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Roller coaster rents

If Yogi Berra followed the
land rental market instead of baseball, he might be saying, “It’s déjà vu all
over again.”

Think back to February 2007.
At that point, grain prices were significantly higher than they had been in
September 2006, and much of the 2006 crop had been priced before prices started
increasing. The 2007 crop could be priced at relatively high levels, but
producers were reluctant to sell a large percentage of that crop in advance.
Yet there was also concern that those prices might drop between February and
harvest. Input costs were going up. And the land rental market was in turmoil.

That’s a lot like the
current situation, and the land rental market is once again in turmoil. Corn
and soybean prices started going up last summer, but most of the increase came
after August. Futures prices for the 2011 crop were relatively strong through
the fall, input costs started going up, and land values have increased
dramatically in many areas. An Iowa survey released in December shows that land
values had increased 16% from November 2009 to November 2010.

Fixed cash rent agreements
don’t respond well to volatile markets. “If everyone went back to or stayed
with crop share leases, the volatility in grain and fertilizer prices wouldn’t
be nearly as problematic,” Kansas State University ag economist Kevin
Dhuyvetter said in late December.

At that point, he was
partway through a series of land rent meetings around the state. At a
mid-December meeting in Clay Center, he asked the attendees what they thought
of fixed cash share leases compared to equitable crop share leases.

The group was about equally
split between landowners and producers.

• 23% thought fixed cash
rent was a good thing.

• 23% thought it was a bad
thing.

• 54% thought fixed cash
rent was neither good nor bad, just different.

At that same meeting,
Dhuyvetter asked the attendees how much they thought rent would increase for
2011.

• 45% said up 2% to 5%.

• 38% said up more than 5%.

• 14% said remain steady.

• 3% said down 2% to 5%.

Purdue University ag
economist Craig Dobbins expects fixed cash rents to increase in Indiana, also.
And he sees evidence that tenants are being proactive. “This winter, I have
been getting a new kind of call from landlords,” he says. “They indicate that
the tenant is suggesting that the rent be increased. This is an experience that
most landlords have not had before, and they are not exactly sure what to make
of this.

“Here is an opportunity for
the tenant to strengthen the relationship with the landlord,” says Dobbins.
“Explain to the landlord the details for why the rent should be raised. Use as
much detail as you would if you were arguing that the rent should be lowered.
This is an opportunity to show landlords that you are using sound business
procedures. So if you need to ask for a rent reduction in the future, the same
procedure can be used.”

Barry Ward, an Ohio State
University ag economist, had this to say about the land rental market in late
December: “I believe cash rental rates will be higher on average across Ohio
for 2011 than they were for 2010. But there will be regional differences as
some areas experienced poorer crops in 2010 and may not see the upward pressure
that other areas see.”

He acknowledged that grain
prices were up significantly, but said, “Many sold 2010 crops ahead and haven’t
priced much 2011 crop. And inputs are up.”

Also in late 2010, Iowa
State University (ISU) ag economist William Edwards said,

“There will be more than the
usual variability in Iowa because the rise in grain prices happened mostly
after our September 1 deadline for renewing leases. Leases that were renewed
before September 1 probably did not change rents from last year in most cases.”
(Most states have later rent renewal deadlines than Iowa.)

“Some tenants and landlords
routinely let the lease roll over but expect to negotiate next year’s rent
later,” he added. “For these there will be upward pressure, but it’s hard to
say how much. Some tenants will voluntarily offer more; some will wait and see
if current grain prices persist into the next crop year.

“Most operators will not
price a high percentage of the 2011 crop yet,” he said, “so higher incomes are
not a given.

“Landowners may overestimate
how their tenant did in 2010,” Edwards added, “because much of the crop was
priced before the harvesttime price increases. And in some cases, not as many
bushels were harvested as the year before.”

Steve Johnson is an ISU Extension
farm management specialist in central Iowa. He was dealing with lease issues at
the end of the year, and said, “The average cash rental rate for 2011 will be
higher than 2010, but forecasting these numbers will be difficult. Likely, cash
rents and renegotiated leases are $10 to $30 per acre higher.

“In Iowa, the lease
termination deadline of September 1 meant many landowners did not provide legal
termination, since 2011 prices had increased only a fraction of their overall
prices moves higher,” he said.

