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Land values & rate risk

Jeff Caldwell 05/20/2011 @ 3:11pm Multimedia Editor for Agriculture.com and Successful Farming magazine.

The land you farm has probably never been worth more than it is today. Will it last?

Low interest rates have been one of the variables behind surging land values over the last few months and years. They've helped float other markets on the surging land tide, from fuel and fertilizer to the crops grown on the land themselves.

But, interest rates can only really move in one direction now. As they creep up, they may send land values lower. And, the other crop costs could be slower to adjust, meaning there's a fair amount of risk built into the land market right now, according to a recent report from Federal Reserve Bank of Kansas City economist Brian Briggeman and Omaha Fed branch executive vice president Jason Henderson.

"Farmland values often rise with persistently low interest rates and strong crop prices. Low interest rates lift farmland values by reducing the discount on the future income stream produced by the land. In addition, low interest rates depress the value of the dollar, which in turn boosts agricultural exports, raises commodity prices and enhances farm revenues," according to Briggeman and Henderson. "Conversely, rising interest rates can reduce farmland values by widening the discount on the value of future income streams."

Midwestern land values have been jumping at a rate well higher than the increase in land rental rates; Over the last 7 years, that trend in values adds up to 40%, while rents have gone up 17%. That's a sign, Briggeman and Henderson say, that other factors are behind land values. That includes interest rates.

"If historical relationships hold true, Midwestern cropland values hinge on farm revenues, interest rates and their relationship with the capitalization rate. Assuming average Midwestern crop yields, various combinations of corn prices and capitalization rates can rationalize current cropland values," the economists say. "However, all of these combinations assume historically high crop prices or historically low capitalization rates, which raise the risk in land markets. With economic models suggesting that today’s historically high farm revenues have been capitalized at historically low rates of return, agricultural real estate values could fall sharply if crop prices sag or future interest rates rise."

The result: The risk that interest rates pose to farm land values, Briggeman and Henderson say, is quite high. That's because interest rates have jumped to the head of the pack in terms of influence on land prices, which are assumed under sustained lower rates. As they climb, they could send land values lower, the economists say.

"Record high farmland values are based on expectations of interest rates remaining low for an extended period. As the economy strengthens, however, interest rates could rise, which may lift capitalization rates and lower farm revenues. Events such as these could become a recipe for falling land values and the erosion of farm wealth.

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correction on my comment 07/31/2011 @ 4:30pm I mistyped. Eliminate the word not. Just use the word can

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