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Watch interest rates for land value direction

Jeff Caldwell Updated: 10/28/2010 @ 7:42am Agricultural content creator and marketer.

For the most part, farmland prices have remained fairly steady overall during the last 2 years of economic uncertainty and volatility. In the past, this type of scenario has typically preceded a drop in land values, like in the 1980s, one economist says. So, as the economy continues to claw out of its recessionary hole, will this happen again?

"Unlike many other assets, farmland prices have not fallen during the recent troubled economic times. This has led to questions on whether farmland prices will have large price declines similar to those experienced by many stocks during 2009 or by farmland during the 1980s," says University of Illinois ag economist Gary Schnitkey.

The answers to these questions hinge largely on 2 variables: Farm returns and interest rates. And, for the former, Schnitkey says it's fairly clear-cut.

"Before a large farmland price decline will occur, farmland returns likely will have to decrease or interest rates will have to increase, but neither seems likely in the near future," he says. "Over the next year, farmland returns are likely to increase because of above-average commodity prices."

As for the latter, the Fed seems bent on keeping interest rates lower, Schnitkey says, which will keep some positive pressure on land prices for at least the next year, and for more than one reason.

"Declining interest rates make it easier to finance farmland purchases. As interest rates decrease, loan repayment amounts decrease, thereby increasing the demand for farmland," he says. "Second, interest rates represent returns on alternative, fixed income investments to farmland. As interest rates fall, the attractiveness of fixed income investments fall relative to farmland, thereby providing support for farmland prices."

Talk: Land price forecasts

Looking ahead, rates will have the biggest potential impact on farmland prices. It's a new fundamental in the land market; historically, adjustments in the relationship between cash rents and interest rates have been the fundamental driver when it comes to rates. That's changing.

"Farmland prices in the future will be impacted by changes in farmland returns and interest rates rather than by adjustments back to a fundamental relationship indicated by cash rents or interest rates," Schnitkey says. "In my opinion, the longer-run risk for a large farmland prices decrease comes more from interest rate increases than from farmland return declines."

So, long story short, in the current economic climate and with the current direction of interest rates, don't look for them to have much of an influence on land values just yet. "At this point, further interest rate declines seem unlikely because interest rates already are at very low levels compared to historical averages. Moreover, there does not appear to be any upward pressures on interest rates currently," Schnitkey says.

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Cap Rates 10/29/2010 @ 9:09am This trend makes farmland prices behave more like other income-producing commercial real estate. As interest rates go up, cap rates go up, causing income-producing land values to decline and vice-versa.

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