There are definitely some
dollars on the table.

Johnson points out that
December 2011 corn futures prices had increased over 45%, and November 2011
soybean futures prices had increased by more than 40% since late June.

“Cash rent represents about
30% of the total cost of corn production costs and 40% of soybean production
costs,” says Johnson.

“Think about this one,” he
said. “The potential profit margin for corn per acre, assuming other costs
remain constant in 2011 (which he acknowledged they won’t), would indicate that
more than $90-per-acre net profit potential could be reflected in increased
cash rent.” Here’s his math: 180 bushels per acre of corn × a $1.80-per-bushel
price increase = $324 per acre. Multiply that by 30% and you get $97 per acre.

For soybeans, he said the
soybean profit margin increased by more than $70 per acre over the six months
from June until December, if other costs remained constant. Here’s his math for
soybeans: 50 bushels per acre × a $3.82-per-bushel price increase = $191.
Multiply that by 40% and you get $76 per acre.

In January, ISU increased
the cash rent equivalent number in their crop cost estimates by $20.

Cash rents can go down, too,
of course. An Illinois survey showed significant erosion in 2009 cash rents according
to when the rent was set. Land rented prior to September 2008 brought $285 per
acre. Land rented in September and October brought $272. Land rented in
November and December brought $260. Land rented from January to March brought
$222.

University of Nebraska ag
economist Bruce Johnson says to “negotiate cash rent levels annually and
understand year-to-year cash rent levels can move both up and down.” He
forecasts a saw-tooth pattern for cash rents.

Cash rent for 2010 didn’t
change much from 2009 in many areas. And until grain prices took off last
summer, 2011 rents had been expected to remain fairly stable.

Purdue University ag
economist Craig Dobbins reported in August that the statewide average for
top-quality land in Indiana in 2010 increased 2% ($4) to $202 per acre.
Average-quality land increased 1.9% ($3) to $161 per acre. Poor-quality land
increased 2.5% ($3) to $124 per acre.

Statewide, rent per bushel
of estimated corn yield ranged from $1.02 to $1.08 per bushel.

For top-quality farmland,
cash rent as a percentage of farmland value was 3.8%. The percentage for
average-quality land was 3.6%, and for poor-quality farmland, the figure was
3.5%.

In January, Nebraska’s Bruce
Johnson said, “Rental rates will be higher for 2011 due, in large part, to the
grain price run-up in the last half of 2010. Many cash rent contracts were
already in place before the big grain price gains, but contracts negotiated
closer to the first of the year in areas where there is strong competition for
rental land are definitely showing increases.” He expects increases in the
double-digit range.

Cash Rent Is A Fickle Friend: The pros and cons of fixed
cash rent

Cash rent is the primary
method of leasing farmland in many areas. That’s especially true in the Corn Belt,
where over 80% of the rented land in the Seventh Federal Reserve District
(Iowa, Indiana, Michigan, Wisconsin, and most of Illinois) is rented for cash.
In tranquil times, cash rent works fairly well. But in tumultuous times like
these, its flaws stand out.

“When yields and prices are
relatively stable, setting the cash rent may be fairly easy,” says Iowa State
University (ISU) ag economist William Edwards. “However, when conditions are
volatile, it becomes more difficult to determine a mutually agreeable rent.”

Most years, the volatility
relates to grain yields or commodity prices. But over the past few years, there
has also been a lot of volatility in input costs, particularly for fertilizer.

Risk has also become a
bigger factor. University of Illinois ag economist Gary Schnitkey says farmers
now face more risk than they did a few years ago for three reasons.

“First, price variability
likely will be higher over the next several years.

“Second, commodity programs
will not provide as much downside price protection.

“Third, revenue for crop
insurance must fall more in periods of high prices before insurance payments
are received,” he says.

Howard Doster, a retired
Purdue University ag economist and longtime proponent and developer of flexible
cash rents, says the problem with most rental agreements is “they start going
out of date the minute they are signed.”

Under a crop-share lease,
the landowner and tenant share the expense of raising a crop and the income
from that crop. There are many possible arrangements. A recent Iowa survey
shows a 50-50 split is still the most common. In central and western Kansas, a
67-33 split is the most common arrangement.

