By John Blanchfield and the American Bankers Association’s Agricultural and Rural Bankers Committee
Rising crop and livestock prices have generated significant profits for many farmers, which some are using to buy additional land. The increased demand has driven land values to record highs in some areas.
The American Bankers Association’s Agricultural and Rural Bankers Committee, which is comprised of leading agricultural bankers in the country, has developed these recommendations for buying farmland.
Buying land should include a well-researched financial plan. Establish a basis for purchasing additional land and stick to the plan. There are once-in-a-lifetime purchases that have an emotional connection for the buyer: land that may adjoin the home farm or once was part of the family farm. These purchases may take precedence over business decisions, but the majority of farm land purchases should meet cold, hard business tests.
1. What is your business’s financial condition?
Consider needed investments, expected expenditures, and crop conditions to determine if buying land is the best use for your cash. Are there other opportunities that can provide a better return?
2. Have you created a pro-forma cash flow?
Research sales trends and expected revenue of a potential plot of land to determine how well the purchase fits within your plan. Does the potential return meet your objectives? Your banker can help you develop this essential planning tool.
3. Given your revenue forecast, are you overpaying?
If you are paying a premium, how long will it take you to recoup? Determine how much your business should prudently spend on a land purchase and the revenue needed to justify your purchase and stay within those targets.
4. Have you thought long and hard about it?
Never be rushed by a broker and never confide your best price or financial goals with a party working for the seller. Don’t buy impulsively or make a deal before visiting the property numerous times. Rework the standard broker’s purchase contract with your lawyer, deleting what you don’t like and adding what you want, before presenting the offer.
5. Does it make more financial sense to rent the land rather than owning it?
Rental rates are high, but renting frees your cash for other activities. What will be your total land payment per tillable acre owned and how does this compare to cash rents in your area?
6. Should you go all in with your cash?
Talk to your banker about alternatives to using all cash in the transaction. Land is an illiquid asset and purchasing it will impact your farm’s liquidity. Your banker can work with you to structure a loan that will enable you to acquire the land you need while preserving some of your working capital for necessary expenditures.
7. How much land are you acquiring?
Sounds simple, but many times there is confusion about how much land is actually being purchased. Know exactly what you’re getting before making a bid. See if the land has been surveyed and make sure it matches the details of the offer. If the land has not been surveyed, work with your attorney to determine the acreage based on the legal description or consider having the land surveyed and determine who will pay for it. Make sure that there are no special easements tied to the land. If there are, make sure you spend time studying them and understanding them completely.
8. What does the land appraise for?
Are there some comparable sales in the area? Appraisals are expensive, but they are the best way to establish value. Even if you do not get a full appraisal, attempt to find some comparable sales to determine if the purchase price is reasonable.
9. What is the soils story?
What is the capability of the soil you are buying and how does this impact your revenue forecast? Good soil is paramount. Know the type of soil you’re buying and the history of annual crop rotation. Any seller should be more than happy to provide you with a soil’s profile and information about past farming practices.
10. What is the water source?
Is the property irrigated? Do the water rights convey with the property? Adequate water is essential to establishing the value of the property. Account for water cost in your financial plan to ensure this cost doesn’t negatively impact your return. Make sure all water wells are registered with the appropriate authorities. Each state has its own water laws so make sure you are familiar with the state that you are doing business in.
11. What do you know about the gas, mineral, and wind rights for the property? Do these rights convey to you as the purchaser?
Have they been surveyed or severed from the surface rights? Are they currently under lease? If so, under what terms? Have a thorough knowledge of property rights, as mining and drilling can have an impact on surface and water quality, access to the property, and the viability of the farm or ranch.
12. How is the property zoned?
Will your plans for the property conflict with existing zoning restrictions? Are there conservation easements that could restrict use of the property? This factor has a significant impact on your valuation of the property, particularly if your plans conflict with current zoning restrictions. Make sure that you understand the assured leases that may go with the property -- many of the states in the west have a large percentage of their ground that falls into this category (bureau of land management, forest service, state land, national grass land).
13. How will you hold deed in the property?
Will you own it individually, jointly with a spouse, in a family owned entity (corp., LLC, LLP) or in a trust? The pros and cons of how you own the land will depend on your long term goals.
14. Are there any environmental problems?
The last thing you want to buy is a costly environmental problem. Paying for an onsite environmental audit before you buy the land may be worth the cost and will help ensure you are not buying into an expensive cleanup.
15. Have you considered your age and health?
The debt you may be able to service from production profits may not match the debt service capability of leasehold income. Make sure your financial plan addresses your ability to service any potential post retirement debt. Equally important is having a financial plan for servicing debt if health issues arise which might alter your capabilities as the producer. Do you have sufficient life insurance and disability insurance?
No one knows more about financial budgeting and cash flow planning than your banker. ABA recommends making an appointment to talk with your banker about the significance of purchasing land and how it will impact your business.
The American Bankers Association represents banks of all sizes and charters and is the voice for the nation’s $13 trillion banking industry and its two million employees. The majority of ABA’s members are banks with less than $165 million in assets. Learn more about the American Bankers Association.