For decades, the US
farmland market has been dominated by local farmers as the primary buyers of
land, especially in instances where nearby land was added to an existing farm
operation. These farmer buyers used a
practice which is still prevalent today, and that is cost averaging of the land
price with their other holdings, and the spreading of fixed costs, such as
equipment, over more acres.
There were limited attempts
in the 1970s and 1980s by investment managers to form farm investment funds,
but they were met with limited success in the financial marketplace, and with opposition
by rural interests in some parts of the country. That began to change, slowly, as significant
commodity price increases occurred in the mid 2000s, and other important
factors, such as the ethanol mandate, and organic crop production, came into
the picture.
From barely a blip on the
meter ten years ago, the institutional investor role in the US farmland market
has reached several billion dollars in invested capital. In addition, individual investors have been
active, either through direct investments, or through the two publicly held
REITs that were created in recent years with the specific purpose of investing
in farmland, or through private funds.
Farmland is viewed by many
investors as a safe haven, an inflation hedge, and as an asset class that, over
the long term, has outperformed most other investments. It does not have the volatility of the stock
market. This is also an asset class that is not well
understood by many non farm investors, and gaining such understanding cannot be
done via “book learning.” There are
nuances about this asset class that can only be learned from experience, or by
investing with someone who has that knowledge base. Further, the US farmland
market is highly fragmented, and there are often differences in land quality,
pricing, and other farms, from one side of a county to another.
For an investor considering the
purchase of a farm, it makes the most sense to utilize the services of a
professional in the sector who can quickly provide the investor with a sense of
the market in a certain area, along with advice on the most sensible operating
method given the investor’s appetite for risk, and an evaluation of various
properties. As we have noted, the
market is highly fragmented, and unless an investor gets “grass roots” level
advice, he or she may be misguided.
There are several types of
operating methods for a farm owned by an investor, and we will touch on three
of them here. One is a cash lease of X
dollars per acre. The tenant receives
all of the crop, and takes all of the operating risk. Another is a crop share
lease, where the landowner receives a % of the crop, and may pay a
proportionate share of some crop input costs.
Third, there is a custom farming arrangement, where the landowner pays
all production costs, and receives all of the crop. The cash lease is the lowest risk, and the
custom deal is the highest risk, of the three approaches. There are ways to mitigate risk using
irrigation, multi-peril crop insurance,
and crop marketing strategies. There
are also hybrids of these farming arrangements that are in use on some crops in
certain areas of the country.
Whether an investor decides
to spend money directly on the purchase, or to invest in a private fund that
buys farms, questions to consider include the following:
·
What is the crop yield history of the farm as
compared to others in the area, and how do the sales prices compare?
·
If the land is irrigated, what is the
reliability factor for the water source(s), and what is the cost per acre for
the water?
· Are there regulations currently in place, or
likely to be at some point, that could impact the value of the land? (This is especially important in California,
where pending regulations will impact the ability to use groundwater to
irrigate land in many areas).
·
If the investment is via a fund, what is the
track record of the fund as far as purchase prices of other farms in the
portfolio, and what is the crop mix in the fund? What have been the annual cash distributions
in the past three years?
·
What is the quality of the tenant pool in an
area if a farm is expected to be leased to a third party?
These are but a few of the many questions that an investor should ask
before putting money into farmland. The
importance of utilizing the services of an independent professional advisor
cannot be overstated.
