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Grain Farm Incomes Won't Dictate Farmland Price Direction

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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