that is

significantly in excess of the national average at £775k with a number of higher value (£1m+) homes;

and

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18 PwC Cost report

whilst there is limited supporting data, it is generally accepted and logical that blight follows a curve

that is at its peak during the construction phase of a project before dropping and values moving back in

line with the norm as construction completes and a project commences operations.

On this basis, following discussion with DfT and HS2 Ltd, the cost model has been prepared on the basis of the

blight curves shown in the graphs below.

All of these curves follow a similar pattern involving:

a constant level of blight from the introduction of any property bond to 2023 when construction begins

to complete (NB: the traditional blight curve shows blight increasing as construction approaches. In the

case of HS2, the route has been public knowledge for up to 5 years prior to any property bond

commencing so it is assumed that blight could already be at its construction level);

the peak blight is 40% in the 120m pessimistic scenario which is at the upper level of what has

traditionally been experienced for individual properties in other schemes but reflects a prudent view

that blight could be more severe as a result of HS2 than other recent transport schemes;

blight declines from 2023 to 2026 with the level of ongoing blight at the end of the scheme ranging

from 10% in the pessimistic 120m scenario to 2% in the optimistic 500m scenario; and

the level of blight is expected to be lower the greater the distance from the line.

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19 PwC Cost report

3.8 Property management

The decision that HS2 Ltd may make in respect of managing any properties it acquires is critical to the overall

output of the cost model.

In practice, HS2 Ltd would need to develop a set of asset management principles that would consider for each

individual property the optimum way to manage that property in terms of rental or disposal alongside the

potential to enhance value through making investments in the property stock. It should be noted, however, that

large numbers of disposals into the market at blighted values could have the effect of creating a two tier market

and undermining the efficient operation of any property bond scheme.

For the purposes of developing the cost model, it is assumed HS2 Ltd would take one of two approaches with

any property it acquires:

1. Lease property to tenant

Where a property is leased to a tenant, HS2 Ltd is assumed to obtain income from the tenant in line

with the rental assumptions outlined in section 3.9.

The cost model assumes that once a property has been leased it is then leased until construction has

been completed and is then sold in 2025/26 when blight is at its lowest levels during the life of a

property bond scheme and, due to house price inflation, it is assumed that the value achieved in the

market may be closer or potentially higher than the price paid on acquisition.

Leasing to a tenant would allow HS2 Ltd to generate on-going annual income from the property and

hence the cost model projects a reduced loss on disposal compared to disposing of a property at the

point of acquisition. Indeed, in a rising property market the cost model shows HS2 Ltd could make a

gain (ignoring financing costs) on any properties that have been acquired in the early years of the

scheme and not sold until up to a decade later.

2. Dispose of property

Where it is assumed that HS2 Ltd would dispose of a property this would be at the blighted value at the

point a property is put on the market.

For instance, in the 120m optimistic scenario a property that is acquired in 2016 at a protected value for

£500,000 is assumed to experience 20% blight and therefore if HS2 Ltd seek to dispose of this property

the cost model will show income on disposal of £400,000 and a net loss on the property (excluding all

fees and costs) of £100,000.

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20 PwC Cost report

A third option would be to leave properties vacant but this is unlikely to be attractive in the vast majority of

situations as there would be costs associated with securing a vacant property and it would fail to generate any

revenue for HS2 Ltd whilst unoccupied.

Based on the options available to HS2 Ltd, it is likely that the overall cost of a property bond scheme would be

minimised when as many properties as possible are leased and disposed of following completion of the line

when blighted values have recovered to close to normal. However, increasing the number of properties that are

leased increases the maximum cash resources that a HS2 property bond scheme would require at any point in

time. In this scenario HS2 Ltd could potentially become landlord for a substantial number of properties within

the eligibility boundaries of any scheme. In addition, in holding a significant number of properties HS2 Ltd

would potentially have a larger exposure in the event of adverse market movements.

We understand that under existing compensation schemes, HS2 Ltd has sought to lease properties whenever it

has been economic to do so although the sample size on other schemes is smaller than would be potentially

covered with a property bond.

