Higher farmland values reflect new economy

Supply and demand has long been a term used to describe the ups and downs of the commodity markets. Now it's being used to describe the market for the land where those commodities are raised.

In the last year, farmland values have escalated to new heights.

The Minneapolis Federal Reserve Bank District reports farmland values as of second quarter 2011 up 17 percent from the same period a year ago, while the Kansas City District reports farmland prices up 20 percent.

Nebraska has seen one of the largest increases, with nonirrigated land up 30 percent. Oklahoma ranchland, suffering from a prolonged drought, saw values up just 6.4 percent, with what increase there was driven by oil and gas exploration.

A group of three experts in farmland value analysis discussed the skyrocketing costs of farmland during a plenary session of the 2011 American Bankers Association Agricultural Bankers Conference, held recently at Indianapolis.

Michael Duffy, Ph.D., professor of economics and director of the Beginning Farmer Center at Iowa State University; Don McCabe, an accredited farm manager with Soy Capital Ag Services, Bourbonnais, Ill.; and R.D. Schrader, manager of Schrader Real Estate and Auction Co., Columbia City, Ind., offered their thoughts about higher farmland prices and what they mean to producers and rural America as a whole.

"There are differences, not all of the states are enjoying what we are enjoying now with land values as they are," Duffy said. "But when you adjust these peaks and valleys for inflation, you can see them much more clearly. This year, we are seeing the highest nominal and inflation-adjusted land values ever. They're now exceeding values we saw in the 1970s."

As in any market, land values are being determined by supply and demand, Schrader said, with the increasing global appetite for food, the demand for renewable fuels driving corn prices to new highs and a shrinking value of the U.S. dollar driving sales.

"I am bullish long term on land," Schrader said. "There is a low correlation between land to other asset classes, such as bonds, T-bills and stocks. Farmland is outperforming so many things these days and is becoming part of a diversified portfolio, since right now it's undervalued versus gold. There are some very savvy, sophisticated, successful investors understanding this and it's getting their attention in a big way."

For the most part, buyers purchase the land to extract an income from the land. McCabe said.

"Production agriculture right now, with a 3 to 5 percent return on your land costs, beats all returns on the alternatives, which have done so poorly in the recent past. Many people question the future of these alternative investments, so they're turning to purchasing farmland for production instead.

"More than one person over the last year has said to me they are not in the stock market and proud of it. They have to do something with their money, so they're buying farmland."

These producer-land buyers plan to hold onto their land, Schrader added.

"These buyers are not speculators," Schrader said. "They are not looking to flip their land. They're buying to live with this land and live with it a long time. These guys experienced the 1980s firsthand. They are not going into the market with the intent of getting out."

Schrader doesn't see the climb in farmland values as anything sudden. In fact, those price hikes have been happening for quite a while.

"As we look at the future we need to look at how we got to today. We are not experiencing some overnight sensation," Schrader said. "This didn't happen just in the last year or two or five or even 10 or 20 years. It's taken 25 years of appreciation to get where we are at today. That differentiates us with other markets."

McCabe said, by his surveys, about 60 percent of all farmland is being purchased by active operators, with 15 percent purchased by nonlocal investors, 13 percent by local area investors, 7 percent by institutions and investment groups and 5 percent by other entities.

"The institutions who are acquiring land are things like hospitals and universities that people bequeath land and it's not acquired by purchase. Some institutions sell the land and others are long-term holders who rent out the land, depending on the institution's investment strategy. Hedge funds are another factor, but they are buying less than 10 percent of the market. They're more talk than action, from what we've seen."

Using his state of Iowa as an example, Duffy notes that as farmland values have increased, so to have rental costs.

"On the flip side of this, however, is the rent to value index is at a record low. The previous low we had was back in 1921. We peaked at 9.6 percent in the early 1980s and now we're at about 3.4 percent. This is something that looking forward we'll see some correction.

"We need to remember that about one-third of the rents are between relatives and another 20 percent are between family friends. I think that will temper the rise somewhat, but we're hearing a lot more big increases among land plots that are open."

Rental agreements also have become more complex over the years.

