Farmland may seem like a good investment now, but it might not be the best use of your capital.
Even though farmland value is expected to continue the climb upward, at least during the short-term, that’s not necessarily where young farmers should invest their capital, explains Brent Gloy of Purdue University at Tomorrow’s Top Producer conference in Chicago, Ill.
"We see a great deal of pressure on land values because of incomes and interest rates," says Gloy, who is an ag economist and director of Purdue’s Center for Commercial Agriculture.
Incomes are up and interest rates are down, he notes. Demand expansion calls for more output on all price levels. Today we use about a quarter of our acres for biofuels and a quarter for exports to China, Gloy adds, noting that about 10 years ago, these numbers were negative.
These factors have all been beneficial to farmers, but they can’t continue to fuel the fire long-term, Gloy says.
"If we throw a lot of credit on the fire, asset values will spike," he says. "We don’t want to use a lot of credit in this environment to purchase land."
Gloy encourages young producers to pay attention to what the Federal Reserve is doing. "In the 1970s and 1980s, interest rates kept going up while capitalization rates went down," he says. "When treasury bonds start going in the opposite direction, we need to be concerned."
Farmland values are pressured when incomes increase or land values fall. "Today people aren’t necessarily valuing farms based on income or prices, but what they think it will be worth in the future," Gloy says.
Farmers must be good risk managers. "It’s not risk when you make $100 to $450 of economic profit per acre," he says. "Are you prepared to manage risk if we get into prices that really hurt? Are you exposed to someone else’s risk? Volatility creates winners and losers."
Gloy asks young farmers to look at how they manage costs. Consider non-land capital investments, he encourages.
"You have the power of time and compounding working to your advantage," Gloy says. "Your capital is going to grow during a long period of time. Invest in operational excellence. This investment pays off no matter when you make it."
Gloy also advised young producers to build their management capacity, build a good understanding of the economics of your business, build relationships and invest in assets that have a high return.
"Don’t misallocate scarce capital and overpay for fixed assets or buy at any costs," he warns. "It’s also important not to bank on the next five years being as profitable as the last five years."
See full coverage of the 2013 Tomorrow’s Top Producer event.
Thank you to the 2013 Tomorrow’s Top Producer sponsors:
Agrotain, Farm Credit, SFP