Select Committee on Transport, Local Government and the Regions Memoranda

Memorandum by Office of Project Appraisal Training (OffPAT) (ERF 02)

  OffPAT is a best practice support unit jointly funded by its member agencies (the Regional Development Agencies, the London Development Agency and English Partnerships). Our job is to provide our members with advice and training on project appraisal and delivery. DTi, DTLR, DfES and DEFRA are also on our steering group.

  OffPAT is grateful for this opportunity to offer comments to the Urban Affairs Sub-Committee on the need for a new European framework for delivering regeneration.

  Regeneration is not solely or even principally about physical redevelopment but development projects—which bring derelict, contaminated and other brownfield sites back into use and which pull investment, jobs and better homes into run down areas—can make a major contribution to broader based regeneration strategies. But the cost of assembling and cleaning up such sites can be high and the end values of the completed developments are often lower than they would be in more attractive locations. This means that many of the most effective regeneration projects are not profitable and cannot go ahead without public sector support.

  Recognising that obstacle, the former Department of Environment ran a succession of grant regimes based on the principle of gap funding. Urban Development Grant, City Grant, and under English Partnerships' management—the Partnership Investment Programme (PIP) all worked by offering money to close the gap between the cost of a regeneration project and its market value on completion. The gap was usually attributable to difficult site conditions or to the blighting effect of the locality on end values. Grants were offered only after a thorough appraisal of each project's estimated costs, forecast values and expected outputs. Offers were subject to formal Funding Agreements incorporating appropriate clauses to cover default and to clawback a share of any cost savings and outturn values in excess of the forecasts.

  These highly effective programmes operated for many years achieving high levels of take-up. They were well received because they worked on clearly defined principles and in most cases were able to deliver decisions fairly quickly—though never as quickly as developers wanted! They levered in substantial amounts of private sector investment, typically on a gearing of four to one (private to public) under City Grant. The Partnership Investment Programme then took over and ran from 1993 to 1999. It took a more pro-active role in generating and steering projects but even so managed to achieve a gearing of three to one. It was able to operate on a much larger scale and by 1999 it had committed £1,223 million (almost all of this now spent) and this is levering in £3,193 million of private sector investment. Projects ranged from £100,000 grants for minor urban regeneration projects up to multi-million pound investments in projects such as the redevelopment of the Manchester Hulme area, the whole of Victoria Dock Hull, London's OXO building and Project Eden in Cornwall. In total PIP projects are delivering 2,500 hectares of regeneration, 3.8m2 of employment floor space and 12,000 new and regenerated homes.

  The two key features of all these gap funding schemes were that they were available in any urban area needing physical regeneration and that the amount that could be offered amounted to the whole of the appraised shortfall. The project was to cost £5 million and was forecast to be worth £4 million on completion on the open market, then offering less than £1 million would have left a gap and the project would not have been able to proceed. (Where a project displays a cost/value gap only a grant will help—the project cannot support a loan sufficient to fund it).

  Following the European Commission's change of mind on the status of PIP, DTLR closed the programme down in December 1999. Projects already under appraisal were allowed to continue to decision but no new applications could be entertained. In April 2001 the administration of the rump of the programme was transferred to the RDAs and by the end of 2003 the final projects should be more or less complete.

  The loss of PIP, and the parallel loss of the ability of SRB and other programmes to continue to offer similar gap-funding arrangements, has knocked a big hole in urban regeneration. Many local authorities had agreed regeneration strategies with EP which were inherited by the RDAs, and which can no longer be delivered as intended. We lost the ability to assist the private sector to take on the regeneration of difficult inner city and fringe urban sites for housing, employment and mixed use projects. RDAs and EP were left with direct development as their only way forward. This involves the public sector in direct action to select and assemble sites and then to let contracts for their reclamation, servicing and development. It is questionable whether the public sector has the commercial skills to do this effectively. By cutting out the private sector—other than as buyers of the completed project—we do not just lose their financial input, we do not profit from the private sector's more detailed knowledge of local markets and the public sector is left to carry all the risk.

  DETR and now DTLR have sought to mitigate the loss of this powerful tool by obtaining European approval for five new gap funding arrangements. Despite their titles these are not new schemes or programmes and they do not come with any new budgets. They are merely instruments available for use within the RDAs/LDAs Single Programme and by English Partnerships. In practice the first of these covers direct development (and a rather limited form of joint venture arrangement) so does not add much. The next two are only for small scale projects—one for the voluntary sector but limited to £100,000 per project and the other for the reclamation of land for soft end use only, not for industrial, commercial or housing development. The remaining two are the more significant in terms of their potential for assisting large scale urban regeneration but are in practice almost identical—both cover commercial development, one of speculative projects and the other non speculative. Both can include housing but only as a minor element.

  The two commercially oriented gap funding instruments are workable within limits and go some way towards replacing PIP, but, apart from the exclusion of predominantly housing based projects, they suffer from two great disadvantages. They are only available within the Assisted Areas defined for regional policy purposes and they are only available up to fixed percentages of the project's costs irrespective of the size of the cost/value gap. Thus many very worthwhile projects on major brownfield sites and in areas of urban deprivation will not be eligible and, even in areas where grants are available, the amounts on offer within the EC limits will often be insufficient to close the gap and enable the project to proceed.

  Both these limitations stem from the fact that the gap funding instruments have been notified within the existing regional framework for state aid with its focus on the Assisted Areas map and fixed percentages related to end user investment. There is also an environmental framework operating out with the regional map but, at this stage, the sponsor Departments do not appear to be notifying schemes under that framework or to be encouraging our member agencies to do so.

  For these reasons OffPAT considers that an attempt should be made to create a new regeneration framework. This would be to enable state aid compliant arrangements to be set up to tackle the physical regeneration of difficult sites in priority areas. These areas would need to be defined not by economic performance indicators, which leave large areas of the country ineligible, but by more local indicators of land market failure[1] and social and economic deprivation. The former City Grant for example was not bound by the regional aid map but by local deprivation indices which lead to the selection of 57 target local authority areas across England. A new regeneration framework could perhaps be applied to all brownfield land.

  Any gap funding schemes approved under a regeneration framework should enable the public sector to offer grants sufficient to close the whole of the appraised cost/value gap—subject as before to effective default and claw back arrangements. If a cut-of percentage is essential it should be set at a relatively high level. In some PIP cases grants of up to 50 per cent of end value were sometimes necessary to kick start the project whilst still leaving it in the private sector.

  A regeneration framework would of course permit the notification of other instruments for the support of the private and voluntary sectors; grants are not the universal answer. But while regeneration remains constrained by the regional aid framework none of the existing or potential instruments will be capable of levering in the volumes of investment previously seen.

1   The market in brownfield land can be said to have failed in situations where the vendor will not accept offers based on the site's residual value. If the best permitted use of a site is worth £5 million and it will cost £4 million to develop it (construction, fees, interest, and profit) then the residual value (the most the developer can offer) is £1 million. But if the land needs £0.6 million of reclamation work before the developer can even start then its residual value is reduced to only £0.4 million. So if the vendor holds out for more than that the deal will fall through and the site will remain un-regenerated. The market has failed not because either party is behaving irrationally but because vendors' holding costs are low and they face an asymmetric risk. They risk a greater loss by selling when they should have held than by holding when they should have sold. So they note the new interest in their derelict site and hang on to it rather than accepting its current low residual value. One answer is to increase the holding costs of vacant land whilst not adding to its development costs. Another is to structure deals which persuade the vendor to accept the residual value in return for a share of any upside above the forecast end value of the project. Back

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Prepared 25 February 2002