No 1980s redux, but time to rein in costs
While crop prices have done a 180-degree turn and land values and rents might edge lower, 2014 will usher in a period of moderation—not a crash.
"We’ve been in boom times, but there won’t be a bust out of this," predicts Mike Boehlje, a Purdue University ag economist.
Still, farmers should anticipate a correction. "This is not a crash like we had in the 1980s when we saw a 50% decline in land values," he says.
Michael Langemeier, also a Purdue University ag economist, says he expects cash rents to decrease 10% to 15% and land values to drop 15% to 25% for the next three years.
"Land values will fall faster and harder than cash rents because land prices went up at a faster rate," says Langemeier, noting that Indiana land values increased 10% per year from 2000 to 2013, and rents jumped 6% per year. "That’s unprecedented."
Economists think this correction should be more like a soft landing. "Land is a real bond," Boehlje says. "When interest rates go up, Treasury bonds and land go down."
Based on Federal Reserve Board statements, T-Bond interest rates will double from 2012 to 2016, going from 2% to 4% to 5%.
"Today, interest rates are about 5.5% for operating loans and 4.5% for land," Boehlje says. "It wouldn’t surprise me if rates are 7% to 8% within three years." That’s still half of what they were in the 1980s, and are just back to historical averages.
Even so, calculations show that some producers need to employ aggressive strategies to reduce their vulnerability. With all costs included, breakeven for corn is about $5 per bushel, according to Indiana data.
"Futures markets tell us to get costs down to $4.50 or lower," says Chris Hurt, a Purdue ag economist.
Breakeven for soybeans is $12, but Hurt says farmers need to be in the $11 range. For the next three years, he expects $4.50 corn, $11 soybeans and $6 wheat. Corn margins might have compressed by as much as $2 per bushel during the past year.
For farmers who want to better position themselves for this compression, Boehlje advises: locking in margins with more pre-selling, buying higher levels of crop insurance, fixing interest rates on long-term debt, paying off debt, holding financial reserves, slowing down growth and funding expansion with more equity than debt.
It’s also time to tune up business management, specifically cost control, efficiency and productivity.
However, Boehlje cautions that reducing debt reduces costs and boosts working capital. While it’s a laudable goal, keep taxes in mind.
If producers sell inventory to get their financial house in order, the result could be an unwelcome $100,000 tax burden in a low income year, he explains. "That might not be much of a problem in 2014." He’s more worried about 2015.
Farmers should take a cue from Warren Buffett. If they can avoid such a tax trigger, Boehlje encourages farmers to build up a war chest of cash.
Cash Protects. "Even Warren Buffett, the third wealthiest person in the world, has $47 billion in cash," he explains. "He says don’t think about cash in terms of the rate of return it generates, but that it buffers you from tough times and gives you opportunity."
Poorly structured debt can be as big a problem as too much debt. "Some producers are borrowing with terms that are too short—10 years for farmland when it should be 20," Boehlje says. Lengthening terms lowers payments.
It all comes back to Econ 101. Growing global grain supplies outpace demand growth. Hurt forecasts 2014 corn production to be about 14.1 billion bushels. "We have a 13 billion bushel plateau on use," he explains. "Production gives us a very weak tone." Corn could reach $4.40 to $4.60 per bushel this winter, but only if exports and livestock feed demand kick up to offset decreased ethanol demand, Hurt says.
With global crop production increasing by 147 million acres in eight years, increasing crop surpluses are a worldwide issue. "The signal that moderating crop prices sends to U.S. competitors is likely a good thing in the long run," Hurt says. "This will help reduce the build-up of the crop production factory."
For more information from these Purdue University ag economists, view their 2014 outlook at http://tinyurl.com/Purdue-Webinar.