As outlined in 3.2, currently only a small proportion (assumed to be 5%) of residential properties within the

property bond area are assumed to be privately rented. Therefore, some concerns could exist about the capacity

of the market to absorb an increased number of rental properties. Whilst this remains a risk, based on

discussions with HS2 Ltd and others this risk is believed to be reduced by:

major infrastructure projects employ significant numbers of workers during the construction phase

many of whom would require rental accommodation during the period of their involvement in the

construction of the railway. This was observed in the case of HS1;

whilst there may be up to 5,000 properties covered by a property bond, these properties are spread over

a large geographical area and make up only a very small proportion of the local property market in

which they are located (of the local authority districts which HS2 passes through, less than 0.5% of the

property stock in these areas would be in areas covered by the bond). This means it is unlikely that any

properties that HS2 would acquire and manage would significantly increase the size of the local rental

market; and

the rental yields that are assumed in the model are, as detailed in 3.9, lower than the market yield in the

current market to reflect a projected increase in supply.

Whilst HS2Ltd should consider the extent to which acquiring properties and renting them meets its overall

policy and risk objectives, the cost model has been prepared on the basis of:

blighted properties are, wherever practical, leased in the market during the life of any scheme;

there would always be some properties that are acquired which are simply uneconomic to convert to a

condition where they are capable of being let. Up until 2021, this is assumed to be 5% of the properties

within the 120m band. This then increases from 2022 onwards where the limited amount of time that a

property would be rented for, combined with a reduction in the level of blight, means that the number

of properties where the economic decision is to sell rather than rent increases in the final years of any

scheme.

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21 PwC Cost report

3.9 Rental market

As outlined in 3.8, the cost model assumes that a large number of the properties that HS2 Ltd acquires are

rented during the period covered by the project bond.

A number of factors could impact the size and characteristics of the rental market and broader market

conditions at any point in time and this would subsequently impact on the likely returns that would be realised

from the rental market.

The relatively small size of the rental market for properties of this nature means that there is limited

information available about rental yields. However, a series of property surveys point to net rental yields (for

areas outside London) in the region of 5-7%2 and we have therefore used this as an appropriate assumption for

properties in a comparable location.

The cost model has been prepared on the basis of net rental yields that are lower than the 5-7% national average

as a result of a number of factors including:

properties that HS2 Ltd would acquire (especially in the Country (South) area) are likely to be higher

value properties than those typically found in the rented market. These higher capital values may not

lead to an equivalent increase in rent and therefore we have prudently assumed that yields would be at

the lower range of current averages;

the property bond cost model projects an increase in supply of properties to the rental market. Without

an increase in demand (which may be provided by construction workers) yields may reduce;

the properties could experience an element of construction blight. Generally, the rental market is much

less susceptible to the characteristics of blight but at certain points the level of blight may depress the

rents that can be achieved (especially in the pessimistic scenario); and

2 For instance, the Complex Buy to Let Index for Q4 2013 prepared by Mortgages for Business shows an averageyield for an average buy to let property of 5.9%.

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22 PwC Cost report

the properties that are being rented out would not necessarily have been fitted out with the rental

market in mind. Therefore, the costs of maintaining these properties are likely to be higher than a

property which has been specifically developed for the rental market.

On this basis, the model assumes that HS2 Ltd would earn a net rental yield at the levels shown in the table

below. This net rental yield is calculated on the basis of the protected or un-blighted value of a property.

Assumption Net rental yield (based onprotected value)

Optimistic case 5%

Pessimistic case 3%

This assumption is assumed to be consistent in all three eligibility scenarios as the distance from the line would

be unlikely to impact rental tenants in the same way it affects homeowners.

Alongside the net rental yield, the following assumptions are made in relation to rented properties:

Assumption Model assumption Comment

Cost of converting property to a lettablecondition

£20k per property Existing properties under HS2 schemescosting up to 1 year’s rent.

Housing Associations generally achieveconversion costs that are lower than thislevel.

Void period 6 months Assume that tenant is found within 6months.

The National Landlords Associationpublished research in May 2013 showingthat average void periods for residentialrental properties is 60 days (i.e. 3months).

A longer void period than average isassumed to reflect the fact that the ruralnature of these properties and that theyare, on average, larger than typical rentalproperties so there are likely to be fewerpotential tenants.

3.10 Property sales

A number of assumptions are made in the cost model about the level of income that could be achieved when

HS2 Ltd disposes of a property.

The cost model assumes that HS2 Ltd sells any properties for a price level which reflects:

(i) The protected value of the property when it was purchased;

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23 PwC Cost report

(ii) The blight on the property at the point of sale; and

(iii) House price inflation between the point of purchase and the point of sale.

