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Grain Farm Incomes Won't Dictate Farmland Price Direction

Jeff Caldwell 08/25/2014 @ 3:07pm Multimedia Editor for Agriculture.com and Successful Farming magazine.

Grain prices may have fallen -- and continue to do so -- but that doesn't necessarily mean the farmland market will follow suit, a team of economists and land experts say.

The land market's one that many experts have said in recent months that would likely ultimately follow the grain markets lower, but that it may be a delayed reaction. Now, months into the turn lower in grain prices, land prices continue to stay out of the red. Is this still a delay in the land market's reaction or is it not coupled in lockstep with the grains as earlier thought?

"During the previous several years, increasing return to farmland and decreasing interest rates have placed upward pressure on farmland price. Now farmland returns are no longer increasing and interest rates may be set to increase," according to a report from University of Illinois ag economists Gary Schnitkey, Bruce Sherrick and Todd Kuethe. "The drivers of large farmland price increases from 2006 through 2013 have likely eased, however, that does not mean that farmland prices will decrease. We may enter a period of more stable farmland prices."

So, why isn't the land market following farm income lower? Though there is a strong connection between the 2 markets, that doesn't mean every move in the latter will be followed by similar movement in the former. The answer lies in the variables that make up the land market and how changes in them are manifested in overall market trends.

Take interest rates, for example. For years, they've been trolling along at low levels, and that's contributed to the continued strength in the farmland market. Lower rates have generally meant more incentive to buy.

"A reasonable proxy for the farmland capitalization rate appears to be 10-year Constant Maturity Interest rate. As a proxy for the 'cap rate,' changes in interest rates impact farmland prices through 2 effects. First, lower interest rates decrease farm mortgage costs, thereby reducing the costs of acquiring farmland. Secondly, lower interest correlate with lower returns on an alternative investments, making other investment less attractive, and vice versa. Interest rates have been on a downward trend since the mid-1980s, with significant decreases in interest rates since 2008," according to the U of I economists' report. "Of course, increases in rates are far from certain. Indicators could suggest the economy is nearing recession, leading the Fed to continue low interest rate policies. Even if more typical monetary policies are pursued, there is uncertainty about the path of interest rates as the Fed winds down extra-ordinary policies and their associated enormous balance sheet positions. While interest rate increases are not certain, it appears that interest rate increases that affect farmland's capitalization rates pose a greater threat to decreasing farmland price decreases than does the prospect for decreases in farmland returns. Of course, the impact of interest rates increases will not only impact farmland prices, but also will put downward pressure on all assets' values."

While major variables like interest rates comprise a big part of the land market's future, the real thing to watch is capitalized value. That's essentially an indicator of a market's future direction. For example, Schnitkey says the Illinois farmland market had a higher capitalized value than its actual value for about the last 5 years, meaning it would likely continue upward.

The biggest indicator of capitalized value in the farmland market, specifically, is cash rent. The higher the rent, the higher the capitalized value, essentially.

"If low prices persist for several years, downward pressure on cash rents could continue into 2016 and 2017. Of course, a return to higher commodity prices would relieve this pressure. However, cash rent decreases would have to decrease by a large margin and perceived to be permanently lower before implied capitalized values would drop below current farmland values," according to Schnitkey, Sherrick and Kuethe's report. "To illustrate, given the 2014 10-year Treasury rate of 2.65%, cash rent would have to fall below $204 per acre before the capitalized value would decline below the current farmland value of $7,700. A decline of $30 per acre for cash rent from the current $234 per acre level is highly unlikely.

"Based on the above capitalized value comparisons, decreasing agricultural returns alone likely will not trigger a farmland price decrease. This conclusion assumes that adverse events will not permanently lower farmland returns," the report shows.

So, all in all, look for farmland values to stabilize around where they are right now instead of tracking farm incomes, even if those incomes continue to trend lower. Instead, watch these key variables moving forward.

"Shocks to interest rate markets could result in farmland price decreases, along with pressures generally on other assets as well," according to the university report. "Over the next several months, watching actions of the Fed and reactions in debt markets could be telling for the direction of farmland prices in the future."

