By Greg Steele
I’m frequently asked about farmland values, real estate bubbles and borrowing determinations. Here’s how I respond:
Question: Given the rapid increase over the past few years in land value and cash rental rates, how is the limit for lending on farmland determined?
Answer: We have developed a lending approach which looks at the whole operation. It considers the production of the land being financed as well as the producer’s yield history. Other standards that measure equity, working capital, repayment capacity and the loan amount as a percent of the collateral offered are also taken into consideration. While not a dramatic change to our underwriting philosophy, this represents evolution in our process of realigning loan standards to make them relevant to current market conditions.
Question: Given the increased market price of land today, is there a dollar limit per acre that AgStar is able to lend?
Answer: We look at each opportunity to lend as a unique situation. When it comes to what a financial institution may lend per acre, there are a lot of factors that come into consideration, such as productivity of the land—which can vary by location—and the financial strength of the borrower.
At AgStar, we’ve developed an approach to land values based on a formula which uses an analysis of historical data from several sources in order to project a value we believe can be sustained throughout agricultural cycles.
- Our baseline value was calculated on the following long-term assumptions: $10.50 beans and $4.50 corn. Land value should equal approximately 25 times the rental value.
- Additionally, the long-term assumption is that rental rates should be about 34% of gross revenues.
- Due to the variability in land quality and management (tillable, irrigation, etc.), a set dollar amount per acre is not an appropriate, long-term approach to real estate lending.
- Based on this approach, if a parcel of land generates $1,000 of revenue per acre, you could expect the rental rate to be approximately $340 per acre. If you run the calculation on this same land at 25 times the rental rate, the land value could be expected to be $8,500 per acre.
Question: Is there is a farmland real estate bubble?
Answer: We don’t believe we are on the verge of a real estate bubble. There will likely be a correction at some point, but we don’t know when or how much. We consistently monitor certain metrics to signal if a bubble is on the horizon, which could increase the chance of correction. Some of these metrics include:
- Farm debt-to-asset ratio.
- Availability of export markets.
- The existence of a farm safety net (for example, government payments and crop insurance).
- nIncreasing interest rate environment.
- Land not being rented and cash rents not being paid.
Question: How can a producer be prepared for a possible correction in land values?
Answer: Sound risk management plans and maintaining a solid level of equity capital are critical to withstanding a correction in real estate values. Risk management has proven itself as a key tool to determine how to build profit margins for long-term financial success.
Greg Steele is vice president, dairy industry, for AgStar Financial Services. He can be reached
- January 2013