Everyone has to eat in order to survive. The production of almost all food can be traced back to farmland around the world in some way. Demand is growing for farmland as the world's population and global needs for food are growing. What many don't realize is that the supply of farmland is not changing, thus creating a severe imbalance in the supply and demand of farmland.
An investment in farmland over the long-term will provide a steady stream of income and capital gains due to the increasing global demand for agricultural commodities, driven by the rising world population, rapid growth in emerging markets, and continued demand for ethanol and bio-fuels. Demand for agricultural commodities is outpacing supply, which positions farmland for long-term appreciation.
We believe that now is an excellent time to invest in farmland due to the compelling fundamentals of agriculture, the inflation hedge farmland provides, the bottoming of land prices, and the stable return profile.
World and emerging market population growth:
According to the USDA, world population growth is expected to increase at 1.1% per year through 2018. The United Nations estimates that the world’s population will increase from roughly 6.6 billion people to 9 billion people in the year 2050. As the global population increases, demand for food will increase proportionally. This will also cause the supply of agricultural land to diminish due to development, thus increasing the value of existing farmland.
Rapid population and economic growth, primarily in India and China, will increase food demand and U.S. exports. China is one of the largest importers of grain as the country has roughly 20% of the world’s population although only 7% of global arable land. China was a major exporter of grain but increasing incomes and the development of a middle class have changed consumers’ diets, moving away from carbohydrates towards proteins. The continued transfer to protein will significantly increase the demand for grains as one pound of meat requires roughly 10 to 15 pounds of grain.
The increasing global demand for grains needed to feed the growing world population and its changing dietary habits will continue to increase U.S. agricultural exports. Looking forward, the USDA baseline projections show a continuing upward trend with total U.S. agricultural exports reaching $113.0 billion in 2017 from $82.2 billion in 2007.
A recent advertising campaign from Monsanto highlighted the importance of sustainable farming and food production. The campaign highlighted the fact that agricultural output will likely need to double by 2050 to meet the growing global demand. Monsanto also noted that in 7 of the last 8 years, the global consumption of grain has outpaced total production. To meet future demand, Monsanto is predicting that we will need to produce more food in the next 50 years than what was produced during the previous 10,000, putting more and more pressure on future farmers and the land they use to produce food.
The fight for “food security”:
In order for developing countries to meet their growing demand for grains, many countries have begun to reconsider their future “food security” by acquiring foreign farmland. Countries such as China, South Korea, and the United Arab Emirates, have purchased farmland to support their growing need for grains in areas such as Africa, Australia, and Eastern Europe. The nations are sending expatriate farmers to foreign countries to farm the land and export the grain directly back to their respective homelands, thus ensuring a consistent supply of grains.
Increasing use of ethanol and bio-fuels:
Concerns regarding climate change and fossil-fuel dependency have led to a significant focus on renewable fuels, such as ethanol, as a replacement for high polluting carbon-based fuel sources. Ethanol is primarily manufactured from crops such as corn, wheat, and sugar cane. According to the USDA, ethanol production in the U.S. has increased from less than 3 billion gallons in 2003 to over 6 billion gallons in 2007 and is estimated to exceed 12 billion gallons in 2020. The Renewable Fuel Standard from the 2007 Energy Act calls for total renewable fuel to reach 36 billion gallons by 2022. The USDA estimates that more than 33% of the U.S. corn production will be used to produce ethanol by 2010.
President Barack Obama is expected to continue to be supportive of alternative energy sources. In April, the Environmental Protection Agency proposed raising ethanol limits in gasoline. The agency said it is seeking to raise the limits of ethanol blends in gasoline from 10% to 15%. The increase has largely been driven by a petition initiated by the trade group Growth Energy, which cited a Department of energy study that found raising blends to 20% would result in no significant drivability issues.
Declining ending stocks to usage ratio:
Increasing U.S. exports and ethanol use have caused consumption to increase faster than production. Ending corn stocks to usage ratio (current inventories as a percentage of annual consumption) has declined over the last four years from roughly 20% in 2004 to 9% in 2008.
In the USDA’s May update of World Agricultural Supply and Demand Estimates (WASDE) report, ending stocks for 2009/10 are projected to be down 28% to 1.1 billion bushels, as corn use is expected to exceed production by 470 million bushels. A difficult harvest season, or any unexpected demand for grains, could put a significant strain on global grain supplies, which are currently at record lows. U.S. corn stocks have declined to a 33 day supply, meaning that if corn production was halted, the U.S. would run out of corn in a little over a month.
Strong farm income:
The increasing population, growth in emerging markets, changing dietary habits, and increases in ethanol production will result in higher commodity prices and an increase in farm income over the long-term. The USDA expects farm income to remain strong through 2018 due to sustained biofuel demand and rising global food demand, partially offset by lower government payments and rising farm production expenses.
