As we have talked about many times before, the best answer to this question is that it's worth whatever money is left in your pro forma once you've accounted for everything else. This is what is called the "residual claimant" in a development model. And it means you start with your revenue, you deduct all project costs, including whatever profit you and your investors need to make in order to take on the risk of the development, and then whatever is left can go to pay for the land.
This is the most prudent way to value development land; but of course, in practice, it doesn't always work this way. In a bull market, the correct answer to my question might be, "whatever most market participants are willing to pay." And sometimes/oftentimes, this number will be greater than what your model is telling you, meaning you'll need to be more aggressive on your assumptions if you too want to participate. (Not development advice.)
Given that determining the value of land starts with revenue, one way to do a very crude gut check is to look at the relationship between land cost and revenue. This is sometimes called a land-to-revenue ratio. And historically, for new condominiums in Toronto, you wanted a ratio that was no greater than 10%. Meaning, if the most you could sell condominiums for was $1,000 psf, then the most you could afford to pay for land was $100 per buildable square foot.
However, this is, again, a very crude rule of thumb. I would say that it's only really interesting to look at this after the fact. Because in reality, things never work this cleanly. For one thing, there is always a cost floor. Don't, for example, think you can buy land in Toronto for $80 pbsf and sell condominiums for $800 psf, because this will not be enough to cover all of your costs. You will lose money.
Secondly, there are countless variables that have a huge impact on the value of development land. Things like a high required parking ratio, development charges and other city fees, inclusionary zoning, and so on. All of these items are real costs in a development model, and so they will need to be paid for somehow.
Typically this happens by way of higher revenues (in a rising market), a lower land cost (in a sinking market), or some combination of the two. But in all of these cases, it means your land-to-revenue ratio must come down to maintain project feasibility. This is why suburban development sites typically have a lower ratio -- too much loss-leading parking, among other things.
Of course, there are also instances where the correct answer could be a land-to-revenue ratio approaching zero, or even a negative number. In this latter case, it means your projected revenues aren't enough to cover all of your other costs, excluding land. For anyone to build, they will require some form of subsidy. And this is basically the case with every affordable housing project. They don't pencil on their own. (For a concrete example of this, look to the US and their Low-Income Housing Tax Credits.)
So once again, the moral of this story is that the best way to think about the value of development land is to think of it as "whatever money is left in the pro forma once you've accounted for everything else." Because sometimes there will be money there, and sometimes there won't be.
Photo by Jannes Glas on Unsplash
At a high level there are two components to the value of a house. There's the value of the land and there's the value of all the improvements. That is, the bricks, wood, and other stuff that form the actual house. When a media outlet runs a sensational headline about some shack in Toronto selling for, oh I don't know, a million dollars, what it actually means is that the land in this particular area was just valued by somebody at this number. In fact, if the property is very clearly a "knock down" the improvements sitting on the land become a liability/cost rather than anything of value. Because whoever buys the land will almost certainly need to remove the improvements before they can build whatever it is they want to build.
This distinction between land and improvements is a valuable one for many reasons. Here's one example. In cases where the improvements aren't some shack, you may be faced with a scenario where a property can be valued in two different ways. You can value it based on the development potential of the underlying land or you can value it based on the income (either in-place or potential) that the improvements are generating, or could be generating with some hard work on your part. If the development value is greater than the value of the improvements, then there will be pressure to redevelop. Conversely, if the opposite is true, it is likely that not much will happen other than maybe capital expenditures applied to the existing building(s).
Of course, you could also run into a scenario where there's little development potential and there's zero ability to invest in the existing improvements, either because the market rents are too low in the area or because they're capped and/or controlled in some way. In this scenario, it's likely that not much will happen other than the normal and expected depreciation of the improvements. Maybe one day the development/investment math will work. But in the interim, you probably won't be seeing any of those sensational media headlines.
Photo by Andre Gaulin on Unsplash
Westmount Gaurantee hosted a Champagne tasting event for its clients this evening. Obviously it took place over Zoom. It was a great event and I learned a few things about Champagne. As most of you will know, sparkling wine cannot be called Champagne unless it's from Champagne, France -- a region that, as of 2008, included about 76,000 acres of vineyards and 319 villages. But as I started thinking about this acreage, the developer in me couldn't help but wonder: "How was the boundary for the Champagne region established? Is it based on unique soil conditions that can't be found anywhere else in France and the world, or is this a way to artificially control the supply of Champagne and fix prices?"
As you might imagine, the answer is complicated. (See the Champagne Riots of 1910-1911.) The viticultural boundaries of Champagne were legally defined in 1927. And the entire area is compromised of five wine-producing districts. But there have been revisions to this boundary. In 2008, the production zone was increased from 319 communes to 357. (I'm sure this was highly controversial.) And since the value of land is dependent on what you can do with it, this would have had a dramatic and overnight impact on land values. Yesterday you couldn't apply a Champagne label, but today you can. According to this article from 2008, we are talking €5,000 a hectare to €1 million per hectare because of a simple boundary change. That is the value of "Champagne."