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7 ways to compute cash rent

02/14/2011 @ 2:35pm

Afixed cash rent agreement is the simplest rental arrangement there is. But it is not as simple as it first seems.

“Determining a fair rate is not easy,” says William Edwards, Iowa State University (ISU) Extension economist. “Cash rents are likely to be too low during periods of rising prices and high yields, and too high during periods of declining prices and low yields.”

Here is the crux of the problem:

“Rates often reflect the results of the past few years more than the upcoming year,” says Edwards.

“It is always in the tenant’s and landlord’s best interest to develop their own lease,” says ISU Extension economist Mike Duffy. “But sometimes it is helpful to know what practices are being followed.”

Here are seven different methods of computing a cash rent, as put forth by Edwards and a colleague, Don Hofstrand. Several of these methods are used throughout the country. One, using corn suitability ratings (see #3), is peculiar to Iowa. Although the titles in the seven-point list come from Iowa, some of the information comes from other sources.

1. What Others Are Charging/Paying

Edwards says the most common way to establish the amount of cash rent is to base it on what other people in the area are charging. He lists three potential pitfalls with this approach.

• Simply charging what others are charging may not be appropriate for a particular farm.

• Rumors about cash rental rates may be quite different than the actual rates, especially in a rapidly changing market.

• “Differences in the quality of land should be taken into account when comparing your rental rate to those of others. Landlords who are unfamiliar with farming often assume that all land is of equal productivity,” Edwards says.

Kansas State University ag economist Kevin Dhuyvetter says, “In areas where there is sufficient cash renting, the prevailing cash rent should provide an approximation of the appropriate measure of fair rent. In some situations, however, there is no established rental rate. Or if there is one, the rate has extenuating circumstances that preclude it from being appropriate.” Those circumstances are things like buildings on the land or rent between family members.

“Furthermore,” he adds, “publicly reported cash rental rates often represent a relatively wide geographical region and, thus, may not reflect local conditions.”

2. Average Yields

With this approach, a farm’s average yields over five or 10 years are used to compute the cash rent.

Edwards gives an example of how this method works. “Assume the average rental rates in your county are $1.10 per bushel for corn and $3.75 per bushel for soybeans, based on the latest survey information. If your farm has an average corn yield of 160 bushels per acre, this results in a rental rate of $176 per acre ($1.10 × 160 = $176). An average soybean yield of 48 bushels per acre results in a rental rate of $180 per acre ($3.75 × 48 = $180).”

You can access the average rental rates for corn and soybeans in Iowa via a publication entitled Cash Rental Rates for Iowa 2010 Survey (www.extension.iastate.edu/agdm/wholefarm/pdf/c2-10.pdf). Several other states publish this type of information as well.

According to Purdue ag economist Craig Dobbins, the rent per bushel of estimated corn yield statewide in Indiana ranged from $1.02 to $1.08 per bushel last year. Rent per bushel in Indiana is usually, but not always, highest on top-quality land compared to poor- and average-quality land.

This type of information is usually available at websites for the ag economics departments of land-grant universities.

3. Corn Suitability Ratings

A corn suitability rating (CSR) is a land productivity index used in Iowa to rank soil types on a scale of 0 (low) to 100 (high). Most fields have more than one soil type, but a weighted average can be calculated by identifying the acres of each soil type and the CSR rating for those soil types. The CSR values for particular tracts can be obtained online from county assessors’ offices.

Rental rates per CSR points are available in the publication mentioned in #2.

“A cropland cash rental rate can be computed by multiplying the average CSR by a rental rate per CSR point,” Edwards explains.

Here’s another example from Edwards. “Assume a typical rental rate per CSR index point of $2.30 for your county. A tract of land with a CSR of 80 would have a rental rate of $184 ($2.30 × 80 CSR = $184.) Be sure and check the actual rent-per-CSR point for your county.”

4. Share Of Gross Crop Value

According to Edwards, “Rental rates tend to follow the gross value of crops.”

Iowa State publishes a table that shows the average cash rent in Iowa as a percent of the gross value of corn and soybean crops. The current table has those amounts for 2000 through 2009. It’s available in a publication entitled Computing a Cropland Cash Rental Rate that discusses these seven methods of computing cash rent (www.extension.iastate.edu/agdm/wholefarm/html/c2-20.html). The 2010 figures won’t be available until this spring.

Edwards says rents have generally averaged about 35% to 40% of the gross value of a corn crop and 45% to 50% of the gross value of a soybean crop.

“These percentages and estimated yields and prices for the coming year can be used to estimate a fair cash rental rate,” he says.

5. Return On Investment

This method involves multiplying the estimated current market value of cropland by an expected rate of return. Surveys show that cash rents for good cropland in Iowa in recent years have averaged about 4% to 5% of current land values.

Edwards is quick to point out, however, that this method is “rather imprecise, especially during periods of rapidly changing land values.”

(Iowa land values increased by 16% between November 2009 and November 2010, according to an Iowa State University survey.)

University of Illinois ag economist Gary Schnitkey says, “While both farmland prices and cash rents have increased since 1987, farmland prices have increased faster than cash rents.

“In 1986,” he adds, “cash rent as a percent of farmland price was 8.1%, the highest level between 1972 and 2010. Since 1987, cash rent as a percent of farmland price decreased, reaching a low of 3.4% in 2008. Cash rents as a percent of farmland price increased slightly to 3.5% in 2009 and 2010.”

Schnitkey worked from USDA figures that are available for other states.

6. Crop Share Equivalent

This approach is a little more complicated, and that could be a deal breaker for people who like cash rents because of their simplicity.

The approach is to calculate cash rent by comparing it to the potential return of a crop-share lease. (A crop-share lease automatically adjusts for changes in grain prices, yields, and input costs.)

“However,” says Edwards, “to compute a cash rental rate using this method, estimates of yields, selling prices, and input costs must be made for the coming year, which is sometimes difficult to do.”

An example of how this method works appears in the ISU publication entitled Computing a Cropland Cash Rental Rate (see #4). This publication also has a worksheet you can use to compute a rental rate for your situation. Or you can enter your figures into Decision Tool: Cash Rental Rate Estimation, which is available by clicking on the Decision Tool icon in that article.

7 Tenant’s Residual

The final method of computing cash rent is to calculate the amount of income  left for rent after the tenant has paid all the costs incurred raising the crop.

As is the case with #6, you first need to estimate yields, selling prices, and government payments. The worksheet mentioned in #6 and the Decision Tool can both be used to estimate a rental rate for this approach.

Another tool for evaluating this approach and others is the KSU-Lease Spreadsheet from Kansas State University. Find it here.