Farmland values may not be in a bubble, but changed fundamentals could undermine recent gains
Strong farmland appreciation, 20% or better in many Midwest markets, makes perfect theoretical sense given today’s low interest rates, strong farm incomes and high crop prices. That’s why most academics and economists generally conclude that an agricultural land bubble doesn’t exist.
"But remember, it’s not just bubbles that cause land values to come down," says Craig Dobbins, an agricultural economist at Purdue University, speaking at a recent conference. "It’s also what people perceive to be the fundamentals. And the perception of the fundamentals could change."
Dobbins was one of several speakers at last week’s Farmland Value and Leasing Conference in Decatur, Ill., who warned that unexpected shocks to ag's foundations could topple farmland values. Investors who are fueling interest in farmland could sour on it if the federal government revises its mandate that gasoline producers buy ethanol; if China’s consumption of feedstock slows; or if South America dramatically increases its grain production, among other activity.
While market conditions favor continued growth in agricultural land values, says David Oppedahl, an economist with the Federal Reserve Bank of Chicago, there's some uncertainty. Oppedeahl outlined some shocks that could disrupt the trend. A divided Congress, for instance, might be unable to find common ground on a farm bill or fail to avert the fiscal cliff. The huge federal deficit might force policymakers to trim the federal crop insurance program.
Farmland values have been increasing at double-digit rates for several years. Lee Vermeer, vice president of real estate operations for Farmers National, expects the growth to slow this year. Vermeer sold about 700 farms last year worth about $500 million, and most of the sales happened at auction. Farmers National also manages 5,000 farms.
"When you see land values doing up 30% a year in some states, year after year, you think to yourself, That can’t go on."
But it has. Farmers National, which witnessed a 20% to 25% rise in values last year, expects to see increases north of 20% again this year. Interest has picked up of late. Investors are clamoring to get in on deals before the end of the year when tax rates and policies might change.
"In every area where we work, 24 states, there’s a record demand for land. We have record rents, record income, record land values," says Vermeer, noting that investors remain bullish on agricultural land, even though profits have gone up 30% since 2007, according to USDA statistics.
But Vermeer, too, worries that the sands could shift under the agricultural economy. "If they take away that (ethanol) mandate, there goes a chunk of our demand. That’s something we have to watch."
Agricultural land, like stocks, bonds or other investments, may be due for a "market correction" says Vermeer, noting that recent yearly price increases rival those of the late 1970s. They were followed by a fall in land vaules in the early 1980s that triggered a farm crisis in the Midwest. "The likelihood of a correction goes up with increased volatility," he says.
Dobbins, who does a survey of Indiana farmland values every year, used to have trouble explaining the steady increases since 2000. It's no longer as difficult, given recent trends in net income, returns and crop prices. There’s also the matter of supply constraints. "There’s never enough land brought to the market, it seems," he says.
A recent roundup of Fed surveys shows that, despite the drought, nonirrigated cropland values rose more than 30% in Nebraska and South Dakota. In Iowa, year-over-year values rose 24%. The Eastern Corn Belt overall witnessed an increase of between 10% and 15%.
Investors account for a growing share of buyers, says Vermeer, even though local farmers still account for 70% to 80% of sales. The broker keeps fielding calls from investors who have read about strong farmland returns and want to diversify their portfolio. They are typically looking to hold long-term.
"They are looking for specific returns," says Vermeer, putting them within the range of 3.5% to 4%. "If they can’t hit that number, they don’t buy … .There’s just a ton of cash pouring into this market, which has been one of the major drivers pushing prices upward."
Investor interest has helped push price-to-earnings ratios on farmland to about 30, compared to roughly 18 for stocks. "That makes you stop and think a bit," Vermeer says.
Low interest rates are one explanation for high P/E ratios. Rates on 10-year Treasuries remain below 2%, and the Federal Reserve Board wants to hold them down until economic growth improves.
The high prices being paid for farmland make it difficult for small farmers to compete. Says Dobbins: "If I’m (a small farmer) in an auction with someone who is willing to spend 33 times current earnings, I don’t have a prayer. The problem is that there are lots of them out there."
Even as they held out the possibility that farmland values could tumble, most speakers at the conference don’t believe they will. Based on current prices for 2013 corn and soybeans, farmer incomes are likely to be higher next year, says Gary Schnitkey, a University of Illinois agricultural economist. Given that scenario, along with the probability of continued low interest rates, "Why wouldn’t farmland values keep going up?"
Demand for agricultural products is different than demand for homeownership, several speakers stressed. U.S. farmers produce a real product that’s needed by the entire world, Vermeer says. And they produce it in an environment with low debt, strong profits and increasing productivity.
"The reality is our production has just been keeping up with worldwide demand. Now with the drought, we’ll need to ramp up our production," Vermeer says.
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