Prospects for rising interest rates and lower crop prices add up to a necessary softening in land values, a new study by Rabobank argues. If values don’t adjust, risks are significant that land becomes an asset bubble—something it not currently is, according to the report released July 31.
Land values are unlikely drop more than 15% to 20%. "A collapse in agricultural land values is not expected unless growth continues despite higher interest rates and lower commodity prices," says Sterling Liddell, Rabobank vice president, food and agribusiness research.
He believes USDA’s annual land value report released tomorrow (August 1) is likely to estimate flat to lower land value growth in 2013/14.
Liddell notes that over the past 12 years, U.S. land values have posted steep increases, with most dramatic spikes in Corn Belt and Plains states. Leading all states was a 242% increase in Nebraska from 2005 to 2013. However, over the past year, land values have plateaued and in some areas declined as buyers show caution. Federal Reserve data show that Iowa values in 2013 showed a 2% decline, the first decline since 1998, while the Fed’s seventh district overall posted the slowest growth since 2009 at 1%. Until 2013, rising Midwest land values were generally supported by gross revenue from commodities.
In Liddell’s view, it’s important for values to decline by more than 10% to regain the historic ratio of gross revenue to land value of 12%. A ratio below 10% for 2013/14 and 2014/15 means that in the past two years on average, land value has grown faster than economic return generated from farming the land. "Land prices should decline to the point where costs become sustainable relative to returns over the long run," he says. "We expect farmers to become more conservative with investments when faced with tight margins. Market forces are likely to be effective in driving needed land value decreases."
Three specific factors will drive values lower, in Liddell’s view: weaker commodity prices, higher interest rates and reduced cash rents.
While he expects production costs to remain above $4.20 for the medium term, corn prices are likely to be in the $3.50 to $4.20 range through 2015/16. "With expected global stocks (for 2014/15) 9% higher for corn, 26.9% higher for soybeans and 2.8% higher for wheat, it is more likely that we will see lower prices over the next two years," he says. Until land prices contract, production costs will remain above $4.20. However, the picture is a more sober one for marginal land that has come into production in recent years. Breakeven on marginal land is $4.80 to $5/bu.
The result, Liddell says, is that while high prices have stimulated a 5% increase in planted area for primary crops—leading to the most acres planted to corn, soybeans and wheat since 1985—"normal yield conditions and growth (mean) that 4 million to 5 million acres will need to be forced out of production. Until this happens, margins are likely to remain low and land values will be faced with downward pressure."
Since 2009, 11 million additional acres have been planted to the three major crops, with 40% of that increase coming from additional acres in North Dakota, South Dakota, Nebraska, Kansas and Missouri. "These newer acres are expected to be at greatest risk of being economically forced out of production," he says.
Interest rates will play a major role in future land values. If land mortgage rates only increase from the current level of 5% to the 2010 rate of 5.8%, mortgage payments at current values "will begin an alarming separation from both rental rates and economic returns." For land mortgage rates to remain competitive with rents and returns at this interest rate, "we estimate that a 15% reduction in land values would be required," he says. Liddell notes that recent statements by Federal Reserve Board Chair Janet Yellen suggest that rising interest rates could be on the near horizon. Historically, low interest rates have accommodated higher land values.
Also impacting land values, commodity price declines are likely to drive decreases in Midwest and Plains rental rates, Liddell says. "Historically, costs for inputs such as fertilizers, chemicals and seed tend to increase quickly; if they decrease at all they do so slowly," Liddell says. "Land is the cost category which is generally squeezed as farm managers are forced to negotiate lower rental contracts to secure sustainable margins."
Farmers are likely to be more cautious as net revenues tighten and liquid assets are tapped to help cover operational expenses other than land, he adds. Rabobank’s outlook for rental values is flat to slightly lower over the near term. "While it may require one to two seasons of tight margins to fully incentivize renegotiation of rental agreements, rental rates are not expected to increase for the 2015/16 growing season," Liddell says. "Rental rates should provide a guideline for the amount of mortgage payment that is sustainable under current circumstances."
Hear a review of the report from Rabobank's Sterling Liddell on AgDay: