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Flexible rent gains ground
Cash rent has been, far and away, the most popular type of land rental agreement for many years, and it will probably remain so for years to come. Tenants like the flexibility that cash rent provides. Many landowners like not having to market grain or to make other management decisions, and many like knowing exactly how much rent they will receive.
But in tumultuous times like these, it's difficult to determine a realistic rent before the crop is even planted.
“When yields and prices are relatively stable, setting the cash rent may be fairly easy,” says Iowa State University ag economist William Edwards. “However, when conditions are volatile, it becomes more difficult.”
Most years, the volatility relates to yields or prices. But in recent years, there has been a lot of volatility in input costs as well.
This volatility has spurred interest in flexible cash rents among operators and landowners alike. With this type of lease, the rent is not determined until the crop is harvested. Another factor making flex rents more attractive is that the Farm Service Agency no longer views certain types of flex rental agreements as share leases. Finally, crop revenue insurance can be used to provide income protection for both the tenant and the landowner.
There are many variations of flex rent. Most agreements flex based on yield, commodity prices, or both. (A few also flex as input costs change.) Edwards cautions against agreements that only flex on yield or price rather than both.
“Leases that base the rent on price only or yield only may actually increase the tenant's risk in some years,” he says. “This is because prices may be high when yields are low, or prices may be low when yields are high. So adjusting the rent based on just one factor does not always reflect the actual profits received in that year.
“The most common type of flexible lease calls for the owner to receive cash rent equal to a specified share of the gross revenue of the crop,” he says.
“Another type of flexible lease formula specifies a base or minimum rent, plus the owner receives a share of the gross revenue in excess of a certain base value,” says Edwards. For more information about these agreements, go to www.extension.iastate.edu/agdm. Scroll down to “Whole Farm” and click on the title “Leasing.” Start with the paper entitled Flexible Farm Lease Agreements (C2-21).
There are advantages and disadvantages with flexible rent for both tenants and landowners. One of the main advantages is that once agreement is reached on a lease, it can be used for years. The automatic adjusters keep it current as prices and yields fluctuate. (Input costs may need to be addressed periodically.)
Another advantage is that tenants and landowners share risks and rewards. Under most flex agreements, tenants have less risk than they do with a flat cash rent. They may also give up some profit potential.
There are also disadvantages with flexible cash leases. Because flex agreements are more complicated, it can take longer to develop the basics and the conditions for using the adjustment factors. And the final rental payment often can't be made until after harvest.
Volatile grain markets
Volatility in the grain markets caused Thad and Denise Bridges, who farm near Elliott in southwest Iowa, to become interested in flex leases seven or eight years ago.
“They are another piece of the puzzle to manage volatility,” says Thad. “With cash rent, you can sign a lease one day with all intentions of it being fair. But then if you have three days of limit-up or limit-down moves in the market, it's not fair at all. We have 365 days of volatility.”
Thad and Denise like to meet as a couple with landowners. “What we have done with our landlords when we have first proposed a flex rent is offer them several options,” says Denise. Those options include crop share, cash rent, and flex rent.
The Bridges currently have flex rent agreements on three farms and cash rental agreements on others.
“We have some landlords who prefer straight cash rent, and that is what we do with them,” says Thad. “Flex rents are not a fit for everybody.”
In their arrangements, the base is set slightly lower than a normal cash rent would be. The Bridges use crop insurance to cover the base rent and their expenses.
“Everybody's personality is different and everybody's goals are different,” says Thad. “Some landowners want to know exactly what they are getting for rent, and some want the opportunity to participate in a better market and a bigger crop. Flex rents are a tool to spread out the risk for everybody involved.”
Allen Henry, Indianola, Iowa, started using flex rental agreements four years ago because of volatility in the grain markets. He sees them as a way to spread the risk and to share the rewards of both the commodity markets and the weather. He farms in an area that has had several wet springs recently. And this year's wet spring was followed by a dry summer.
“I'm worried about the tough times,” he says. “And in the good times, it is easy to share.”
He hopes that flex arrangements will lead to more long-term leases as opposed to having to renegotiate rents every year or two.
When these photographs were taken last November, Henry was working with Mark Gannon on a flex rental agreement for land he has cash-rented for five years. Gannon is the owner of Gannon Real Estate and Consulting, U.S. Farm Lease in Ames, Iowa (www.usfarmlease.com). He is a proponent of flex leases and recently introduced the FAIR Lease Monitoring Service.
Gannon negotiates flex rent agreements, including establishing a base rent, and then he monitors the arrangement. The landowner verifies yields, then U.S. Farm Lease calculates the bonus payment and invoices the tenant when there is a bonus. “We are trying to make the arrangement simple and verifiable,” he says.
Gannon thinks operators are becoming increasingly receptive to flex rent arrangements. “If the alternative is going to a bidding system or a high cash rent vs. coming up with something like a flexible rent, I think they will be receptive to it,” he says. “The biggest advantage to tenants is that they are not locked into the big numbers in the beginning.”
2 Examples of Flexible Rent
1. William Edwards says, “Most of the flexible leases in Iowa specify that the rent will be equal to anywhere from 25% to 40% of the gross crop revenue.” Here is Edwards' example of how that works for corn at the 25% level:
● Cash rent will be equal to 25% of the gross crop revenue.
● Actual yield of corn is 150 bushels per acre; actual price is $6 per bushel.
● USDA direct payment is equal to $20 per acre.
● The gross income is equal to (150 × $6) + $20 = $920.
● The cash rent is equal to 25% × $920, or $230 per acre.
2. Edwards says, “Another type of flexible lease formula specifies a base or minimum rent, plus the owner receives a share of the gross revenue in excess of a certain base value.” Here's an example of how that works for soybeans:
● Base rent is $150 per acre.
● Tenant's cost of production is $260 per acre, excluding land.
● Base gross revenue is $410 per acre ($150 + $260).
● Bonus is 35% of the gross revenue in excess of $410 per acre.
● Actual yield of beans is 52 bushels per acre; actual price is $13 per bushel.
● USDA direct payment is equal to $20 per acre.
● Gross revenue is equal to (52 bushels × $13) + $20 = $696 per acre.
● Revenue in excess of the base is equal to $696 - $410 = $286.
● Rent is equal to $150 + (35% of $286), or $150 + $100 = $250.
● But if the market price of soybeans is only $9 per bushel, the gross revenue would be only $488, the bonus would be ($488 - $410) × 35% = $27, and the rent would be $177 per acre. (See Flexible Farm Lease Agreements mentioned in the main story.)