Whilst there are a number of different indices which capture historic house price inflation there are no indices

which seek to forecast house price inflation either over the 12 year period over which any property bond scheme

would operate or at a sufficiently local level to reflect the market characteristics of properties that would be

eligible for a property bond.

Using historic data on house price inflation and assuming that it will hold true going forward is a practical

assumption to use in the cost model and this is illustrated in the sensitivity analysis within section 5. However,

using historic data is also problematic as there are no guarantees that the housing market will repeat historic

trends in the future and the outputs of the model will be significantly impacted by how any historic data is

applied. For instance, 2008 saw a c. 16% drop in house prices and the model would produce materially different

outputs if the performance in 2008 was assumed to be replicated in either the first year of any property bond

(2015) when HS2 Ltd would acquire the largest number of properties or 2026 when HS2 Ltd would be

anticipated to sell a large number of properties.

For the purposes of the base case modelling, an assumption of 4% nominal house price growth per annum is

used. This is broadly in line with the short-medium term projections published by some of the property

consultancies (e.g. Savills).

The Land Registry’s House Price Index shows the challenges with using historic figures as the average property

price movement for the 11 years to February 2014 is 4.01% but if the average is assessed on either a 10 year or

12 year basis it moves to 2.57% and 5.27% respectively.

In addition, there are a number of transaction costs associated with selling which are detailed in section 3.11.

The table below summarises the assumptions that are made in the cost model in relation to property sales:


House price inflation 4% per annum nominal Sensitivity analysis undertaken to showimpact of this assumption.

Period to sale 6 months This is in line with HS2 Ltd’s assumptionthat properties would not be left vacantwherever possible.

Therefore assume that properties wouldonly be sold (and vacant) at a pointwhere a quick sale can be achieved. Theachievability of this timescale woulddepend on the price the property ismarketed at and wider marketconditions.

3.11 Transaction costs

There are a number of different costs that would be incurred as different transactions occur under the scheme.

The tables below set out the amounts that are assumed within the cost model for:

Scheme registrations;

Cost when a bond holder indicates intention to sell;

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24 PwC Cost report

Purchase costs by HS2 Ltd;

Disposal by HS2 Ltd; and

Independent expert costs.

Registering for scheme or indicating intention to sell


Cost per valuation £780 per valuation This is in line with the average valuation thatHS2 Ltd is paying on its existing schemes.

The amount includes expenses and is higherthan the estimated cost per valuationprovided by NAEA of £500 per property.

Number of valuations 2 per registration/intentionto sell

In line with bond administrative principles.

Registering bond with LandRegistry

£40 per registration Applies to scheme registration only.

Purchase costs for HS2 Ltd


Land Registry Costs £550 on average Based on property price. Maximum price of£910 for most expensive properties.

Conveyancing and searches £2,000 per property Based on standard industry amounts andcomparable to costs on other HS2 schemes.

SDLT No charge HS2 Ltd has informed us that they do notexpect to pay SDLT on any properties thatthey purchase.

Disposal costs for HS2 Ltd


Estate Agency Fees 1.5% of property value Based on discussions with NAEA.

Conveyancing and EPC £1,500 per property Based on standard industry amounts.

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25 PwC Cost report

Independent Expert


Proportion of valuations referredto independent expert

20% In line with the proportion of cases that arecurrently referred to arbitration underexisting HS2 schemes.

Cost per independent experthearing

£2,000 Projected cost but would depend on processand procedures.

Other than the costs that are shown in the tables above, all other costs associated with property transactions on

properties that would have a property bond in place are assumed to be borne by either the purchaser or the

vendor in line with standard market practice.

These costs have a relatively small impact in the overall outputs of the cost model and therefore a small change

in these assumptions is unlikely to produce a material change to the cost model results.

3.12 Administration costs

Alongside identifying the cashflows associated with property transactions and the costs of third parties, the cost

model also includes high level assumptions about the operating costs of any organisation that would administer

any project bond scheme.

These assumptions are currently based on an ‘in-sourced’ model of delivery and this is reflected in the cost of

staffing.

The administration costs assume that a flexible staffing structure would be developed that would allow officials

to dedicate part of their time to carrying out administration in relation to a property bond alongside performing

other roles. This is particularly important in the case of scenarios where any property bond team is expected to

deal with a relatively low number of transactions each year and towards the end of any property bond period

where there is unlikely to be sufficient activity to justify full time employees (‘FTE’) in areas such as

registrations.

