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Are farmland prices in line with farmland returns?

Agriculture.com Staff 02/14/2016 @ 5:21pm

Reports suggest that farmland prices continue to increase. Results from a lender survey conducted by the Federal Reserve Bank of Chicago suggest that prices increased by three percent in northern Illinois between the middle 2006 and middle 2007. Members of Illinois Society of Professional Farm Managers and Rural Appraisers indicate that prices increased 5.9% during the first half of 2007.

Recent increases raise questions about whether increases in farmland prices are outpacing increases in farmland returns. This issue is examined here by comparing farmland prices to capitalized values.

USDA's estimates of average Illinois farmland prices mask differences across the state. Farmland prices, for example, are much higher near Chicago. Because differences exist, price-to-return relationships vary across Illinois.

Farmland prices increased from $490 per acre in 1970 up to $2,023 per acre in 1982. Then prices decreased, reaching a low of $1,149 per acre in 1987. Since 1987, farmland prices have increased each year. The average yearly increase since 1987 had been seven percent.

Since 2003, increases have been above seven percent. Farmland prices increased 7.4% between 2003 and 2004, 27.6% between 2004 and 2005, 14.1% between 2005 and 2006, and 13.9% between 2006 and 2007. Between 2003 and 2007, farmland prices increased by $1,900 per acre, representing a 78% increase.

Capitalized values represent the earning potential of farmland from agriculture. A capitalized value for a given year equals cash rent divided by an interest rate and assumes that investors receive the current cash rent each year in the future and the interest rates do not change. Higher cash rents cause higher capitalized values. Lower interest rates cause higher capitalized values.

Farmland prices and capitalized values closely tracked each other from between 1986 through 2004. During this period, farmland prices averaged seven percent higher than capitalized values.

Farmland prices exceeded capitalized values recently. In 2006 and 2007, farmland prices averaged 46% higher than capitalized values. Prior the current period, the last time farmland prices exceeded capitalized values by a large margin was from 1977 through 1981. During the late 1970s, farmland prices increased because of strong commodity prices. In the 1980s, financial stress occurred, leading to declining farmland prices.

A question exists whether the current period of high farmland prices relative to capitalized values will mirror the 1977 through 1981 period. Will farmland prices decline in the future? While farmland prices may decline, there are two differences between the current period and 1977 through 1985.

First, much of the decline in capitalized values between 1977 and 1981 was associated with higher interest rates. Interest rates increased from 7.42% in 1977 to 13.92% in 1981. It is doubtful that interest rates will show similar increases in future years.

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