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Will farmland bust? Here are 3 key variables

Is the farmland market -- one many experts say is starting to level off from the boom in values over much of the last decade -- just taking a breather from its rocket ride higher, or is the expected leveling an inevitable function of the marketplace?

History has certainly proven the cyclical nature of the land market; the last century of land market observations reveal a few common drivers of that cycle. But is today different? "Speculation on what is happening and what will happen to Iowa farmland values abounds," says Iowa State University Extension ag economist and farmland values expert Mike Duffy.

Obviously, farm income is the primary key to rising or falling land values. And, just as it's so important to the farmland equation, it's also far from clear exactly where the average farm's income is headed in the near future, and how it will manifest itself as a key land variable, Duffy says.

"What happens to farm income will have a direct bearing on land values. While it isn’t a perfect correlation, it is a strong one," he says. "I think some of the factors that created the busts we saw after the past two booms haven’t been as strong this time."

So since income is something of a wildcard right now, Duffy has stepped back to examine those two land booms of the last century; he looks at how they unfolded and what ultimately happened to the land market and those with stakes therein. The first of these golden eras was from 1900 to 1920, Duffy says, a time when rising corn prices sent land in Iowa up almost 500% in the first 19 years of the century. Then came the early 1970s.

"The second boom period, 1973 to 1981, has been referred to as the second golden era in agriculture. Land values in Iowa increased by over 30% per year in 1973, 1974, and 1975. Over the entire boom period, Iowa farmland values went from $482 an acre in 1972 to $2,147 an acre in 1981, an increase of 345%," he says.

Prices and returns

Those two past boom times have some similarities and some differences when viewed with the meteoric rise in land values of most of the last eight to 10 years. Though these cloud the crystal ball, there are three common features of the boom cycles that could shed light on how the current one will unfold. The first is a simple matter of dollars and cents.

"One feature is that the booms were driven by increasing prices and returns. A 1967 publication by the State Historical Society described the first boom period: 'For agriculture this was prosperity piled on top of prosperity,'" Duffy says. "The second boom in the early 1970s was fueled by the rapid rise in commodity prices due in part to the opening of major export markets. Corn prices in Iowa averaged $1.04 per bushel in 1972 and they averaged $2.58 per bushel in 1974."

Land has investment safety

The second common thread among past land boom periods and today lies in the investment side. In both the 1910s and the 1970s, the idea that land's value had little to no downside lines up fairly closely with many attitudes surrounding the land market in the last few years, up until just the last few months. In previous similar cycles, that optimism has fed a frenzy of borrowing by land buyers -- farmers or not -- though the degree to which they leveraged themselves has varied.

"Responses to a 1919 survey illustrate the prevailing attitude in the first boom. A Tama county (Iowa) banker responded saying land, '...will never be worth any less and the tendency will be for higher prices from now on, as land will be the safest investment in the world.' There were contrarians to this position. Another Tama county banker responding to the 1919 survey expressed concerns the high prices wouldn’t last, saying, '...I believe it behooves us all to go cautiously, and instead of contracting heavy future obligations we should be utilizing these high prices to free ourselves from debt,'" Duffy says. "Similar statements can be found regarding the boom in the 1970s. 'They don’t make land anymore, everybody has to eat, and I made more money owning the land than I did farming it,' are common phrases that were heard or recorded during this 'second golden era.'"

General unrest and land

The third piece connecting the past two land boom cycles with today takes a broader view of the general economy -- and society -- as a whole. The boom times of the 1920s, for example, preceded the Great Depression that decimated not just the ag economy, but the entire nation. The 1970s ushered in a period of financial constriction that culminated in the farm crisis of the mid-1980s. In both cases, land values -- like many asset classes -- tanked. Will this repeat?

"Exceptionally higher income and an increasing optimism for the continuing rise in land values, which led to excessive debt and mortgages being assumed, are two of the hallmarks of the boom periods. The third common feature with both the booms is they ended dramatically and with significant social unrest," Duffy says. "Land values dropped 73% from 1920 to 1933 and they dropped 63% from 1981 to 1986. The decline in the 1920s was more severe and lasted longer due to the major depression in the entire economy that followed the initial depression in the agricultural sector."

Income overtakes all

Duffy is careful to point out that these correlations between two past farmland boom periods and today, though common, are features that "provide some guideposts for us to begin thinking about whether or not land values have peaked or are just catching their breath." Ultimately, it's farm income that will decide when and how sharply the land market falls. And, in this case, the correlation between income and land's value is a virtual lock.

"A major similarity between now and the booms of the past has been the accelerated increase in income. The estimated 2012 Iowa net farm income is 340% higher than in 2004. Iowa farmland values were 265% higher over the same time period. There is a very direct correlation between farm income and farmland values. The correlation is higher between land values and gross farm income than between land values and net farm income," Duffy says. "Since 1949 there is a .97 correlation coefficient (1 is perfect correlation) between gross farm income and land values and a .88 correlation between land values and net farm income. Given these very high correlations, it is possible to estimate what might happen to land values with a change in income."

He continues: "The most important variable to watch is income. What happens to farm income will have a direct bearing on land values. While it isn’t a perfect correlation, it is a strong one. I think some of the factors that created the busts we saw after the past two booms haven’t been as strong this time."

The final verdict

All these variables aside, there's an overriding fundamental in play in the farmland market that Duffy says will likely cause a continued leveling-off in values, but not an altogether bust similar to what followed the 1910s and 1970s. Just as the fact that farmers are generally not leveraged as far as they were financially in the 1970s is now a common argument against a total collapse in land values, the steepness of the recent value climb is a valid argument for general leveling, Duffy says. The last few years' gains have simply been too sharp to continue.

"I do not think land values will continue to increase as they have in the past few years. There has been too much pressure put on farmland prices to be sustainable. Farmland value increases of over 60% in two years are not sustainable. Increases in the number of alternative investments, changing interest rates, and lower expectations for farm income will all stop the rapid rise in farmland values," he says. "I think the double-digit increases in land values might be over for now. I also think if the projections for income hold, then we will see a decline in land values. In 2009 we saw land values drop slightly over 2%. I think we will likely see a larger drop than that in the years ahead but I don’t think a collapse is a high probability. War, interest-rate changes, fiscal paralysis, world economic conditions, and a host of other factors will exert influences on land values. But in the end, income will continue to be the key."

Bearing these facts in mind, Duffy adds it's important to view farmland as a longer-term asset, not something that, through changing hands more frequently, can net continued income as a commodity. In other words, take a broader view with your land management.

"Farmland is an investment for the long run. In fact, most land is bought by farmers and most farmers buy land to own it, not sell it," he says. "The land is obtained with an idea that it will become the legacy, inheritance, and social security, not as a get-rich scheme."

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