The following roles are assumed to be driven by the volume of transactions:

Function Number of cases perannum per FTE

Cost per FTE

Processing scheme registrations 175 £35k plus £10k of general overheads per FTE

Processing properties whereowner has indicated intention tosell (including where HS2acquires)

30 £60k plus £10k of general overheads per FTE

Managing acquired propertyportfolio

50 £50k plus £10k of general overheads per FTE

In addition to the FTE calculated in each scenario based on projected transaction volumes and the number of

cases each FTE is expected to handle, an assumption is made that a Manager would be appointed for each 8

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26 PwC Cost report

FTEs. This Manager is estimated to cost £60k per annum plus £10k of general overheads and at all times there

is projected to be a minimum of 1 FTE Manager employed.

In addition, the following roles have also been identified as required and are included in the cost model.

The exact structure of the management team would be dependent on the volume of transactions that occur each

year and the extent of a property bond area.

Role Cost per FTE

Director £120k plus £10k of general overheads per FTE

Strategy and Policy Officer £100k plus £10k of general overheads per FTE

Communications and Data Analysis Officer £50k plus £10k of general overheads per FTE

IT and web support £50k plus £10k of general overheads per FTE

Alongside the staff and ongoing costs of the administration company an allowance has also been made in the

cost model for scheme set-up and recruitment costs in the 2014/15 financial year in order for any property bond

administrative functions to be in place and tested prior to ‘go live’. The costs that are included within the cost

model are in the table below and are based on high level estimates only that broadly reflect those on comparable

projects. These estimates would need to be subject to a detailed specification and review in any business plan

produced for any property bond scheme administration organisation.

Role Cost

Set-up costs £2,500k

Recruitment costs 25% of first year salaries

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27 PwC Cost report

3.13 Other assumptions

There are a number of other assumptions that are included in the cost model that are recorded in the table

below for completeness. Each of these assumptions is capable of being flexed in order to change the output of

the model:


RPI 2.5% per annum In line with Treasury projections and appliedto administration and transaction costs

Discount rate 3.5% real Treasury Green Book Discount Rate

All NPVs are calculated on an annual basisusing the NPV function within Excel

VAT 20% on ‘third party’ costs In line with guidance from HS2 Ltd, themodel assumes that irrecoverable VAT isincurred in relation to ‘third party’ costswhich consist of:

- Valuation cost;

- Independent expert fees;

- Conveyancing costs;

- Estate agency fees;

- Cost of converting property to allowrenting; and

- Set-up costs of the scheme.

No allowance is made for VAT on any othercost within the model.

Once the final structure and administration ofany property bond scheme is agreed then areview of the VAT position should be carriedout.

Tax n/a The model does not include any allowance fortaxes other than the VAT costs detailed above.

Should a property bond scheme beimplemented, further tax advice should beobtained to confirm the tax implications of theproject.

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4 Outputs

The assumptions set out in section 3 have been applied in the cost models and the illustrative results of thismodelling exercise are set out below.

In the event that changes are made to any of the underlying assumptions then the outputs of the modellingexercise would also change. In particular, if property values fall at the point that houses are disposed of (eitheras a result of higher levels of ongoing blight or volatility in the wider property market) then projected potentialgains could become potential losses.

The results that are shown below are based on the projected cost of a property bond scheme only and do nottake into the account the cost of any other schemes (e.g. safeguarding) which may apply to some propertieswithin the eligibility criteria.

4.1 120m eligibility

Cost of the scheme

The table below shows the illustrative cost of implementing a property bond scheme with a 120m boundary

eligibility criteria based on the assumptions that have been outlined:

Scenario Total unblighted value ofeligible properties (July 2013)

Net Present Value/(Cost)discounted at 3.5% real

Optimistic £242.6m (£13.1m)

Pessimistic £242.6m (£38.5m)

In particular, this shows that:

both scenarios illustrate a Net Present Cost (NPC) to HS2 Ltd with the NPC being over 3 times higher in

the pessimistic scenario than in the optimistic scenario;

the NPC per property eligible for a property bond is £34k in the optimistic scenario and £99k in the

pessimistic scenario; and

on an undiscounted basis, both the optimistic and pessimistic scenarios are assumed to result in an

overall positive income for HS2 Ltd. This is on the basis that HS2 Ltd would hold properties acquired

and dispose of them at a time when values have recovered thus potentially producing a surplus over the

initial acquisition cost if no discount rate is applied.

