Think Value

The demand for construction land is derived demand, not direct demand. Land serves as a production factor—it is not needed for final consumption but rather for hosting buildings and equipment that produce goods for final consumption.

Unlike other production factors, land is immobile. Any other factor, be it labor or construction materials, can be moved to another location, but land cannot. Consequently, compensating mobile factors is prioritized to prevent their departure, and the remaining value constitutes the value of the land. This principle is described by the Residual Theory of Land Value.

For this reason, the value of land depends on the residual value it generates when put to its highest and best use (HBU Value). You can find more details on this topic here: Best Use and Option Analysis of Land Value.

The HBU value of different plots of land varies primarily due to transportation costs. Essentially, transportation costs arising from the distance to central locations are the key factor determining HBU residual value.

Two key points should be considered here:

1. Transportation costs are not limited to fuel expenses. This is a more complex concept that includes costs for receiving raw materials, delivering services, supplier and customer expenses, and financial, time, and even psychological costs.
2. Central location does not necessarily mean the geometric center of a city. It refers to a location where overall transportation costs are minimized for a specific entity.

This logic leads us to a fundamental concept in classical urban economics known as the Bid-Rent Function.

The sensitivity of different entities to transportation costs varies, and this determines their demand for specific locations based on land prices.

Below is a representation of the Bid-Rent Curve. On the vertical axis is land rent (conceptually, land value or the share of rent attributable to land), and on the horizontal axis is the distance from the central area. The diagram shows land use for three different purposes (A, B, C). Depending on the intended use of the land, sensitivity to transportation costs differs, and so does the optimal location.

In essence, due to the existence of optimal locations, zoning of similar-use lands should occur automatically in the long run. Functions highly sensitive to transportation costs will cluster closer to the center, while less sensitive functions will group farther away.

Source:

Commercial Real Estate Analysis and Investments, D. M. Geltner, N. G. Miller, J. Clayton, P. Eichholtz