Under a cash rent lease, the
landowner receives a cash payment in exchange for the use of the land. This
article deals primarily with fixed cash rents that are established in advance.
There are also flexible cash rents that have price adjustments for yields,
commodity prices, and, in some cases, input costs.

There has been a steady
shift from crop share leases to cash leases over the past 30 years or so. Iowa
State University conducts a land ownership and tenure survey every five years.
The last one was taken in 2007. In 1982, 49% of the leased farmland in Iowa was
under a cash lease, and 49% was under a crop share lease.

Twenty-five years later, in
2007, 77% of the leased farmland was cash-rented and only 22% was crop-shared.
(A flexible cash rent was used on 12% of the acres that were cash-rented. The
other 88% had a fixed cash rent.)

In 2007, 60% of the farmland
in Iowa was rented. More land was cash-rented (46%) than was farmed by the
owner (40%).

There are lots of reasons
for the shift. ISU ag economist Mike Duffy, who conducts the survey, says, “The
most important reason appears to be the relative ease of using the cash rent.
As tenants have more landlords and vice versa, it is simply easier to remember
a dollar amount than some division, especially if it involves dividing a crop.”

Over the past decade, there
has been a significant shift from crop share rent to cash rent in Illinois, as
well. University of Illinois ag economist Nick Paulson says, “The average
proportion of total acres that are operated under a share rent agreement has
fallen from about 48% in 1997 to 37% in 2009. Over the same time period, the
proportion of total acres operated under cash rent agreements has increased
from just over 25% to approximately 40%, while ownership rates among grain farm
operators have declined slightly from 25% to about 23%.”

Paulson says these trends
have significant implications for farm profitability and the risk exposure
facing both the producer and the landowner. He links the risktakers to the
increased availability and breadth of crop insurance programs.

“While economic theory would
suggest that farmers should earn a premium for taking on additional risk, lower
farm returns have been linked to Illinois farms which cash-rent a significant
portion of their total acreage,” says Paulson.

Kevin Dhuyvetter, a Kansas
State University ag economist, says, “A risk premium, or risk adjustment,
represents a reduction in the cash rent relative to what is expected from a
crop share arrangement, to account for the shift in risk from the landowner to
the tenant. The amount of risk adjustment is a function of an individual’s
aversion to risk as well as the income variability.

“Since an individual’s
aversion to risk is difficult to quantify and because this varies considerably
between people, recommending a risk premium appropriate for all situations
really isn’t possible,” Dhuyvetter says. “In the mid- to late 1980s, a risk
premium of 10% was typically recommended. But in the late 1990s and early
2000s, we often observed risk premiums of zero. That is, producers would pay
cash rents equivalent to the expected crop share returns. Today, I think the
value is back to at least 10% and, in some cases, is significantly higher than
that due to the increased volatility.”

Cash rent has worked fairly
well or it wouldn’t have kept growing in popularity. But with the tremendous
volatility in grain prices since late 2006, the inherent problems with cash
rent have surfaced.

“Extremely volatile input
prices and crop prices make negotiating fixed cash rents very difficult and
risky,” explains Dhuyvetter. “Most crop share arrangements have a built-in
buffer to much of this risk.”

Kansas is a state where crop
share leases are still common. “Crop share continues to be the most prevalent
in Kansas, but the trend has been a shift from crop share arrangements towards
more cash rent leases,” says Dhuyvetter. In 2006, 64% of rented ground was
crop-shared vs. 31% that was cash-rented.

As grain prices soared in
2007 and the first part of 2008, tenants on cash rented ground experienced a
windfall. Some producers paid landlords a bonus in an attempt to maintain good
relationships. And some producers lost rented land for the next year because
landlords didn’t think they received enough rent.

Cash rents went up, but not
as far or as fast as commodity prices. There is always a lag time with cash
rent. Then, in the second half of 2008 and on into 2009, as input prices
(primarily for fertilizer) skyrocketed while grain prices fizzled, rents lagged
the downturn.

Purdue University ag
economist Craig Dobbins points out the problems with trying to set a cash
rental rate in the fall of 2008 for the 2009 crop. “Given price and cost
expectations in September 2008, the estimated return to land and unpaid
machinery and labor resources for a 2009 crop corn/soybean rotation was $308
per acre. Given this estimate, a cash rent of $200 per acre for 2009 may have
been reasonable. During October 2008, cash corn and soybean prices went through
a significant decline. Expected grain prices for fall 2009 also declined,”
Dobbins says.