Scheme cashflows

The table below illustrate a potential cashflow impact of a property bond scheme with a 120m boundary. Any

deficit generated from the operation of a property bond scheme would need to be met from a capital allocation

to HS2 Ltd.

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29 PwC Cost report

Scenario Projected peak annualcash requirement

Projected year of peakannual cashrequirement

Projected maximumcumulative cash

requirement

Optimistic £32.9m 2015/16 £104.1m

Pessimistic £54.5m 2015/16 £169.3m

In particular, this illustrates that:

in a pessimistic scenario, the peak cash or capital requirement is projected to be£54.5m which is 1.65

times higher than in the optimistic scenario. This reflects the increased number of properties that HS2

Ltd would acquire in the early years of any property bond scheme under the pessimistic scenario;

the projected maximum cumulative cash or capital requirement for a 120m boundary eligibility criteria

is £104.1m in a optimistic scenario and £169.3m in a pessimistic scenario;

at the point of peak cashflow requirement, HS2 Ltd is projected to hold £118.0m and £178.6m in assets

in the optimistic and pessimistic scenario respectively; and

the maximum projected gap between the value of the assets that HS2 Ltd hold and the cumulative cash

requirement is £25.2m in the optimistic scenario and £57.0m in the pessimistic scenario.

These results compare to the estimated total value of properties that would be covered by a property bond in

Phase 1 of £243m in April 2014.

Properties

The table below outlines the number of properties it is assumed that HS2 Ltd would acquire, is leasing at any

point and owns at any point under a 120m boundary eligibility scenario.

Scenario Projected total numberof properties purchased

by HS2 Ltd

Projected maximumnumber of properties

leased by HS2 Ltd

Projected maximumnumber of properties in

HS2 Ltd ownership atany point

Optimistic 188 154 163

Pessimistic 280 235 248

In particular, this shows that:

in the optimistic scenario, HS2 Ltd is projected to acquire 48% of properties that are within 120m of the

railway line over the life of any property bond scheme; and

in the pessimistic scenario, HS2 Ltd is projected to acquire 72% of properties that are within 120m of

the railway line over the life of any property bond scheme.

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4.2 300m scenario

Cost of the scheme



Scenario Total unblighted value ofeligible properties (July 2013)


Optimistic £1,066.0m (£17.7m)

Pessimistic £1,066.0m (£85.0m)


the NPC per property that would be eligible for a property bond is £11k in the optimistic scenario and

£52k in the pessimistic scenario; and

the pessimistic scheme is assumed to produce more income on an undiscounted basis for HS2 Ltd than

the optimistic scheme but has a higher NPC. This reflects the fact that, on average, in the 300m

scenario, HS2 Ltd would potentially be expected to make a profit (ignoring the cost of capital) for each

property it acquires and leases before disposing at the end of any property bond scheme. The

assumptions used in the pessimistic scenario mean that HS2 Ltd would acquire a greater number of

properties in the early years of the scheme and these are the properties which, due to inflation and

excluding any cost of capital, it is assumed would generate the greatest return

Scheme cashflows

The table below illustrate a potential cashflow impact of a property bond scheme with a 300 metre boundary.

Any deficit generated from the operation of a property bond scheme would need to be met from a capital

allocation to HS2 Ltd.




requirement

Optimistic £61.0m 2015/16 £235.0m

Pessimistic £143.3m 2015/16 £509.4m


in the pessimistic scenario, the illustrative peak capital or cash requirement is projected to be £143.3m

which is 2.35 times higher than in the optimistic scenario;

the optimistic scenario has a single year peak cash requirement which is projected to be lower than in

the 120m boundary pessimistic scenario but the maximum cumulative capital or cash requirement is

projected to be higher;

the projected maximum potential cumulative capital or cash requirement for a 300m boundary

eligibility criteria is £235.0m in the optimistic scenario and £509.4m in the pessimistic scenario;

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31 PwC Cost report

at the point of peak cashflow requirement, HS2 Ltd would be projected to hold £273.8m and £516.8m

in assets in the optimistic and pessimistic scenario respectively; and

the maximum potential projected gap between the value of the assets that HS2 Ltd hold and the

cumulative cash requirement is £41.2m in the optimistic scenario and £119.9m in the pessimistic

scenario.

