4  Residual Value

The land interest transferred under a non-HRA Project is usually for a period longer than the concession period in the Project Agreement and therefore gives rise to residual value.  Authorities should seek to maximise residual value to reduce the Unitary Charge payable under the Project Agreement and to enhance VfM of Government support in respect of the level of PFI credits required.

Authorities will need to take detailed advice on how to maximise residual value for its own project.  Factors which affect residual value are as follows:

(a)  the land interest transferred by the Authority.  Experience from past non-HRA Projects has been that no higher residual value is achieved:

(i)  if a freehold interest is transferred rather than a lease; or

(ii)  if a lease term longer than 99 years or 125 years is transferred,

and these would not normally be recommended.  Authorities should still however explore this issue with bidders (bearing in mind other factors do also influence the use of a leasehold transfer of land) to ensure best value is obtained;

(b)  an Authority's requirements on nomination or allocation rights for Dwellings following termination or expiry of the Project Agreement.  This will affect the Contractor's ability to sell Dwellings.  See paragraph 5 of this Guidance;

(c)  restrictions on the permitted use of land.  If the Authority restricts the use land is to be put to following termination or expiry of the Project Agreement this may have an impact upon residual value.  It may nevertheless be an important policy objective to secure the long term use of the land and Authorities therefore often do require social housing to be made available for longer than the duration of the Project Agreement.  Restrictions for use as social housing are therefore common in non-HRA Projects. This is linked to post contract nomination allocation rights.  If such rights are required post contract then permitted land use is in effect restricted to use for social housing;

(d)  land or assets already in the Authority's ownership are not normally eligible for PFI credit funding support.  It is common for such land to be transferred at a peppercorn value.  If such existing assets are sold the value of the receipt should be netted off the PFI credit value.  However if the land or assets were bought specifically for the PFI project then support may be provided.  Authorities are referred to Section 3.3 of the PFI Project Support Guide for fuller guidance.5

An Authority may have a requirement for a capital receipt for the land at the time of transfer.  It is a balance for Authorities to consider whether a capital receipt is required for land or whether value is extracted by way of a reduced Unitary Charge which impacts on the affordability of a scheme.  It is more common for land to be transferred at a peppercorn value with value being extracted by way of a lower Unitary Charge;

(e)  the inclusion of options for the Authority to re-acquire the assets on termination or expiry of the Project Agreement.  Options have been included in non-HRA Projects as a mechanism for the Authority to test (and if necessary realise additional) residual value at break points (on termination and expiry) in the Project Agreement.  It may also be a political requirement in the case of Contractor Default termination for the Authority to have such an option available.  If options are not used then Authorities will need to be able to demonstrate their approach to having maximised residual value from their project both at bid stage and in respect of any future increases in residual value during the concession period.  Increased residual value during the concession period may of course be a product of the beneficial acts of the Contractor and the Contractor should itself be able to receive some benefit of any increase in residual value.  Accordingly, it is normally appropriate for overage sharing provisions to be included in the Project Agreement along with options to be exercised on termination and expiry of the Project Agreement.  

Suitable drafting for the use of options at termination and expiry of the Project Agreement are set out at paragraphs 35, 36, 38, 39, 41 and 42 of this Guidance.  The appendix to this Guidance contains further detailed explanations of the principles to be adopted.

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5  Land or other assets sold or transferred to the project.  It may be better in some projects for the Authority to provide the assets needed - including land - rather than the Contractor acquire them independently.  In such cases, they may either be sold to the Contractor or transferred in exchange for a reduced unitary charge.  Any decision on which of these options to use should be made on VfM grounds.

The way in which these costs may or may not attract PFI credit support depends upon whether the land or assets were already in local authority ownership, or whether they were bought specifically for the PFI project.  PFI credits should not be given in the former case and if existing assets are sold the value of the receipt should be netted off the PFI credit value.

If, however, the Authority can demonstrate that there was nothing suitable available (but that it is still better VfM for them not to purchase the land/assets in advance) then support may be provided.  If sale is the better VfM option then receipts are not netted off the PFI credit value.  If transfer is the best option, then the value of the land should be added to the PFI credit amount.  The value of the land should be based on the cost of purchase, not the value of the receipt from the Contractor.