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The cases for high & low farmland
Some say there's not a bubble building in the farmland market. Others say some factors are lining up to send the market tumbling. So, which one's right?
The answer to that question, experts agree, lies somewhere at the convergence of factors like 2013 crop yields, grain prices, crop insurance levels, interest rates and other factors, both ag-specific and in the macroeconomy.
So, how will all these variables unfold? A brief history lesson shows precedent for past instances when things like input costs and grain prices have moved land values and, in some cases, yielded a "new equilibrium" in land values and prices, says Iowa State University Extension ag economist and farmland values specialist Mike Duffy, who conducts Iowa's annual land values survey, the 2012 results of which will be released on December 11.
In 1973, the marketplace reached one of the "new plateaus" in corn prices. That fueled a surge in land prices. Fast-forward 30-some years and it was energy costs that fueled another period of sharp gain. But then, in 2009 came the "fertilizer crisis" when nitrogen prices skyrocketed and caused a pause in the land value climb. Right now, Duffy says it's grain prices that likely hold the farmland trump card.
"Most people thought values would level out. Then a year ago, the drought hit and away she went," Duffy says of the land market. "Many farmers have made more money than ever. So, what'll make [the market] go down? The biggest thing is a drop in commodity prices and or significant increase in input costs."
If the land market's going to buck the trend of climb, corn prices are going to have to stay in the $7 to $8/bushel range, Duffy says. At such a price range, demand attrition sets in and, if prices stay in that territory long enough, that could lead to a longer-term reversal for farmland.
"When we hit $7 ot $8 corn, a lot of users said 'we have to find something else,'" he says. "In a lot of cases, particularly on the industrial side, they'll substitute and they won't be too excited to get back into the corn market."
Rain -- or a lack of it -- is just as big a factor to land prices. If the tap turns back on after a year or so of drought in farm country, it won't take long for a potential return to trend yields to work its way into farmland prices.
"What if the U.S. produces 3.5 to 4 billion additional bushels of corn in each of the next couple years? This could easily happen if corn yields return to trend levels and farmers plant the corn acreage they brought into production the last couple of years," says longtime University of Tennessee farm policy expert Daryll Ray. If demand doesn't match the pace of production, this could depress grain prices and eventually send land lower. And, the odds of that happening are increasing.
"Clearly corn demand for ethanol will not repeat the explosive growth of earlier years," Ray adds. "High feed prices and widespread drought have destroyed a significant portion of prospective livestock feed demand and US exports are likely to be affected as much by our export competitors supplying additional grain as importers demanding more grain."
Is land worth as much as everyone in the marketplace thinks? That's another key factor that could lead prices lower, and if expectations for land values -- which Duffy says have hovered above actual values in the last 7 years -- are still much higher than actual market price levels, it could lead to a sort of bounceback reaction in which prices could snap lower. The question here, he adds, is how low those prices go, for how long, and how much farmers have borrowed to keep ahold of the land they have.
"Right now, we've jumped up and I think we overshot our mark so will come back down a little to a new plateau," Duffy says. "How much will that impact land values depends a lot on how much debt people took on. If we see a lot of debt, then we'll see some pretty big drops."
Are you more optimistic about higher land prices down the road? If so, grain demand's a big part of the outlook and you probably won't be bothered by a dip in grain prices since, at levels down to around $4.50/bushel, demand that's trimmed by higher prices will return. And, a resurgence in grain demand will mean a strengthened land market, Duffy says.
Another sign that land could continue on its surging path lies in the investment community. Farmland's still a fairly safe place for investment dollars, and if that continues -- something that depends greatly on grain prices -- it will underpin land prices in general.
"Look at farmland as a part of a larger company's portfolio. There's been talks that they've been burned so bad in the urban market, but the urban market did what the farmland market did in the '70s. They were 90% to 95% loaned out, and once that moves, it's underwater. That really was a bubble," Duffy says.
There's also the notion that there's more elasticity in grain demand than earlier thought; some say there's been proof of that in the last few weeks, when demand has been rationed to the extent that it's kept prices from skyrocketing based on the drought-shortened 2012 crop. And, Murray Wise, farmland realtor, broker, and land market expert with Murray Wise LLC, in Champaign, Illinois, says that flexibility works both ways and will ultimately keep grain prices and ultimately land values afloat.
"Current commodity prices resulting from increased global demand have producers in position to have outstanding cash income . . . even in a severe drought year," Wise says. "Simply put, farm income supports those values."
Finally, look beyond the walls of agriculture and to the general economy. If farmland's going to continue to stay on a bullish track, the relative stagnation of values in the equities and other commodities will help a lot.
"For years, I’ve felt that there was no clear financial incentive for retired farmers and folks who inherited land to sell. Where would they invest to do better? Frankly, no other reasonably stable asset class could match the total return on quality farmland," Wise says. "Nor would the alternatives be likely to match land’s inflation protection."
So, what does Duffy think? The veteran student of the farmland market says there's likely never been a time when there's been as many and varied ideas on the direction of farmland values. He says he's less inclined to see factors like the upcoming "fiscal cliff," or expiration of tax cuts at the calendar year's end, as a dealmaker or breaker to the farmland market. Still, there's a lot of room for fluctuations in values in the next year.
"I think [the fiscal cliff] has got quite a few people's attention. I think it's more overblown than it really is," he says. "Right now, everybody's got their own ideas on the farmland market. People want to know. Personally, I don't think we've hit the peak."