At Zeifmans, we have over 60 years of experience assisting clients throughout all the phases of their land development projects. We’ve seen how the market has changed over the years, and we have a unique understanding of the strategies that will yield the best results as the market continues to evolve.
Today, in the first of a three-part series on land development and investment, we’re going to take a closer look at the strategy of land banking, to unpack its risks, benefits, and tax implications.
What is land banking?
Land banking is a real estate investment strategy in which investors purchase large parcels of undeveloped land with the intention of holding it for a period of time, and then selling at a profit. The land is held until it has been approved for development, or for future development beyond the approval date for rezoning.
Land banking may be a good investment for home developers and long-term corporate land investors who have extensive development experience. The project could vary from immediate use to stretching ten or twenty years into the future. It’s not uncommon for developers to list projects that begin today, but will roll out in several phases spanning many years to completion.
Is land banking profitable?
Like any major investment, diligent research is required to ensure that land banking remains profitable. Environmental considerations, financing, and market changes are all important factors that will dictate the profitability of the venture.
Since land banking is a long-term investment, it could take years before the investor sees any benefit. Land tends to appreciate as it is developed, so the price may not rise until the project officially gets underway. Investors also need to hold the land for several years while it is being developed.
It’s important to consider the land location in purchasing a parcel for land banking. If there is a supply and demand issue in the area you are investing, land banking may be a more profitable venture than in an area with plenty of vacancies. Given the limited land supply in many of Canada’s cities, developers are tending towards upward development to maximize mass and space.
Ian Hunt, Senior Vice President of CBRE adds, “Land banking has been a consistent practice throughout the GTA and GGH development land markets for decades and continues to be an investment vehicle in today’s changing environment. Although many consider it to be speculative and thus higher risk, our team has witnessed a tremendous amount of success stories given the rapid development of the GTA and GGH.”
What are the risks?
Real estate investment is rarely an exact science. In making the decision to invest in a land banking scenario, it’s wise to consider all the risks.
When interest rates rise, the cost to maintain vacant land increases. This may make it more difficult to obtain financing for vacant land, as lenders could view the project as risky.
In developing the land, you’ll need to secure the right permits. This is a notoriously slow process, and any delays could result in further costs.
If the land isn’t suitable to the type of development you’re seeking, or is generally unsuitable to development – due to natural disasters for example – the investment will not be profitable.
If the real estate market collapses, values could continue on a downward trend, resulting in a loss for the investor.
Potential market changes
The intended use of your development will depend largely on the population of the area, the economic conditions, and the local real estate trends. If any of these factors change, your project may no longer be suitable to the area.
Limited or no regular cash flow
In a land banking scenario, funds are tied up in the land and do not generate cash flow until the land is developed or sold.
In the event that the property requires immediate upgrade or repair, the investor will need up-front cash to solve the problem.
CBRE recommends that buyers focus on fundamentals in order to mitigate the risk inherent in a land banking investment. According to Ian Hunt, “To minimize risk, buyers should focus on three main aspects; future availability of servicing capacity, higher order transit available/planned, and ensuring municipal planning policy will be advantageous given past trends in an area. Focusing on these fundamentals is the most effective way to mitigate risk on this type of land investment.”
What are the benefits?
Though there are undoubtedly risks inherent in land banking, there are also significant benefits.
Unlike a traditional land development investment, land banking has limited maintenance costs, including property tax, insurance, and financing.
High profitability over time
Provided that the location has been wisely chosen, land banking can be very profitable over time as the land value increases. Once the land is developed and sold, profitability could be substantial.
How should the investment be held?
A land banking investment can be held through a corporation, partnership, or individually. It could also be held through a joint venture, or any other applicable tax structures available for tax planning purposes. It’s important to discuss the details with your tax counsel or accountant to ensure that you structure correctly early on.
Tax implications of land banking
The tax implications of land banking need to be thoroughly considered prior to purchase to ensure that your taxes are minimized as much as possible. For example, treating income on a disposition as a capital gain versus business income can have a big impact on your bottom line. This position is not always advisable, and a tax advisor must be sought to determine the proper treatment. Furthermore, you’ll need to take HST into consideration when banking and subdividing land.
What’s next in land development?
Up next in Part 2 of our series, we’re going to take a look at land planning: the process of preparing a parcel of land to be developed. To learn more about how the Zeifmans team can help you to maximize profitability on your land development project, start a conversation with us today.
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