June 25th, 2015
One of the more common questions we have received over the last few years has been, “When is the farmland market bubble going to burst?”. Potential sellers wanted to know if they needed to sell before losing value and investors wanted to know if they should stay on the sidelines in anticipation of prices drastically falling. As of now, it appears that there will be no large burst, but the continued leaking of air that we have been experiencing the last few years.
A recent article on Market Watch (Spiking Farmland Prices Offer a Lesson on Market Bubbles) takes a look at the topic of market bubbles and why they may not always be similar. The article suggests that the farmland market was not in a bubble, but responding to the financial boom in the underlying agricultural economy during the same time period as we say prices dramatically increase. The argument against the bubble theory is that cash flows increased along with the pace of farm prices, but once cash flows started to decrease, then farm prices followed suit. In a bubble market, argues Purdue agricultural economist Brent Gloy, farm prices would have continued to rise as cash flows decreased.
Another telltale sign is to look at who was actually buying land and paying the highest prices. In our experience, it was farmers and local landowners that were paying most of the “high water mark” prices, not investors. The local farmer who has been driving by a tract of ground his entire life is typically going to bid more for a piece of farmland than an outside of investor because the farmer has the emotional attachment to that tract that the investor simply doesn’t have. According to the article, during a bubble, investors would have been bidding right along with farmers up to the record-breaking sales, regardless of the underlying return. In most sales, this was not the case. Investor bidders would come to an auction knowing what rent they could receive on the farm and knowing what they needed their net return to be and they backed into a price they would stop bidding at.
So what does that mean for the market moving forward? The article insinuates that caution still needs to be taken and the possibility of a larger correction is still a possibility. Two items to keep an eye on are 1) Interest rates – If we start seeing rates creep up then buyers will scale back what they are willing to spend. 2) If commodity prices continue to fall, some over-leveraged farmers may need to sell off some farmland to cover expenses. If a glut of farms come on the market at the same time, it may dilute the pool enough to cause a more rapid decline in prices. Although at this time it appears that while the market may continue to soften in certain areas, the risk of a drastic across-the-board drop is unlikely in the near term.
May 29th, 2015
We often discuss the variables that play a role in farm prices, particularly grain prices and interest rates. However, there are many other factors that help shape the market as well and one of those is government programs. A recent article published on the University of Illinois Farm Doc Daily website highlights the impact of direct payments (The Influence of Direct Payments on US Cropland Values). As the article discusses, the direct payment program was not directly tied to the current price for grain, but was based on historical base acres. This program gave producers a floor to help with budgeting and cash flows. In the 2014 Farm Bill the direct payment program was eliminated in favor of an insurance-based system to help manage risk. It remains to be seen how this may affect the income to farmers, and as a result, how land prices will be affected. According to the article, a recent study showed that for every dollar in direct payments, land prices increased by $18 per acre.
May 22nd, 2015
The Federal Reserve Bank of Chicago just released their 2015 First Quarter Agricultural Newsletter, and their survey of agricultural bankers during this time period showed little change in the average price of good farmland across the six state region. Surprisingly, especially considering the current prices of corn and soybeans, over half of these lenders believed that land values would remain fairly steady throughout the second quarter of this year as well. The report noted that demand for farmland has been weakening the past several months, but it appears that the available supply is shrinking even more. This in turn has provided the necessary support to keep prices stable.
In my opinion, this quarter’s publication, which you can download by clicking here > Chicago Fed Ag Letter, contains a lot of additional information that may portend how land values will react later this year. On page 2, there is a graph that reflects the trend in cash rental rates. Across the district, rents decreased by 8% for 2015, which is the biggest annual average drop since 1987. This decline will likely impact what investors are willing to pay for land as they often have a benchmark rate of return that they must achieve before buying. On page 4, you will find a table of selected agricultural economic indicators that show the changes in commodity prices over the past two years, along with other data. This information may be the best reflector of how farmers’ income will be impacted in 2015. Finally, and probably the most positive news in the report, can be found in the credit conditions table on page 3. Yes, there has been mild deterioration in many of the ratios, but overall interest rates remain low and agricultural banks continue to be strong financially. Many lenders have become more proactive in their borrowing polices and they appear to slowing down the expansion plans for any of their high-risk borrowers.
All-in-all, I think this edition of the ag letter provides a good overview of what I’ve been seeing and hearing in the countryside. Grain prices remain a major concern for all, but many farmers are beginning to prepare now for the potentially volatile times ahead.
May 15th, 2015
Forecasted profits for 2015 continue to look bleak for farmers and they will more than likely see the lowest returns of the last 5 years. A new article posted by Gary Schnitkey on the University of Illinois’ Farm Doc Daily (Farmland Returns in 2015) analyzes the hard numbers and where the financial outlook may end up, if grain prices stay at expected levels.
As Schnitkey addresses, one of the main deciding factors that will determine whether a farmer is profitable or not in 2015 will be the level of cash rent that they are paying. When factoring in non-land costs such as fertilizer, seed, chemicals, and equipment there is a very good chance that the farmers that are paying the very high cash rent prices will be losing money on those particular farms. According to the article, average non-land costs more than doubled from $302 per acre in 2006 to $615 per acre in 2013. Gross profits were for the most part going up during that same time period, so farmers were able to still take some profits. However, the input costs have remained at a high level while grain prices have been cut in half from their highs of a few years ago.
The main takeaway for landlords: For those in a cash rent situation, don’t expect tenants to be able to maintain current rent levels in 2016 if both grain prices and input costs remain static. Even if you are locked into a long-term lease, there is a chance the tenant may need to renegotiate terms to stay afloat financially. For those under a shared lease agreement, there should still be profits there, just at a reduced rate from previous years.
May 7th, 2015
As part of the 1985 Farm Bill, the Congress implemented rules for farmers and landowners to follow if they wished to be receive government farm program payments in the future. These regulations focused on areas that were considered the most environmentally fragile – wetlands and highly erodible soils. Not all farmers were happy with these rules because it forced them to change many of their production practices. On many fields with rolling hillsides, they were told to leave crop residue on the surface in order to stop the erosion of the topsoil. This was quite a change for those who had spent decades moldboard plowing field after field. They could also no longer, without government permission, drain any wet areas on their properties that might make these tillable tracts easier to farm. In theory, the government believed that these rules would help protect the environment (which I think they have for the most part), yet many farmers did not like the idea that “big brother” was telling them how to run their businesses. However, most farmers and landowners did comply because thirty years ago the annual government farm program payment was the only thing keeping them financially afloat.
Over the past three decades, farmers have accepted conservation compliance as part of the guidelines they must follow to stay in business and modern equipment, chemicals, and no-till practices have made life much easier. In the most recent Farm Bill that passed, adherence to protecting the environment was still a priority but Congress realized that many of the compliance rules had to be adapted because farmers would no longer be receiving direct payments from the government. However, since the U.S. taxpayers are subsidizing crop insurance premiums, the USDA mandated that farmers still follow conservation guidelines or they would no longer receive these subsidies. An article on the University of Illinois’ farmdocdaily website (Reviewing USDA’s Revised Conservation Compliance Regulation) provides an excellent overview of the revised rules and why they were made.
Perhaps the most important fact for farmland owners to understand… they, too, will be penalized if their tenant does not comply with the conservation rules. This could not only cost them money, but also their farm may be environmentally damaged. So even though these laws seem antiquated in today’s high-tech agricultural world, they must still be followed… if for no other reason than it’s the right thing to do.