Before 2022, being a land developer was a perfectly reasonable business to be in. In fact, it was a lucrative business to be in. What this business entailed was buying development land, getting it rezoned for some higher-and-better use (which here in Toronto usually takes a few years), and then selling it to another developer who would then build the thing that you got approved (or something close to it).

This kind of business practice is sometimes looked down upon by the general public, presumably because it feels like a speculative endeavor that doesn't actually result in anything physical. But another way to look at it is that it's just dividing up the same required work across multiple firms. Projects can take a long time and sometimes investors want their money back.

It is also good practice to look at this option even if you aren't a land developer, per se. One way you do this is by plugging in the market value of your land in your pro forma (not book cost). This way you can tell if your development margin is coming from your land uplift or from the build out. If most of your margin is coming from the former, then it may not be worth taking on the risk of construction.

In any event, the problem with this business is that it no longer works. (At least not in Toronto.) Land prices are moving in the opposite direction. Without a clear understanding of potential revenues (such as condo sales), it's very difficult to value development land. And if you can't accurately value land, then it's pretty challenging to run a business predicated on selling it.

What this means is that the development margin, if any, has shifted away from land toward the full build out (or whatever else your strategy may be). It's not enough to just entitle land. There's lots of entitled land out there right now. That is not the constraint. The constraint is figuring out how to actually make sites feasible. And to do that, you have to roll up your sleeves and really work each project and each asset.

Those who know how to do that will be the ones who come out ahead in the next cycle.

This is an interesting chart from the Centre for Urban Research and Land Development at Toronto Metropolitan University (TMU).

It is based on recent population estimates from Statistics Canada, and what it is saying is that the Greater Toronto Area grew by 233,000 people during the 12 months ending July 1, 2023. If you include Hamilton, this number increases to 246,000. And if you include the entire Greater Golden Horseshoe, it increases to 340,000.

This is significantly more population growth compared to any of the six preceding years. And assuming this 2021 population estimate of about 9.8 million people is more or less correct, it represents an almost 3.5% growth rate. That's remarkable. It's also happening at a time when housing starts are declining.

Generally speaking, the value of a piece of land depends on what you can do with it. If the highest-and-best use is agriculture, then it might be worth $X. But if the highest-and-best use is a supertall skyscraper, then it's going to be worth a lot more than $X.

This is why the land component is typically thought of as the residual claimant in a development pro forma. Start with what you can build, forecast your revenues and expenses, and then see what is left over and can be attributed to the land. This is, at least in theory, how the mechanics should work.

An interesting thought exercise, though, is to consider how different developers might value the exact same piece of land.

One obvious scenario is that a developer could just get their forecasts wrong. For instance, maybe they understate their costs, which then leads them to believe that they can pay more for the land. In this case, an error makes them the highest bidder.

In a rising market, there will also be developers who believe that they can almost certainly collect higher revenues in the future. In this case, the most bullish developer often becomes the highest bidder for land. And as long as the market continues to rise, they might not be wrong.

But things change in a slower or flat market.

Now the market isn't there to save you if you happen to overpay for land. It's a less forgiving environment. But it's also a market where you really benefit from conservative underwriting and solid execution. Now it's these groups who are the high bidders.

And I know that some/many developers prefer it this way.