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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