With land prices and competition down, it might be a good time for investors to secure strategic land assets with a view to selling them on in the medium term. Kerrie Shaw reports

Strategic land is land that has either been allocated for development by local authorities, or that is unallocated but has the potential for future development for housing or other uses. A significant increase in value can be obtained by promoting land through the planning system - for example, changing the planning use-class from agricultural to residential or commercial use. Housebuilders pay a premium for plots of land that have consent, because it reduces risk and the amount of time their capital is tied up in a development. Moreover, they have historically been prepared to pay disproportionately more for smaller ‘oven-ready' plots where they can commence development with minimal delay. Hence, investors can create value by buying larger tranches of land, and inputting services and undertaking any required remediation works before sub-dividing and selling smaller sites to housebuilders. The upside in identifying and converting land for residential development is extremely large.

There are opportunities for strategic land investment across the major markets of Europe, but it is a particularly strong story in the UK, where the residential sector has consistently failed to deliver sufficient housing to meet demand, residential development land is scarce and achieving planning permission is difficult and time-consuming. When the market for land is strong, the best returns tend to be achieved by buying land that does not already have the benefit of planning permission, but where this can be quickly attained before onward sale.

So what is needed to take advantage of opportunities in strategic land? There are potential pitfalls, not least is when investors take on the risk of buying land and paying planning, environmental and legal fees for sites that might then fail to secure planning permission. Investment in strategic land requires a high level of expertise and knowledge of the planning process and is comparatively capital intensive. It is crucial to have a network of contacts to identify potential opportunities and to have a process in place that factors in socio-economic drivers to pinpoint areas that will generate demand for housing and that takes account of existing and expected supply.

In the short term, distress in the UK's property markets is acute. This is particularly true of the residential development land market. It has seen little activity since the fourth quarter of 2007 and data from property fund manager Savills suggest greenfield land values declined by 48% in 2008, with average values now back to levels last seen in early 2000.

According to the UK's Valuation Office Agency, the average value of land with residential planning permission in England and Wales (excluding London) was £1,990,000 in January 2009, whereas the average value of mixed agricultural land with vacant possession in England and Wales was £11,819, just 0.6% of the value of the residential land. For investors willing to take a medium to long-term outlook, this situation presents a major opportunity, because strategic land can be bought relatively cheaply, yet the long-term fundamentals of the UK housing market remain incredibly supportive.

The UK's underlying demand for housing is fundamentally strong. Data from the Office for National Statistics show that, with the exception of 1976, the UK gained population through natural increase (more births than deaths) throughout the 20th century. This trend is expected to continue. The latest projections indicate that the number of households in England will grow by an average of 252,000 a year between 2006 and 2031, with growth accelerating due to the combination of a growing population and smaller average household sizes. The South East is expected to experience the largest absolute increase in households of the English regions over the period: 39,000 a year between 2006 and 2031, equivalent to a 28% rise.

While demand for housing is high and rising, the UK faces significant supply constraints, because the number of new homes built has failed to match the number of new households created, especially in the South East of England where pressure on land use is greatest. The Barker Review of 2004 highlighted that the under-supply of homes was a key reason for the substantial, unsustainable increase in house prices over the past decade, and that this weak supply hindered labour market flexibility, constraining economic growth. To remedy this, the July 2007 Housing Green Paper committed the government to raising the annual target for net additional homes to 240,000 a year by 2016. Further initiatives have sought to enhance development prospects in specified growth zones, a high proportion of which are in the South East and wider South East of England, in such locations as Milton Keynes, the Thames Gateway and Ashford.

However, recent data show the government's house building target was significantly undershot in 2008, with less than 142,000 dwellings completed in England, 19% fewer than the previous year. Indeed, the Department for Communities and Local Government recently reported  that it is likely that net housing supply will fall in financial year 2008-09.

Moreover, the number of homes completed in 2009 will be lower still because housebuilders are deferring new project launches and mothballing existing developments because of the current economic and residential market environment.

Just 105,000 homes were started in England during 2008, the lowest number since records began in 1990, and the Royal Institution of Chartered Surveyors projects that less than 80,000 new homes will be completed in 2009.

The clear conclusion is that this development hiatus will exacerbate the disparity between the number of homes needed and their supply, and that house building will have to be substantially increased if government targets are to be met.

For the medium-term outlook, investors need to consider the prospects for the UK economy. Here there are reasons to be cautiously optimistic. Consensus estimates predict positive results from the swift and decisive policy response of the UK authorities to the financial crisis. In line with Cordea Savills' own thinking, they suggest this recession will last approximately six to nine quarters (from the beginning of Q3 2008).

While this is more protracted than the recession of the 1990s, it is not comparable to the depressions of the US in the 1930s and Japan in the 1990s. The UK also has a significant advantage over its European neighbours due to its greater flexibility in the use of fiscal, exchange rate, monetary and labour market policies. These are being used to promote recovery.

Assuming recovery occurs in the medium term, and with housing still at the top of the political agenda, we expect residential development to increase again, supporting demand for land. Indeed, unless housing density is significantly increased, achieving the government's target will require a substantial increase in the supply of land for residential development.

There is currently a window of opportunity as land prices and competition to acquire sites have fallen dramatically yet the ability to promote land through the planning process has improved as fewer competing sites emerge. Now is a very good time for investors in strategic land to secure a wide portfolio of assets at attractive prices and enhance their value by promoting them through the planning system, before selling them on in the medium term once the housing and residential development land markets have recovered.

Kerrie Shaw is an associate director at Cordea Savills