“Using the futures market as
a guide for prices for the fall of 2009, the estimated return to land and
unpaid machinery and labor resources for the corn and soybean rotation in late
October 2008 was $200 per acre. In this case, $200-per-acre rent would not
leave any margin for the cash rent tenant’s unpaid machinery and labor,” he
says.

There is evidence that crop
share arrangements or flexible cash rent arrangements are more equitable than
fixed cash rent arrangements and that they foster more cooperation. Operators
come and go more often on cash rented land than they do on land that is
crop-shared. According to the 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.

The ISU survey also shows
that older landowners are more inclined to crop-share land than are younger
landowners. “This means it is likely that the crop share lease of today will be
converted to a cash rent,” says Duffy. “However, there are signs this change to
cash rent will not continue indefinitely. More of the crop share leases are
between relatives. Crop share is one way an older party can help a younger
party by sharing risk. This is not only the production risk but also the costs
of production.”

A major problem with setting
cash rents is that accurate information is scarce and usually a year behind. As
Edwards points out, “Informal information about cash rents is plentiful, but
often focuses on extreme cases.” It’s also hard to avoid comparing apples and
oranges. Soil types, tile drainage, and fertility levels can vary a lot among
nearby fields.

Dhuyvetter says, “Publicly
reported cash rental rates often represent a relatively wide geographical
region and, thus, may not reflect local conditions.”

Schnitkey adds, “The cash
rental market has local factors that influence rental rates. Hence, what may be
occurring in one county may not be occurring in another county. And cash rents
vary considerably from farms of similar productivity within a county. There
will be rents more than $100 higher and $100 lower than average. Some of the
differences between averages from year to year may simply be based on which
farms get sampled.”

Although published
information is scarce, some is available. The National Agricultural Statistical
Service (NASS) started providing county rent estimates in 2008. That
information is available at

www.nass.usda.gov/Surveys/Guide_to_NASS_Surveys/Cash_Rents_by_County/index.asp

ISU Extension conducts a
survey every spring after rates for the year have been set. Results are usually
available in May. Past surveys are available on the ISU Ag Decision Maker
website (

www.extension.iastate.edu/agdm/

).

Timing can also be an issue
with cash rents. 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. Grain
prices started going up last summer, but most of the increase came after
September 1. Input costs increased during the fall, also.

By March, there may be less
uncertainty on grain prices and input costs, and the base prices for revenue
crop insurance policies should be set. Provisions are made for compensating the
operator for fall tillage and fertilizer application if an agreement on price
is not reached during the winter.

Many tenants and landowners
have willingly turned from crop share arrangements to cash rent. Depending on
individual circumstances, there are lots of valid reasons for making the
switch. But there are also lots of valid reasons to avoid cash rent.

An ISU publication entitled
Improving Your Farm Lease Contract lists the principal advantages and
disadvantages of a straight cash lease. Here are the advantages cited in the
ISU publication:

• The lease is simple with
relatively few chances for misunderstanding.

• The owner is relieved of
making day-to-day operating decisions.

• The owner has very little
financial risk.

• The tenant has maximum
freedom in planning and developing the cropping and livestock programs.

• The tenant has fewer
records to keep.

Here are the disadvantages
and potential problems of the straight cash lease, as presented in the ISU
publication:

• A fair cash rental rate
may have to be renegotiated each year.

• Cash rents are likely to
be too low in times of rising prices and increasing yields, and too high in
times of low prices or low yields.

• Tenants are required to
supply more operating capital.

• Tenants bear all the risk
of price and yield variability.

Edwards sees that first
disadvantage as the main drawback of cash rental arrangements. “The primary
disadvantage of a cash lease is the need to agree on a rental rate that
accurately reflects the profit potential of the farm,” he says.

Edwards contrasts that with
crop share leases. “The most desirable feature of a crop share lease is that
both parties automatically share in increases or decreases in profits, making
yearly negotiations about rental terms unnecessary,” he says.

Flexible cash rental
agreements can accomplish that, also. “Tenants and owners who are willing to
share risk but want the simplicity of a cash lease may prefer some type of flexible
cash rent agreement,” says Edwards. 

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