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There is maybe another factor. Since there is on 08/25/2014 @ 11:08pm and so much of it is in really strong hands now - at least around my area -- why lower the price if ur the owner? that makes it a whole different game. It's got a sort of premium on it now.

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Nonsense! 08/25/2014 @ 7:24pm Pure and utter nonsense. Farmland values will fall significantly by the time this is over. And poof - like magic watch record farm debt to equity ratios appear when land values adjust to the true fundamentals. Idiots who expanded rapidly and bought farmland at record high prices are about to get a rude awakening -- and you know what, they absolutely deserve it. Mr. Caldwell, for many years your articles have been of the "cheerleader" type, boasting to the world how farmland has "outperformed" other investments in recent years, primarily due to the phony ethanol mandate and the fact that FCS will loan unlimited funds to any farmer with a pulse -- well, that's all about to change my friend. The fundamentals that led to a record runup in farmland prices are all unwinding at the same time and the result is predictable. Smart landowners work against the cycle - for those of us who have saved our money, protected our credit and saved our breath (from AGvocating) we are about to be proven correct yet again. History repeats itself over and over, but don't tell that to the Purdue "new era" crowd. You can bet their next act is to start whining and begging the government for even more welfare, subsidies, special farmer tax breaks, subsidized credit, etc.

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Re: Re: Nonsense! 08/25/2014 @ 9:49pm Farmland prices may adjust to evolving idiosyncrasies in the market in a somewhat rational manner, but the sky is not going to fall... We have a new baseline in effect as a result of the Great Recession.

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Re: Re: Nonsense! 08/25/2014 @ 9:41pm New technologies & this new economy establishes a new baseline for farmland price points. Farmers have never been more efficient than in today's current Ag environment. And, today's demand & outlook for farmland is very different from that of the previous decades... Since the great recession, farmland has now established itself as a staple in almost every major pension fund portfolio manager's arsenal. The University of Illinois crowd (TIAA Creft Center) has it right... There is much more to the intrinsic value of an acre of farmland than just the current yield/bushel per acre. Dairy is experiencing a continued renaissance and feeder cattle and hogs are not far behind. Lower commodity prices allow increased profitability to take place in these & other sectors (Ethanol). Nutrient Management Plans for Dairy Farmers allow dairy's to expand which requires more acreage. The hypothetical "return to land" calculation is much more than just number of corn bushels per acre. Take a large dairy farmer for example. If acquiring an incremental forty acre field allows him to increase his herd by an incremental 40 dairy cows (assume 1 acre per cow for securing a nutrient management plan approval), he can increase in gross revenue by 40 cows x 25,000 lbs milk per cow per year x $21 per hundred for Class III Milk price = $210,000 in gross revenue. If the true cost to produce a hundred weight of Class III Milk is $17 per hundred = $170,000, then the difference between gross revenue and cost is $40K which is allowed to take place because the farmer acquired additional acreage. The simply return to land calculation for producing baseline commodities does not take the application of dairy, beef & hogs algorithms into account. Some portion of this 40K in incremental profit has to be attributed to the land... The environment that we live in today has certain "safety" levers which include crop insurance, outside investors (pension & hedge funds) and baseline CRP payments in a given area. Unlike the stock market, land will never go to zero value because someone cooked the books or had to re-state earnings. Land is a pure asset and will always have an intrinsic value. Wall Street now understands this and this why we now have new REITs trying to buy farmland (FPI & LAND). The new normal and equilibrium for land prices will always be derived by taking all of these factors into account. I am very impressed with some of research and forward thinking that many of the University "think tanks" have published from Iowa, Illinois, Indiana & Ohio. Iowa's CR2 rating system and Illinois's soil productivity ratings have taken the guess work/mystery out of land purchasing decisions for the outside investor. This is part of the reason why Iowa & Illinois farmland is valued higher than similar ground in adjoining states. Information & knowledge allows informed investors to make better decisions. Think of these ratings systems along with FSA's annual crop yield statistics as a "car fax" equivalent for buyers looking to acquire good farmland. Higher interest rates will have an effect on farmland prices, but don't look for the 80's to repeat anytime soon. The sky is not falling, but the equilibrium in land prices will continue to adjust itself. The elements of the "new baseline", will ensure that we do not experience any catastrophic price decreases in farmland in the near term.

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