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On The Farmland Market: 'There is a Ton of Money out There!'
There is a ton of money out there, land is an inflation hedge, balance sheets are strong, and things are different now than they were in the ’80s. These are some of the points that are made when the topic of land values comes up today.
With the prospect of selling corn for less than $3 a bushel out of the field this fall, the coffee shop conversations have turned from record-high land sales or staggering cash rents to the discussion of “no sales” at farm auctions, and what will the reduction in land rents will be.
You don’t have to look very hard to find a farmer who terminated his or her farm lease, or a banker capping out operating lines for cash rents exceeding $300 an acre. I have grown up in production agriculture. And until this year, I’ve never seen a farmer terminate a lease. It’s always the landowner seeking a better opportunity. For the first time in my career, I will experience a reduction in cash rents. Something that’s not been seen since the ’80s.
Though things in production agriculture have turned from bullish to bearish in a short period of time, there doesn’t seem to be a consensus on where land values are headed. Similar to any market looking for direction, there’s going to be greater volatility and a wider range of outcomes until that direction is established.
There are examples of soft land sales, yet you can find an equal number of strong sales that rival the record prices of 2012 and 2013. This trend continues to be driven by the fact that farmland purchases aren’t always economically driven. With record farm profits, historically low interest rates, and a lack of alternative investments, farmland continues to be the investment of choice for farmers and many investors.
Furthermore, unlike a house or commercial building, farmland often trades generationally, which means the time to buy is when a successor generation finally decides to sell. Given the record profits in production agriculture, if a piece of land comes up for sale next to your farming operation, the attitude has typically been to buy even beyond what makes economic sense.
In other businesses, this is called a blue sky investment; value placed on the business is above its obvious economic return. Unfortunately, your neighbor was also operating on the same philosophy. To put it simply, today’s land values aren’t supported by today’s economics but rather the record profits of those in production agriculture.
In fact, farmers have represented nearly 80% of all land purchased over the past three years, as investors have by and large been sitting on the sidelines. We all recognize changes on the horizon. At the same time, there is still hope that the commodity market will bounce back, and business will continue as usual. While that is my hope as well, I’m not as optimistic as some. The wealth creation that we have experienced over the past five years has been staggering. In 2008, the average price of Iowa farmland was $4,468 an acre. In 2013 the average price had nearly doubled to $8,716 an acre, resulting in a market cap of $255 billion for Iowa farmland, or $120 billion in new wealth over that five-year period.
So, where were we in 2008 and where are we today? In 2008, the price of corn averaged $4.78 per bushel, and the 10-year treasury was at 3.66%. Corn averaged $5.96 a bushel in 2011, $6.67 per bushel in 2012, and $6.22 a bushel in 2013. The 10-year treasury bottomed out at 1.80% in 2012, the same year the price of corn peaked. This created a perfect storm for land values – and not surprisingly, also created the peak in the land market in 2013.
What’s the difference between today and 2008? Unfortunately, not so much. Balance sheets are certainly stronger coming off of three years of record profits, and interest rates are nearly 1% lower than they were in 2008. But that’s about it.
On the bearish side, commodity prices are at levels comparable to 2007, when farmland values averaged $3,908 an acre. The general consensus is that there is a ton of money out there, meaning land values won’t likely fall as much as they potentially could. And though I agree with that statement in some cases, I don’t think it will be the case consistently.
For example, if you were willing to accept a 3.5% cap rate on $400 rent in 2012, that means you’d be equally as willing to pay $11,428 per acre for a piece of land. Given the high demand for land in 2012, cap rates decreased to 3.5% as farmers and investors competed to own land. Now that the frothiness is out of the market, I expect not only cash rents to decline but cap rates to increase, as well.
If cap rates were to increase to 4% and $400 rent reduced to $350, then this would translate into $8,750 an acre and a 25% decrease in land values.
What will ultimately prevail? Are we headed back to 2008 where farmland values were nearly 50% off of today’s levels? Will values decline by 25% per the example I outlined above? Or will the statement that “there is a ton of money out there” trump the economics and preserve current land values?
For many investors, land is being purchased as an inflation hedge. Not only has land inflated since 2008, so has almost every other asset class. This begs the question of what will land values do in an inflationary environment? Would an inflationary environment cause land to inflate further, or will inflation trigger higher interest rates and ultimately a reduction in land values?
I’m certainly not making a prediction. The liquidity that is in the ag economy will continue to prop values up in many cases. In other cases, where neighbors aren’t driving values with blue-sky bids –- and it’s purely economically driven –- sale values should come down.
The big questions are how far the liquidity in agriculture will go, and what the appetite of investors will be moving forward.
I agree with the statement that there is a ton of money. But I do not believe that money will overpay for land consistently and, ultimately, land values need to reconcile with the economics of current commodity prices and interest rates. What I can’t get my hands around is how land will perform in an inflationary market and if there is so much money in the system in general that land will continue to inflate as investors look for a place to store cash.