The estimated return to the public sector from the Peninsula land deal is now lower than initially forecast in 2004

3.8  EP's forecast financial returns from the Peninsula land deal (excluding The O2) are inherently uncertain and any assessment provides only a snapshot as at that point in time. As with any long term, market-based deal, EP's returns will be affected by changes in the timetable of development and are sensitive to fluctuations in economic conditions (e.g. changes in the rate of inflation, interest rates, housing supply and demand etc). EP and MDL have been working since end 2006 to develop a more sophisticated financial model for forecasting returns to replace the 2002 model which is not detailed enough for monitoring profits and is out of date in terms of the phasing and timing of the development. The time taken is explained by the complexity of the model and the contracts on which it rests. Against expectations in 2004 that EP's returns from the development of land on the Peninsula would be £216.4 million, EP's forecast financial return as at June 2007 in net present value terms, is lower than was forecast in 2004 (see Figure 14).

3.9  The June 2007 calculation is based on an update to the value for money assessment carried out in 2004 and on assumptions used in subsequent valuation exercises carried out by EP's advisers.31 This calculation is based on the best information presently available but is uncertain because it is derived from the current, out of date financial model. On the basis of a methodology which uses a 4.55 per cent discount rate for the first three years of the deal rather than the 8.5 per cent originally used in 2004, EP estimates the financial return to be in the region of £171 million. The 4.55 per cent discount rate reflects the Government opportunity cost of money rather than a future risk rate on the basis that any risk to the project is still in the future and all that has happened is that timescales have slipped. Using a constant 8.5 per cent discount rate as in the original forecast, the forecast returns would be some £156 million. The application of a constant 8.5 per cent discount rate is on the basis that an opportunity cost of money would only apply if EP's contribution was not already at risk. In this case, however, once the deal became unconditional in 2004 EP had effectively committed itself to the deal and as a consequence its investment was at risk.

3.10  Most of this reduction in expected returns can be attributed to the delay in getting residential development on the Peninsula started. Delayed development leads to delayed income to EP, which in turn reduces its returns in net present value terms. In addition, build costs so far have risen more quickly than anticipated in 2004 and this has also affected EP's returns, though the impact of this has been partially offset by increased land values.

3.11  MDL's plan to accelerate development, if successfully implemented and maintained over a number of years, could reverse this reduction in returns over the lifetime of the deal, as could any unexpected rise in property values. On the other hand, high build cost inflation, uncertainty in the property market and delay in development will have the opposite effect. Owing to the structure of the contract EP's returns are spread over a longer period of time than MDL's which means that losses caused by delay affect EP financially more than MDL.32 In structuring the deal, there were arguments both for and against deferring EP's share of the profits. If property values increased in real terms then deferral would mean EP would receive higher returns. It was recognised, however, that property values might not increase consistently in real terms. Deferral would also give confidence in the incentive on Government to provide essential public infrastructure and mean that MDL bore most of the costs and risks of setting up the project. On the other hand deferral meant that EP was more exposed to downturns in property values and delays. Government also needed confidence in MDL's commitment to invest in infrastructure and keep up the pace of development in later years. Following professional advice EP judged that the balance of risk and reward provided for in the contract was in the interests of the taxpayer, taking into account expected changes in property prices and the need for all parties to have confidence in each other's long term commitment.33

3.12  In its 2005 hearing on the NAO's Regeneration of the Millennium Dome and Associated Land report, the Committee of Public Accounts was informed that £33 million of proceeds were anticipated to be returned to the taxpayer during 2008-09, on the basis of the development plans at the time. EP now anticipates that actual receipts generated from the land-based deal with MDL at the end of this period will be in the region of £25 million.

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31  These annual valuation exercises value EP's freeholder interest in the deal with MDL. These make use of a financial model (see paragraph 3.2) with updated assumptions mainly relating to movements in inflation and property values in the year covered by the valuation exercise. The updated value for money assessment took these update assumptions and looked at their impact on the income EP can expect to receive over the lifetime of this deal, which went unconditional in 2004.

32  Given that money has a time value, an acceleration of development will also benefit MDL's overall returns more than EP's.

33  The arguments for and against deferral of EP's share of the profits are outlined fully in Figure 17 of the NAO's previous report on this subject The Regeneration of the Millennium Dome and Associated Land, HC 178 Session 2004-05, 12 January 2005.