Keeping land costs reasonable is not just about buying land.
Given the present long-term outlook for crop prices, it might be a better investment to grow more crops by improving the land you already have than to invest in more farmland.
Here’s why: $10,000 per acre land for corn with average yields of 200 bu. per acre means costs of $2.50 per bushel, land alone. And that’s just for a 5% return. For a 6% return, the per bushel land cost rises to $3, according to calculations by Michael Boehlje, a Purdue University ag economist. That leaves little to cover all other costs if corn prices fall to $4-something.
The numbers are even starker at $15,000 per acre land, and some sales in the Midwest have even topped that. At this cost level, per bushel corn costs are $3.75 per bushel for just a 5% return and $4.50 per bushel for a 6% return. Boehlje spoke at the recent Ag Symposium sponsored by the Federal Reserve Bank of Kansas City.
There might be a better way to boost production that keeps costs more modest, says Michael Swanson, Wells Fargo ag economist and vice president. "It’s about bushels, not acres," he says.
For example, while land prices have skyrocketed in recent years due to high crop prices and record low interest rates, land improvement costs have not really increased—for tiling, leveling, irrigation and soil enhancement. Tiling alone can boost yields by 15 bu. per acre at just a fraction of the cost of a land purchase.
"Farmland is much more vulnerable than we think it is to farm cash flow," Swanson adds. Farmland investment is "almost" backward bending, he adds.
Keeping land costs reasonable is not just about buying land. On the rent side, Swanson notes that lower productivity farmland has increased at a more rapid rate than higher quality rental land. In 2006, land rent in South Central Minnesota for the low 20% in terms of profits was $117 for land yielding 159 bu. of corn, according to farm management data. That cost was just $6 per acre more than the $111 paid by the top 20% for land yielding 195 bu.
The spread has greatly widened. In 2012, rent for the low 20% in profit for land yielding an average of 157 bu. per acre cost $240. That’s $69 per acre more than the $171 the top 20% in profitability paid for land yielding 193 bu.
Put another way, per bushel rent for the lower quality land was $1.53 per bushel, but 89¢ for the higher quality land, while in 2006, spread between the two was only 16¢ per bushel.
In other words, renting lower quality land has become a more expensive alternative. Admittedly, management played a role, too.
Swanson says one key reason to try and keep costs low moving forward is to be prepared for the incredible level of uncertainty moving forward on all fronts. These include uncertainty surrounding interest rates, the strength of the U.S. dollar, global economic growth and the potential for exports, global crop production and policy changes.
Major policy uncertainties that will have a major impact on farmer returns include ethanol policy, monetary policy and global trade policy. "Policy operates on beliefs as much as facts," he says.
Moreover, be wary of forecasts, Swanson believes. "Economics is a lot less sophisticated than we make it appear," he says. "The long term outlook is highly uncertain. You can’t count on global markets to bail you out." Because of that, he says farmers need to understand that while they cannot influence the future, they can change themselves to be prepared for the future.
Furthermore, he adds, some beliefs are inaccurate. One is that better marketing is the answer. Minnesota data show, for example, that high profit farms do not sell their grain at higher prices; rather, they have much lower costs, including higher levels of productivity. Second, "there is an over-emphasis on economies of scale," he says.
Boehlje notes that corn prices were $3 as late as 2006 and dipped below $4 in 2009 and it’s not impossible they could go there again. "I don’t think they could stay at those levels, however," he adds. Long term, he’s optimistic for U.S. agriculture, but he has concerns for the intermediate term.
He thinks cost control, including keeping land costs reasonable, and maintaining strong levels of working capital are some of the keys to give producers the financial flexibility they need to weather a period of lower crop prices.