The opportunities in production agriculture in the years ahead are unlimited. However, with opportunities come obstacles. On numerous occasions, I’ve said the biggest bottleneck for producers is people management—getting the right people, with the right skill set, in the right place at the right time. Recently, I changed my mind, not because people management isn’t important, but because it will be trumped by another challenge: access to capital.
My concerns about capital might sound odd coming off a drought year that still yielded a record net farm income projected near $132 billion and one of the four best years in the last century. However, to best manage your bottom line for the long term, you need to anticipate problems. Here’s why access to capital will be a challenge and what you can do to avoid a problem.
Analyze your debt structure
and build as much working
capital as possible
The agriculture economy will cycle, and net farm income will significantly drop. As Neil Harl, professor emeritus of economics at Iowa State University, taught me more than 40 years ago, the price of agricultural commodities over the long run will level out at the cost of production for those farmers with high costs.
As margins decrease, it will be more difficult to obtain credit. This round will be different compared with past cycles, though. Historically, production agriculture has been largely made up of owner-operators. Today, there are farmers who own their land base and those who own some land but rent the majority. The first group won’t have a problem securing capital. But as margins drop, farmers who primarily rent land and have a below-average working capital to gross revenue ratio might have difficulty securing operating credit.
To avoid that scenario, analyze your debt structure and build as much working capital as possible by refinancing real estate, facilities or equipment and paying down operating debt.
By doing this, you are essentially fixing the interest rate on your operating debt needs for the term of the fixed rate. Then, be disciplined enough not to use much or any operating credit.
The long-term strategy. The Fed says it doesn’t plan to raise rates for several years, but keep in mind it only controls short-term rates. The market dictates long-term rates, and the market can be quite unforgiving. We have rates at 50-year lows, so the current opportunities might not come around for another 50 years. Use this opportunity to reduce risk for the future.
Obtaining long-term credit could also be a challenge, but for different reasons. For example: Assume a producer farms 1,500 acres—500 acres owned and 1,000 rented. One of the farms he rents comes up for sale. When this occurs with our clients, we advise them to buy it. With today’s land prices, a 160-acre farm could cost $1.5 million to $2 million. However, in many cases this one purchase causes the debt servicing "bucket" to be full. What happens when another rental farm comes up for sale?
One suggested strategy is to align yourself with people or firms that could buy the farm and rent it to you. Without a strategy like this, you could end up losing a farm that you have rented for a number of years—and any improvements that you have gained—and jeopardize your existing farm operation as well.
I often hear farmers balk at this idea. However, it’s going to require thinking outside of the box in the next few years to access land to farm while maintaining the working capital to sustain operations. The total amount of capital needed in the years ahead might not be able to be met by the farmers now farming the land.
There are people who want to invest in farmland—and many are interested in good stewardship and the best farming practices for their investment. It’s important to do your due diligence on the individuals or companies before moving forward. Make sure they are who they say they are. If so, aligning yourself with investors like these now might pay off in the long run—by allowing you to sustain or grow your operation, adding to your bottom line.
- November 2012