These results compare to the estimated total value of properties that would be covered by a property bond with

a boundary of 300m of £1,066m in April 2014.

Properties




by HS2 Ltd


leased by HS2 Ltd




Pessimistic 829 690 725


in the optimistic scenario, HS2 Ltd is projected to acquire 25% of properties that are within 300m of

the railway line over the life of the bond scheme; and


the railway line over the life of the bond scheme.

4.3 500m scenario

Cost of the scheme



Scenario Total unblighted value of eligibleproperties (July 2013)


Optimistic £2,905.3m (£30.5m)

Pessimistic £2,905.3m (£158.1m)


the NPC per property that would be eligible for a property bond is £7k in the optimistic scenario and

£335k in the pessimistic scenario; and

as in the 300m boundary eligibility criteria scenario, when the eligibility criteria is extended to 500m

the pessimistic scheme it is assumed more income would be produced for HS2 Ltd than the optimistic

scheme but has a significantly higher NPC.

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Scheme cashflows

The table below illustrate a potential cashflow impact of a property bond scheme with a 500 metre boundary.

Any deficit generated from the operation of a property bond scheme would need to be met from a capital

allocation to HS2 Ltd.




requirement

Optimistic £101.7m 2015/16 £468.0m

Pessimistic £255.3m 2015/16 £1,072.2m


in the pessimistic scenario, the illustrative peak annual capital or cashflow requirement is projected to

be £255.3m which is 2.5 times higher than in the optimistic scenario;

the projected potential maximum cumulative capital or cashflow requirement for the 500m eligibility

criteria is £468.0m in the optimistic scenario and £1,072.2m in the pessimistic scenario;

at the point of peak cashflow requirement, HS2 Ltd is projected to hold £546.3m and £1,183.1m in

assets in the optimistic and pessimistic scenario respectively; and

the maximum projected gap between the value of the assets that HS2 Ltd could hold and the cumulative

cash requirement is £65.3m in the optimistic scenario and £179.3m in the pessimistic scenario.

These results compare to the estimated total value of properties that would be covered by a property bond with

a boundary of 500m of £2,905m in April 2014.

Properties




by HS2 Ltd


leased by HS2 Ltd




Pessimistic 1,757 1,471 1,536


in the optimistic scenario, HS2 Ltd is projected to acquire 18% of properties that are within 500m of the

railway line over the life of the bond scheme; and


the railway line over the life of the bond scheme.

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The analysis set out above is based on a number of assumptions and, in particular, is reliant on the assumption

that properties which are acquired early in the life of any property bond scheme are leased and then sold for a

value higher than the price it is assumed that HS2 Ltd would pay on acquisition. This is reliant on an

assumption that house price inflation would lead to overall increases in un-blighted values and an assumed

reduction in blight (to approaching normal values) on properties within any property bond boundary once the

HS2 line is operational.

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5 Sensitivities

Given the uncertainties that exist around many of the inputs, a number of sensitivities have been run on thecost model to illustrate the extent to which the outputs of the cost model change when the underlyingassumptions are varied.

The sensitivities illustrate that changes in the following assumptions have a material impact on the overalloutputs of the model:

The number of properties that HS2 Ltd may acquire;

The level of ongoing blight at completion of construction;

HS2 Ltd’s property management strategy; and

House price inflation and the timing of property cycles.

Changes to the net rental yield would generally have a lower impact than changes to the other assumptionslisted above but can still have a material impact on the cost model outputs.

Whilst changes in other assumptions, not listed here, would affect the cost model outputs, generally the impactwould be smaller than a comparable proportional change to one of the inputs noted above.

Increase in properties which HS2 Ltd may acquire

In this sensitivity it is assumed that 10% more properties are sold each year than in the base case scenario.

For instance, in the 120m optimistic scenario the number of properties sold during the life of any property bondincreases from 206 to 227. Similarly, in this sensitivity the number of properties that HS2 Ltd would acquireincreases from 188 to 206.

