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Why a 1980s-style Farmland Bust Isn't in the Cards -- Economists
Though it's been far from the gutting of land values that came along with the farm crisis in the 1980s, land values have tapered off and are sliding lower in much of farm country. But, despite the differences between then and now, memories of the '80s are fresh in many farmers' minds, and that's spawned a lot of questions.
That's compelled Gary Schnitkey and Bruce Sherrick to find some answers. The University of Illinois Extension economists have examined the similarities and differences between the 2 time periods, underlying economic circumstances and resulting land market moves then and now.
"There has been a recent increase in the number of inquiries received asking about the current farmland market, and potential parallels to the early 1980s; and about precursor indicators of the farmland value declines in what is often termed the farmland crisis of the 1980s. This line of questions is not new as there have been suggestions about the potential for a farmland bubble from notable commentators and in sponsored events for several years now," they say in a university report. "In particular, technical comparisons and apparent pattern similarities have been highlighted and used as warnings for the potential for a farmland bubble, while the market for farmland has remained strong."
First, the bad news: Operating a farm is a risky business these days; depending on how financially leveraged your operation is, it could be riskier than it is for your neighbor. That's especially true looking specifically at farmland prices and the costs of ownership that can tilt the balance sheet well into the red without maintaining a solid income stream, something that can change much quicker from day to day right now than in years past as grain market volatility's increased.
"It is well-accepted that asset values reflect market participants' expectations regarding income levels and riskiness of income. In the case of farm real estate, there have been several recent years with higher than historic average income, and thus the attendant questions about the ability to continue to generate the same levels," according to Sherrick and Schnitkey. "Recent USDA forecasts of income have been reported in some cases as simply 'reductions in income.' While true relative to recent few years, it is also true that the reductions are to levels that are above the historical averages in constant 2014 dollars. Whether this level matches well with market participants' views of income is also debatable, but the general pattern of income through time remains important to appreciate, whatever the cause and potential effect."
So, any downward shift in farm income -- like in cases of drought or supply-driven price drops -- is going to have more profound effects because of the high price for land and volatility that creates. That will cause some periodic downturns in income, but it won't cause the bottom to fall out of the farmland market. The reason: Leverage.
"The level of indebtedness has also been reduced through time, rendering the sector as a whole less vulnerable to collateral revaluations. The sector has very low aggregate leverage. An implication is that there is more of a 'buffer' built into the current holdings compared to that in the 1980s for asset re-valuations to trigger sell-off or liquidation responses from nearing zero equity," according to Sherrick and Schnitkey. "Typical mortgage loans in the 1980s included longer amortization periods (up to 40 years in some cases) and higher loan-to-value fractions than is typical today. Two important implications include that the principal reduction occurs more slowly in longer length loans, and that the fraction of the asset value in the form of current income required to service the debt was also much higher in the crisis period than is the case today."
Another reason to believe a 1980s-like crisis isn't on the way for the farmland market is crop insurance. Grain prices are more volatile today, but crop insurance can help take the bite out of sharp income swings and preserve a more steady margin.
"Another feature sometimes underappreciated in making comparisons to the 1980s is the dramatically different nature of crop insurance and the degree to which its use can reduce income variability and shortfalls in poor production years. Importantly, the modern crop insurance programs expanded to include revenue coverage later in the period - a product that did not exist in the 1980s when only rudimentary version of APH yield insurance existed, and only at low coverage levels," according to Schnitkey and Sherrick. "Another meaningful interpretation is that the modern insurance programs allow a producer to put a floor under losses, and also to very reliably address risks associated with cash rents of farmland."
So, all in all, the economists say though the potential's out there to stir up volatility that could send farmland values and profit potential lower, there's also more stability underpinning those key pieces of the farm financial puzzle.
"There are substantial risks facing agriculture and the markets for assets used in agricultural production, as has always been the case. To understand these, it is also important to also have a clear sense of the factors associated with the fundamental drivers in the market. Income expectations remain reasonable and fairly stable, debt rates are low and interest rates are also historically low providing a buffer against potential asset revaluations, and crop insurance has fundamentally altered the riskiness of income as intended," according to Sherrick and Schnitkey. "There can still be important adjustments in any market as individuals refine and adjust their understanding of the factors influencing future income potential, but hopefully this "story in pictures" adds to the accuracy of the understanding of agricultural farmland markets."