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Interest grows in flexible rent

The graph above compares a $250 cash rent to a flex rent with a $150 base and 25% of revenues above $500 per acre. If revenue exceeds $900, the landowner receives rent that is higher than the base.

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High grain prices the past two years have caused big increases in cash rent for farmland throughout the Midwest.

Iowa State University (ISU) survey results released in May estimate that the average cash rent for corn and soybean land in the state had increased 18% to $252 per acre. That's a jump of $38 per acre on the heels of a $30-per-acre increase the previous year.

“This is the largest one-year increase since the statewide survey began in 1994,” says William Edwards, an ISU Extension economist. “In many counties, respondents indicated that typical rents were $400 to $500 per acre or more for the higher quality land.”

Iowa is not alone. University of Nebraska ag economist Bruce Johnson says rents in his state for 2012 are up 15% to 20% over 2011 averages. Last fall, Purdue Extension economist Craig Dobbins reported a 13% increase in cash rents for 2011 over 2010.

Those lofty prices illustrate the tremendous volatility in the cash-rent market. Unfortunately, cash-rent agreements don't respond well to volatile markets.

Cash rent has worked fairly well over the years, or it wouldn't have kept growing in popularity. But with the tremendous volatility in grain prices and input costs since late 2006, the inherent problems with cash rent have come to the surface. The primary problem is that conditions start changing the minute you sign a cash-rental agreement.

“Recent volatility in both cash commodity prices and yields has complicated the task of predicting anticipated revenues,” says University of Nebraska Extension educator Tim Lemmons. “Further uncertainty in crop-production expenses has made negotiating cash rents difficult.

5 Flexible Cash Farm Lease Websites

● Iowa State University (ISU) Ag Decision Maker – Extension Economics www.extension.iastate.edu/agdm

● Farm Doc – University of Illinois Extension Economics www.farmdoc.illinois.edu

● Ag Manager – Kansas State Extension Economics www.agmanager.info

● Ag Economics – Purdue University www.agecon.purdue.edu

● Farm Management – ISU Polk County Extension www.extension.iastate.edu/polk/farmmanagement

Source: Steve Johnson, ISU Extension

“In years when crop prices are high and/or yields are good, the landowner may question whether the rent should be raised significantly the following year,” he says. “In years when crop prices are low and/or yields suffer, growers may not receive enough cash income to cover higher cash rents and production expenses.”

This volatility in grain prices, input costs, and, in some regions, yields has created lots of turmoil in the land-rental market. This turmoil, subsequently, seems to be increasing the adoption rate of so-called flex rents.

With this type of lease, the rent is not determined until the crop is harvested. Crop revenue insurance can be used to provide income protection for both the tenant and the landowner.

And the Farm Service Agency (FSA) no longer views certain types of flex rental agreements as share leases.

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Above: This graph shows the trade-off between risks and returns.

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Above: This graph shows how land values and cash rent track together.

A recent survey reveals that nearly 12% of all cash leases in Iowa are flex leases.

Nick Paulson, a University of Illinois economist, cites a survey by the Illinois Society of Professional Farm Managers and Rural Appraisers that shows variable cash leases were used on 21% of rented acres in 2011. That's up from 11% in 2010 and 2009. Everyone who responded to the survey expected variable cash leases to increase or to remain stable for 2012.

Incidentally, the University of Illinois went to flex rent agreements on 10 of their endowed farms for the 2012 season and beyond.

There is evidence that crop-share arrangements or flexible cash-rent arrangements are more equitable than fixed cash-rent arrangements and they foster more cooperation. Operators come and go more often on cash-rented land than they do on crop-shared land. According to a 2007 ISU survey, the average crop-share acre was leased by the same person almost twice as long as a cash-rented acre – 18.1 years vs. 9.5 years.

It's not just the recent past that is spurring interest in flexible cash rent. It's also a palpable concern about the immediate future. In March, the USDA projected that the average corn price for 2012 would be $4.80 per bushel, well below peak prices of the past two years.

The land-rental season starts soon and builds throughout the winter. The deadline for breaking rental agreements varies by state. In Iowa, rental agreements that aren't cancelled by either party by September 1 remain in effect for the following year. Some tenants and landowners, and many farm-management firms, routinely break the rental agreement each year and then renegotiate it during the winter as more information becomes available.

Cultivate stability

Flex rental arrangements offer a way to reduce the emotion, conflict, and even fear that can creep into rent negotiations. One of the main advantages of a flexible cash-rent agreement 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 have to be addressed periodically, unless they are automatically adjusted along with yields and prices.)

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. Of course, they may also give up some profit potential. (See the top graph that illustrates the risk-return trade-off for producers and landowners.)

There are also disadvantages with flexible cash-rent 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.

There are lots of different types of flexible rental agreements. University of Minnesota Extension educator David Bau lists five:

● Flexible rents based on gross revenue.

● Base rents plus a bonus.

● Flexible rent based on yield only.

● Flexible rent based on price only.

● Profit sharing flexible rent agreements.

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