"We're seeing a move away from flat cash rents and crop share deals to a mix that makes it better for the landowner," McCabe said. "We're now seeing more bonuses and kickers (based on price and yield) added into rental agreements. The latest surveys we've seen are that 15 percent of the flat rental agreements have changed to flexible agreements in the last year."

Adds Duffy: "There's also been a huge shift away from crop share agreements, and it's driven by both sides. It's so complicated for the operator who has so many different landlords to deal with, it's hard for everyone to account for bushels anymore. As owners move further away from the land, they don't want to bin corn. They want cash."

"I don't think for the next few years there will be a correction on the land values side. It will be on the rental side. I see a 20 percent increase in rents. We see a lot of land listed and when it is listed it's not for very long.

"The difference between the 1970s and today is drop in the amount of land is being sold under contract for deed. Back in the 1970s it was a lot easier to just walk away from a contract," said Duffy.

"We're seeing a lot of people paying off debt and acquiring land with just a check rather than a loan. That's great," McCabe said. "The odds of farmland prices seeing a collapse similar to the 1980s or the urban real estate market are not high, since we're seeing such low debt levels."

The trio collectively estimated that in Iowa alone, at least 75 percent of farmland is now held debt free, compared with about 67 percent about 10 years ago.

"A widow over the age of 75 owns one in 10 acres of Iowa farmland. It's a figure replicated throughout the Midwest and is growing in size. It's another factor that leads land going from sole proprietors to joint tenants to tenants in common as the land is dispersed among the children," Duffy said.

"This means we're seeing a large increase in the number of out-of-state landowners. The reason why they're holding onto the land is for family or sentimental reasons. Sentimentality has its price, however, but I don't see a drop in land ownership by these people."

As generations continue to move farther away from active production and land holdings continue to split among family members, Duffy thinks the "inner value" of farmland will be different among the disparate owners.

"A big question is will the next generations of an old farm family have the same level of inner value for the farm as the preceding generations who actually grew up on the land do," Duffy said. "Are they going to have the same feelings towards it? If the land is divided among eight to 10 owners to the same piece of ground, will each have the same feeling towards it. That's something renters will have to look out for."

The rise in farmland prices has led to one "regrettable but inexorable move," McCabe said, toward further consolidation of rural areas.

"I can remember how much my dad regretted losing the local co-op elevator because he then had to drive 10 miles to buy dog food," McCabe said. "The vitality of rural communities will be based on things other than agriculture. The retired farmer towns will have to become something more than retired farmer towns. That may be discouraging but that's the way it is.

"We see a lot of wealth in land holdings," Schrader said. "As those holdings are consolidated, it impacts the surrounding communities. Those towns are necessarily the kinds of towns young people want to stay in. It's an issue, but it's the nature of the beast."

Duffy disagreed with his colleagues, mentioning his work as director of the Beginning Farmer Center at Iowa State University in trying to keep rural communities vital.

"One of the things we try to get rural communities to think about is the farmer as the heart of their economic development," Duffy said. "These towns spend a lot of money to bring in jobs while they're continuing to lose jobs.

"I think opportunities are going to be different in the future than they are today. Young people that I work with think differently than I do and as a lot of their parents do. They no longer think of agriculture as growing cheap commodities. They think in terms of differentiation, such as the guy I know who has been selling his hay on Craigslist. These things allow for lots of sales opportunities."

Recalling David and Goliath, Duffy said, is that it was an epic tale because the small man beat the giant.

"In reality, the little guy isn't always going to beat the big guy, but there are opportunities. We talked all the way back in the 1920s about having a land tenure ladder and how young people had to work to move up," Duffy said. "We try to work with young people to think about not owning the asset but rather controlling it without some outside force like government help. These higher land values are a hindrance but they can be overcome."

Some factors to watch for any further increases in land values, Duffy says, includes climate change, changes in oil and fertilizer costs and availability, technology changes, global economic conditions, grain stocks, and debt levels.

"Farmland is a good long-term investment and will likely remain that way for the foreseeable future. Farmers are the majority of land purchasers. They buy land to own it, not to sell it. As long as there is income coming off that land they will hold on to it. Time will tell."

Written By Larry Dreiling

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