How will cash rents respond to higher prices?
Bullish news is rampant in agriculture, at least where there is a significant demand for grains to use in making biofuels.
Although the production of ethanol has been on the increase for several years, corn prices have reacted sharply only in the last six months. Soybean prices have been pulled along for the ride. Recent price increases are due almost entirely to increased demand, however. How long the ride will last is very uncertain.
Higher grain prices will eventually reverberate though other agricultural markets, including the market for land. Surveys of farmland values have shown considerable strength, and most of the factors causing it are impacting the rental market as well.
In Iowa, cash rental contracts must be terminated by September 1 each year or they continue in effect for another year under the same rates and terms. Therefore, many rents will not respond to the higher grain prices until 2008. Some landowners routinely cancel contracts so that rental rates for the following year can be negotiated after the current year's harvest. Terms can always be adjusted by mutual agreement.
Setting a fair cash rent can be done several ways. Many people simply want to match what other farms in the same area are renting for. In addition to some state surveys, informal information about cash rental rates is plentiful, too, but often focuses on extreme cases. Most farm rental agreements in Iowa, for example, are not required to be recorded, so there is little factual information available to the public.
Rental rates should be in line with expected income from the crops to be produced. In the past decade, average cash rents in Iowa compared to gross revenue per acre have been in the 35% to 40% range for corn and the 45% to 50% range for soybeans. Gross revenue was estimated as the state average yield multiplied by the average cash marketing price for that year's crop. USDA loan deficiency payments were included in gross revenue.
Another approach is to estimate the net return to the landowner based on a traditional 50-50 crop share lease. The calculation would be 50% of the expected yield multiplied by the expected market price, minus one-half of the seed, fertilizer and pesticide costs. Estimates of crop production costs for 2007 can be found in Information File Estimated Costs of Crop Production.
Traditionally the same cash rental rate has been paid for acres planted to corn or to soybeans. Under current market price relationships, the approaches just outlined will result in significantly higher rates for corn than for soybeans. The overall rental rate should still be an average for both crops, though, based on the actual acres planted.
Several cautions are in order. First, much of the 2006 crop was priced prior to harvest, when prices were considerably lower than they have been since September. Bushels to be produced in 2007 can be forward priced at very profitable levels today, but most producers will not sell 100% of their expected production in advance.