The table below summarises the results of the sensitivity:

Scenario ProjectedNet Present

Value/(Cost)of scheme in

sensitivity

Movement inNet Present

Value/(Cost) ofscheme from

base case

Projectedpeak annual

cashrequirement

insensitivity

Movement inpeak annual

cashrequirementin sensitivity

120m optimistic (£13.7m) £0.5m decrease inNPV

£36.2m £3.2m increase

120mpessimistic

(£41.6m) £3.1m decrease inNPV


300moptimistic



300mpessimistic



500m optimistic (£31.9m) £1.4m decrease inNPV


500mpessimistic

(£172.2m) £14.2m decreasein NPV


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This analysis illustrates that:

the model is sensitive to any increase in the number of properties that HS2 Ltd may acquire;

the impact on Net Present Cost is negligible in the optimistic scenarios as the higher rental yields andlower levels of ongoing blight mean that HS2 Ltd would be projected to recover its costs (in NPC terms)of any additional properties it acquires; and

the increase in transactional activity would also have a material impact on the projected annual capitalor cash requirements and the budget required for the scheme.

Blight levels

In this sensitivity it has been assumed that blight levels would be 5% higher in each period than is assumed inthe base case cost model.

The table below illustrates the impact of this change:

Scenario Projected NetPresent

Value/(Cost) ofscheme insensitivity

Movement in NetPresent Value/(Cost)of scheme from base

case

120m optimistic (£17.5m) £4.4m decrease in NPV

120m pessimistic (£45.1m) £6.6m decrease in NPV





This sensitivity illustrates that:

a 5% increase in blight would have a material impact on the overall cost of a property bond scheme;

the percentage impact on NPC of a linear increase in blight is higher in the optimistic scenarios as theseassume lower levels of blight in the base case and therefore a 5% increase is proportionally higher inthese scenarios; and

as the majority of properties are leased on acquisition, the level of blight is projected to have nomaterial impact on the annual capital or cash requirements of the scheme.

Property management strategy

In this sensitivity it is assumed that the proportion of properties that HS2 Ltd could rent out after acquisition isreduced. For the purposes of this sensitivity, a 20% reduction is assumed in the proportion of properties thatare leased out in the period until 2022. The properties that are no longer rented are sold on acquisition at ablighted value.

Therefore, up until 2022, HS2 would be assumed to make 75% of the properties it acquires available for rentingand dispose of the remaining 25% of properties.

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The table below shows the impact of this change:



sensitivity



base case


cashrequirement

insensitivity


cashrequirement in

sensitivity

120moptimistic


£30.3m £2.7m reduction

120mpessimistic



300moptimistic



300mpessimistic



500moptimistic



500mpessimistic




increasing the number of properties that would be sold during the construction period of the HS2 linemeans that HS2 Ltd is assumed to sell more properties at a blighted value. This results in a reduction inthe projected income of the scheme and an increase in the NPC of a property bond scheme; and

the projected peak annual capital or cash requirement decreases by between 6%-9% across thescenarios and the cumulative cash deficit by between 8% - 13%. This reflects the fact that should HS2Ltd sell more properties it would be able to recycle its capital quicker and potentially reduce its annualcapital requirement.

House price inflation

Two sensitivities have also been run to provide an initial analysis of the impact of house price inflation on thecashflows associated with a property bond scheme.

The first sensitivity assumes that the level of house price inflation is 2% per annum as opposed to the 4%assumption that is contained within the base case.




sensitivity



base case


cashrequirement

insensitivity


cashrequirement in

sensitivity

120moptimistic



120mpessimistic



300m (£36.5m) £18.8m decrease £59.1m £1.9m reduction

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optimistic in NPV

300mpessimistic



500moptimistic



500mpessimistic




house price inflation would have a material impact on the potential financial outcome of any propertybond scheme;

a lower level of house price inflation would reduce the annual cash or capital requirement of the schemeas it is assumed that HS2 Ltd would then be able to acquire properties at a lower cost; and

a lower level of house price inflation would also significantly reduce the projected income of the schemeas it is assumed that HS2 Ltd would sell properties it has acquired for a lower value.

The second sensitivity assumes that there is a property market crash between the period 2020/21 to 2025/26.In this sensitivity, the following house price inflation assumptions are used:

Until 2020/21 assumed that house price inflation is 4% in line with the base case; and

Between 2020/21 to 2025/26 house price inflation is in line with the actual house price inflationrecorded by the Land Registry for the period from 2008 to 2013 (i.e. the duration of the last propertymarket crash). This is equivalent to -1.4% reduction in house prices each year over this period.

