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Be flexible with 2012 cash rents
With the run up in commodity prices and farmland prices -- some surveys show 30% increases in just the last year -- many cash rent rates have not kept up. So how much should they go up in 2012?
"That depends entirely on where you are now and how proactive you've been in the last few years at making the necessary adjustments," says Kevin Dhuyvetter, Kansas State University farm management specialist.
"If you've been making adjustments the last several years, maybe your rents should change by a small amount. But, if you haven't adjusted them for several years, they may need to change a lot more."
Because of higher risks and general market volatility, Dhuyvetter suggests you and your landowners consider a flexible cash rent arrangement, with a base amount that reflects past conditions, but that adjusts upward automatically if yields and/or prices exceed the base. "Corn prices might be $7 a bushel next year, but they might also average $4. Nobody knows. A flex rent system can share some of that risk, and give the landowner a potential for more, but without committing the operator to a high cash rent in the event prices drop significantly."
One simple way to do this, Dhuyvetter says, is to set a base rent that is reflective of the last five years of performance. For example, for easy figuring, say that a farm has averaged a corn yield of 150 bushels an acre, and the price has averaged $5 a bushel. That's $750 an acre in gross income, and a level of income that probably allows for a modest profit with your past rental rate.
With flex rent, If the gross per acre for 2012 turns out to be above that, due to good yields or higher prices or both, the landowner starts sharing those rewards. He may take a little less in the base rent, with potential for a lot more.
Some farmers, he says, may want the flex rent to kick in when gross returns exceed a higher amount (maybe $800 from the example above), since they carry all the risk of other input costs. If gross revenue should end up at $900 an acre, $100 over the base, you and the landowner would share the $100 at the end of the growing/marketing season.
How much should be the landowner's share? "I'd look at local custom," Dhuyvetter says. "In places like Iowa and Illinois, the old crop shares were 50:50. Here in Kansas, it was more often 60:40 or 2/3:1/3 [larger amount to the farmer]."
"A flex rent is shared risk and reward," says Dhuyvetter, "sort of like crop share, except the landowner doesn't have to hassle with things like government programs, and crop insurance, and marketing the crop. If you have a good year, the landowner shares in it."
If you want to throw in another wrinkle, you could also factor in other costs such as the price of fertilizer or fuel. As they go up or down, the rent flexes. But those factors complicate an agreement that is already something “new and different” for most people so it may be more important to try a flex rent focusing on yield and price initially, says Dhuyvetter.
For flex rent agreements, Dhuyvetter likes to use actual yields from the farm for that year, but he suggests you not use the actual sales price of the crop in question. A crop usually isn't sold at one time in one chunk, but is spread out. So, use a price that is an average of local prices during a certain time frame when crops are normally sold and that you and the landowner can agree upon.
"Depending on what region of the country you are in, cash rent can be the biggest and most variable cost out there," says Dhuyvetter. "It can trump all the others. If you haven't communicated with your landowners about it, you need to do it soon. In some states those conversations have already taken place. In Kansas, they're going to happen over the next three months."
Dhuyvetter acknowledges that he doesn’t have a crystal ball for predicting the prices of inputs any better than other people, but he offers these thoughts for other input costs for 2012:
- Fertilizer and fuel: Strong demand this fall has put upward pressure on prices. Further upward movement into spring wouldn't seem to be a high risk. "If I haven't locked in fertilizer yet, I'm more hand-to-mouth going into spring. And it's a similar story on fuel, futures markets and government reports would indicate there isn't a lot of upward price risk from where we are now."
- Seed and chemicals: Upward movement likely, but not expected to be huge amounts, probably more in line with normal inflation trends.
- Machinery: No giant price bumps here, but Dhuyvetter says you should evaluate your needs now and search out availability early. "If you know you have needs in this area, and you want to do it to your best tax advantage, don't wait until the last week of the year to try to find what you want," he says. "Do your shopping now."