How $12,000 Becomes $6,000 or less
Dec 09, 2013
As corn prices continue to range near multi-year lows and the expectations for increases in interest rates start to perk up (taper anyone), the value of farmland may start to reverse their strong decade or longer advance. For example, assume we have a farmland owner in Northern Iowa who has 190+ bushel acre corn ground. Last year, his neighbor's quarter section sold for $12,000 per acre. Top cash rent ground in the area was going for close to $400 per acre. Over time, about 1/3 of revenues related to farmland is usually earned by the landlord.
In this case, 190+ bushel corn at $6 per bushel (2012 prices) would equal about $1,200 of revenue. $400 cash rent is 1/3 of this number, so the actual cash rent earned on the investment is about right.
Since the person purchasing the property could only earn less than a 1% return on their money in a risk-free investments (savings at the bank, US Treasury bills), they were OK with a 3-4% rate of return on their farmland purchase. Cash rents of $400 less real estate taxes of about $15 per acre resulted in net cash rent income of $385. This results in a 3.2% rate of return. Again, within the range the investor needs.
Now, let's go forward a few years. Corn prices have stayed in the $3.75 to $4.25 range while yields have increased to about 200 bushels per acre. This results in about $850 of gross income on average. Cash rents at 35% drops the cash return to the investor from a net of $385 to about $280. The elimination of "tapering" by the Federal Reserve has now increased long-term interest rates from an artificially low 2-3% to the more normal 5-6%. This results in our investor requiring a 5% rate of return on their farmland investment.
His farmland now has a value of $280 divided by 5% or $5,600. Therefore, a farmland investor using a rational analysis of income and yield would now drop their purchase price from $12,000 to $6,000. I am not stating this will happen, however, if this fact pattern (or similar facts) occur for enough years in a row, I can almost guarantee this will happen. The key question for farmers anticipating purchasing ground for $12,000 under current conditions is how stressful to their farm operation is this same farmland when revenues are lower and interest rates are higher?