Low farm sector debt levels:
Strong agricultural fundamentals and minimal use of debt have allowed the U.S. farm sector to maintain conservative balance sheets. Current debt to assets ratios are at 40 year lows. According to Iowa State University, 72% of the land in Iowa has no money borrowed against it. The minimal amount of leverage on farmer’s balance sheets will limit the potential downside.
Aging population will provide a good buying opportunity:
The aging farming population in the U.S. will create a window of opportunity to purchase farmland in large quantities. Typically, farmland is held for long periods of time and is not available for sale until the owner passes away. The USDA estimates that over one-third of all farmland owners have less than 15 years of remaining life expectancy.
Government farm commodity programs provide a safety net:
Farm commodity programs help stabilize and support farmer’s income by shifting some of the risk to the federal government. Federal assistance exists for roughly two dozen farm commodities and the payments are comprised of direct payments, counter-cyclical payments, and marketing assistance loans. Farm commodity programs, combined with crop insurance, help stabilize farmers’ income and thus reduce the risk of owning farmland.
Opportunity for wind development:
A bonus to owning farmland is that it provides additional opportunities to generate income or capital gains through wind development, oil and gas leases, the sale or lease of water rights, and recreational use.
South Dakota farmland owners are in an excellent position to capitalize on wind energy. According to Dakota Wind Energy, South Dakota has the wind potential to meet 50% of the U.S. electricity demand. Presently, South Dakota ranks fourth in the nation in wind power. Factors that make developing wind energy difficult are that South Dakota does not have the transmission infrastructure to transport energy to populated areas (although projects are being considered) or the policies that are favorable to renewable energy.
Landowners may have the opportunity to lease farmland for wind development that does not interfere with farming operations. The land owner is compensated through an annual payment per wind turbine that are estimated to be between $2,000 to $5,000 according to the South Dakota Energy Infrastructure Authority. One turbine can be placed on roughly 60 acres. Wind development could provide substantial income opportunities to farmland owners in the near future.
President Obama’s stimulus package is providing incentives for wind energy by providing grants to renewable energy developers for 30% of the facility cost. Renewable energy developers must apply by September 20, 2011 to qualify for the 30% grants, which should drive a land grab by developers over the next two years.
The drastic increase in the last few months of the U.S. national debt and the 24/7 operation of the printing presses increasing the U.S money supply will put significant long-term pressures on inflation and the U.S. dollar.
Historically, farmland pricing has maintained a high correlation to inflation, oftentimes outperforming during high inflationary periods. Agricultural land also affords investors the chance to diversify away from stocks and bonds, as farmland is not highly correlated with these more volatile asset classes.
The commodity bull market is also likely going to be reenergized given rising prices. As commodity prices continue to climb, supported not only by an inflationary environment, but broader global demand, the land supporting those commodities will further appreciate. A simple comparison of commodity prices in the inflation era of the 1970’s demonstrate the high levels grain prices can reach in a high inflation environment.
Gold is the asset typically relied on during high inflation periods, which is evident by the fact that prices recently surpassed $1,000 per troy ounce. Farmland is a lot like gold, acting like a hedge against inflation. But farmland offers something that gold does not; intermittent cash flows. Farmland not only offers protection from inflation, it also pays you to own it.
Bottom in land prices:
The recent dislocations in the capital markets have provided a once in a lifetime opportunity to invest in farmland. The recent burst of the housing bubble has depressed most financial and real estate assets, including farmland.
We believe that farmland prices have exhibited a bottom in prices in the first quarter of 2009. Regional Federal Reserve surveys have displayed slight increases or flat prices in the first quarter following declines in 2008. The Chicago Fed said farmland prices increased 2%, the Minneapolis Fed said nonirrigated land increased 1% and irrigated increased 3%, and the Kansas City Fed noted that nonirrigated land increased 1.4% and irrigated land was unchanged.
The Rural Mainstreet Economy Index, a survey of community bank presidents in a 10-state area from Creighton University, displayed that farmland prices increased the last two of the last three months after hitting a bottom in March.
Farmland, through current income and capital appreciation, has provided consistent positive returns. In the last 100 years, farmland has displayed only three brief periods of negative returns (1930’s, 1980’s, and 2008).
Over the last 6 years, farmland as measured by the NCREIF Farmland Index has significantly outperformed stocks and bonds. Despite farmland’s strong performance, bull markets in commodities over the last century have lasted an average of 17 years. The current supply-and-demand imbalance will continue to drive farmland values higher.
Farmland provides an opportunity to invest in an asset class that is not directly correlated to stocks and bonds and has significantly less volatility. Farmland also provides a margin of safety to investors as stock prices can go to zero, but farmland will always have some value.
Read more about farmland and agriculture at farmlandforecast.colvin-co.com/.