Understanding Farmland Values and the Long-Term Outlook
Sep 30, 2013
The last decade for agriculture has been the most exciting in many generations. Rising commodity prices and strong domestic and global demand has driven U.S. row crop farmland and other agricultural assets to record highs. Farming used to be a sleepy business that now is frequently on the front page of the New York Times and The Wall Street Journal.
Over the last decade, U.S. farmland values have increased 116%, from $1,340 per acre in 2004 to $2,900 per acre in 2013, according to the U.S. Department of Agriculture. The Midwest Corn Belt, the primary farming region of the U.S., has been the leading beneficiary of the agriculture boom, with farmland values increasing over 200% in Illinois and Iowa. The global demand for agriculture has not only created wealth in the U.S., but across the globe from South America, to Eastern Europe, and Asia-Pacific.
Jim Rogers said, "the farmers are going to be driving the Lamborghinis," and this is coming true. In Illinois, the average farmer income was over $250,000 in 2012, up substantially from $66,000 in 2005. Higher commodity prices, increased production, and expense management, have led to the record farm income. Farmers have reinvested their profits back into their operations, increasing the size and scale of their farming operations and driving up farmland values.
Farmland values per acre in Illinois and Iowa as of 2013 are now $7,800 and $8,400 per acre, respectively. Yes, farmland has sold for $15,000 per acre and even over $20,000 per acre, but U.S. farmland is a $2.5 trillion asset class and a few million dollar sales are not representative of the overall asset class.
U.S. farmland has been an attractive investment for not only farmers, but investors as well. The consistent income, diversification, lack of correlation to other asset classes, and inflation hedge of farmland has been an attractive investment for individuals and institutions.
Despite the recent enthusiasm for agriculture, we believe farmland values are fairly valued based on current market fundamentals and have substantial upside. Farmland values, like all assets, are a function of their future cash flows. Commodity prices are just one variable in the equation and production and expenses are keys to analyzing profitability.
The average high quality farm in Iowa generates $950 per acre in revenues. We estimate the average input costs for a high quality Iowa farm to be $425 per acre and average cash rents to be $425, leaving a profit for farmers of $100 per acre, which is what most farmers use as their annual profit target per acre.
Over the last 40 years, U.S. farmland has sold at an average capitalization rate of 5.0%. Using this historical multiple, with the average cash rent for a high quality Iowa farm of $425 per acre, generates an average value of Iowa farmland at $8,500 per acre, which is $100 more per acre than Iowa farmland is currently valued at.
The last ten years have been the "Decade of the Farmer," but this is just the beginning and we estimate we are in the second-to-third inning of a long-term bull market. We have highlighted a few data points that are important in driving farmland’s returns over the next decade.
Rising Global Demand – The global demand story will continue to strain the world’s food supply. The global population is expected to grow from 7.0 billion people to 9.0 billion people by 2050. Over this same time period, food production will need to double to meet the needs of a higher protein diet.
Land Scarcity – There are approximately 3.5 billion acres of arable land in the world and the potential for adding a mere 5% over the next few decades. Soil erosion and population growth are also depleting arable land by the minute. Over two acres are disappearing per minute according to the American Farmland Trust.
Improving Technology – Precision technology and sustainable farming techniques will allow farmers to increase profitability over the next decade. Efficient use of fertilizer has already lowered costs to 15% of revenues, from 20% a decade ago. Drought and cold tolerance traits will allow farmers to have more stable yields. New technology will have a substantial affect on margins.
Expansion of the Corn Belt – Planted corn acreage has grown 17% over the last decade as high commodity prices and improving technology has allowed farmers to plant corn farther north and west. Expanding infrastructure is also changing the direction of grain. Historically grain has been sent to the Mississippi River and the east, but rising demand in Asia has more grain being sent to the west.
Multiple Expansion – Despite the rising interest in agricultural assets and low interest rates, farmland values have not seen an expansion in multiples. Over the last 40 years, farmland has been valued at cap rates of 5.0% and farmland still averages 5.0% cap rates in 2013.
Conservative Balance Sheets – Farmer balance sheets are the most conservative in over 40 years according to the USDA. In Iowa, 78% of farmland has no debt against it, up from 75% in 2007.
Investors Yet to Participate – In Illinois and Iowa in 2012, 85% and 82% of farmland was bought by local individuals, respectively. Investors’ have yet to have a meaningful impact or participation in the asset class. There is less than 1% of farmland currently in institutional hands.
Aging Farmer – As of 2007, the age of the average U.S. farmer was 57.1. Over the next decade there will be a substantial change in who is sitting on the tractor as today’s farmers enter retirement. Typically the average parcel changes ownership once every 75 years. We see this generational change as one of the best opportunities to acquire farmland due to the unusually high volume of land potentially changing hands.
Over the next decade, agriculture will have a few bumps in the road. Despite the strong demand story, we have highlighted some risks that may be hurdles in the short-term.
Rising Interest Rates – Interest rates can’t stay low forever and we have already seen a substantial rise in 2013. A considerable rise in interest rates may prohibit growth in agriculture and farmers access to capital.
Washington – Indecision in Washington and to-be-determined Farm Bill has left farmers uneasy about what support the government will provide in the short-term.
Macro Economic Uncertainty – The end of easy monetary policy and potential slowdowns in emerging markets may slow the development of the global demand story.
Identifying Assets – Rising agricultural asset values is making it harder to find undervalued assets. Ten years ago you would have made money by purchasing anything, now it takes hard work and deep analysis to identify the right assets that will outperform over the next decade.
Understanding Farmland – All farmland is not created equal and two properties across the street from each other can have completely different production and economics. Identifying high quality assets that will benefit from the global demand story is key to an allocation in agriculture.
When analyzing an investment in agriculture, it is important to look to the future. Farming has changed drastically over the last decade and will continue to develop over the next decade. Today’s progressive American farmer doesn’t merely work the land: he is also salesman, manager, accountant, buyer, marketer, scientist, agronomist, mechanic, and computer expert.
Over the next decade, famers will continue to consolidate and produce larger amounts of acreage, lowering their fixed costs and overhead. Precision farming and lower fertilizer use will increase margins and drive profitability.
Farmland is a long-term investment and the focus should not be on commodity prices and yield estimates over the next twelve months, but over the next ten, twenty, thirty years. Farmland is the one variable in the farming equation that cannot be replaced and with sustainable farming methods, an investment in farmland will last longer than we can even imagine.
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