It is then assumed that HS2 Ltd would continue to dispose of properties in the period from 2025 to 2027 as perthe base case assumptions.





case







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house price inflation would have a material impact on the potential financial outcome of any propertybond scheme;

under a property market crash scenario, the value of housing reduces and it is assumed that HS2 Ltdwould be able to acquire properties at a lower cost once the property market crash begins. Therefore themaximum cumulative cash requirement would reduce by c. 4% to 8%. The annual peak cashrequirement occurs prior to the point that the property market crash is assumed to happen andtherefore is unchanged from the base case;

the property market crash sensitivity leads to a very significant reduction in the projected income of thescheme as it is assumed that HS2 Ltd would still be acquiring the majority of its properties at a ‘pre-crash’ value and sells properties it has acquired at lower values post any property market crash; and

it would be prudent to design any property bond scheme to have operational flexibility so that, in theevent of a property market crash, HS2 Ltd is not seeking to dispose of a large number of properties at atime when market conditions are not favourable.

Rental yields

A sensitivity has been run where the net rental yields are 0.5% lower than assumed in the current base casemodel. Therefore, in the optimistic scenarios a net yield of 4.5% is assumed and in the pessimistic scenarios theassumptions is that the net yield would be 2.5%.





case








a reduction in the net rental yield has a material impact on the output of the cost model;

the impact is proportionally larger in the pessimistic scenarios as the 0.5% reduction in rental yield is alarger proportionate movement in the rental yield in the pessimistic case than in the optimisticscenario; and

changes in rental yields have between a 2% - 4% impact on the projected cumulative maximum cashrequirement but do not materially alter the annual peak cash requirement.

The sensitivities that are presented in this section of the report represent a small number of the different

elements of the cost model that could be tested. Clearly, there is also the potential that two or more of the

downside sensitivities could be experienced further increasing either costs or capital requirements beyond that

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illustrated. In general therefore we would conclude that the cost and capital/cash requirements of any property

bond scheme would be highly sensitive to key assumptions that are very difficult to predict and would generally

be outside of HS2 Ltd’s control. Should a decision be taken to move forward with a property bond scheme, it

would be important to undertake rigorous sensitivity testing on the preferred option to assist a more detailed

understanding the budgetary and financial risks that would come with implementing any property bond.

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6 Model limitations

The cost model has been developed by PwC in line with industry wide best practice in line with the approachoutlined in section 2 of this cost report.

Notwithstanding this, the results of the cost model should be considered in the context of the informationprovided in this report and, in particular, the following limiting factors:

The assumptions contained in the model are subjective and based on professional judgement

At this point in time, there are a large number of unknowns associated with developing an indicativecost for any HS2 property bond. The assumptions in the model are, by necessity, subjective and areunlikely to directly match the actual outputs that would arise from implementing the scheme.

Section 3 outlines the main assumptions that have been made in developing the cost model.

The model does not cover areas outside the eligibility criteria for any property bond

The model does not attempt to quantify the costs associated with any of the other schemes that HS2 Ltdmight operate and does not consider the impact and costs of the scheme on properties that fall outsidethe eligibility criteria.

The model only seeks to quantify the direct (cash) costs of any property bond scheme

The model has been designed to generate a cashflow associated with a potential property bond scheme.The model does not attempt to capture any non-cash costs or wider economic benefits of introducing aproperty bond and is therefore not a substitute for undertaking a full qualitative and quantitative valuefor money analysis.

The model has not been subject to audit

Whilst PwC has developed the cost model in line with industry wide best practice and the model hasbeen reviewed by an experienced modeller who is not part of the core project team, the cost model hasnot been subjected to a third party independent audit.

The model has been developed as an indicative cost model and not for any other purpose

Any attempt to use the model and its outputs for a purpose other than for those which it has beendesigned may not be appropriate. Caution should be exercised before the outputs of the model are usedfor any purpose other than those intended in developing the model.

This document has been prepared only for the Department for Transport (DfT) and High Speed 2 (HS2) Limitedand solely for the purpose and on the terms agreed with the Department for Transport (DfT) and High Speed 2(HS2) Limited. We accept no liability (including for negligence) to anyone else in connection with this document,and it may not be provided to anyone else.

© 2014 PricewaterhouseCoopers LLP. All rights reserved. In this document, "PwC" refers toPricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom), which is a member firm ofPricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

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HS2 Property Bond Cost Report · 2014-07-07 · HS2 property bond Cost report PwC 1 This document has been prepared only for the Department for Transport (DfT) and High Speed Two