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Time to try flexible rent

I’ve read a lot about land
rental arrangements over the past three weeks while working on leasing stories
for this issue. In fact, it’s about the only thing I’ve read except newspapers,
Christmas cards, and The Economist. The more I read and talk to people about
rent, the more relieved I am that I don’t cash-rent any farmland.

Computing an equitable cash
rent is difficult enough when the ag economy is tranquil. But the past four to
five years have been anything but tranquil. With the volatility in grain
prices, land values, input costs, and in some areas (like where I farm in
south-central Iowa) yields, it’s like trying to put a jigsaw puzzle together
without having all the pieces. How do you arrive at a dollar figure for cash
rent with all this volatility?

Rented land is an integral
part of most farm operations, and cash rent has become the norm in many areas.
But volatile commodity markets and fluctuating input costs have greatly
increased the risk that tenants bear with fixed cash rent. Economic theory
holds that tenants paying cash rent rather than operating under a crop share
agreement  should earn a premium
for taking on the additional financial risk. But evidence suggests they don’t.
Nick Paulson, a University of Illinois ag economist, says, “Lower returns have
been linked to Illinois farms that cash-rent a significant portion of their
total acreage.”

Cash rents always lag
changes in the marketplace. Arguably, they didn’t increase fast enough in 2007
and 2008 when commodity prices increased dramatically. (That’s why some tenants
made bonus payments to landowners or voluntarily renegotiated rental
agreements.) And they probably didn’t drop fast enough or far enough in late
2008 or early 2009 when commodity prices fell and input costs skyrocketed.

It’s hard to really know
what rental rates are doing this winter, following the sharp run-up in corn and
soybean prices since last summer. Many observers expect to see some
double-digit increases, even though grain prices showed signs of stalling at
the end of the year before getting another boost from the USDA’s January 12
supply and demand estimates. And there are reports of tenants who offered to
boost the rent for agreements signed before grain prices really took off.

The volatility in grain
prices and input costs wouldn’t be as much of a problem if tenants and
landowners went back to using crop share agreements. But I don’t see that
happening. And to be fair, there are a lot of drawbacks to crop share leasing,
too.

Flexible cash rents may
provide the best compromise. With traditional fixed cash rent, the amount is
set in advance. With flexible cash rent, adjustors are used to keep things in
balance. Landowners and tenants can share the risks and rewards of changes in
grain prices, yields, and input costs.

Flexible cash rent
agreements are slowly gaining ground. But Iowa State University ag economist
William Edwards says they still don’t account for more than 10% of all cash
leases.

“They are an accepted
practice now and not just a novelty. However, some tenants feel they were
burned by flexible leases in 2010,” Edwards says.

Those were situations where
the price component was based on harvesttime prices, which were generally high.
But the tenants had priced much of their crop prior to harvest, when prices
were significantly lower.

“This points out the need to
structure flexible rent formulas so that the gross income used to set the rent
truly reflects the tenant’s income each year,” says Edwards. It also points out
the need to really understand the various ways to structure flexible cash rent
agreements.  

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