Late last fall almost all farmland and financial gurus staring at $4 corn were predicting a significant reduction—though no crash—in values this year. It hasn’t happened. But experts think it’s not so much if, but when.
"In Iowa, we saw a 10% drop in farmland values in the first quarter," says Doug Stark, CEO, Farm Credit Services of America. "As crop commodity prices rose this spring, values regained that 10%." So by July 1, values were back up to flat. "In spring 2013 we saw $20,000/acre land sales in Iowa, a bell weather state for land values, and the same thing this spring. Values haven’t changed much on the top end."
In indexing 35,000 sales in Stark’s four-state trade area with 65 benchmark farms, Iowa values were barely off 0.9% for the six-months ending July 1, and down a modest 3.7% year over year. Marking a longer horizon line, values over five years not surprisingly have more than doubled and are up 246% over 10 years. In addition to strong farm incomes, "historically low interest rates are a big reason for these increases," he says.
The other states in his district—Nebraska, South Dakota and Wyoming—have seen values continuing to escalate. Looking at the six-month and one year periods, Nebraska values were up 1.5% and 2.2%; South Dakota up 5.8% and 13.6%; with Wyoming, up 5.8% and 9.5%, the latter largely due to strength in livestock incomes. "We’re seeing a much narrower band of land values than in the past," Stark said at the Federal Reserve Bank of Kansas City’s Ag Symposium in late July.
Given the sharp decline in crop values and bearish outlook moving into 2015, Stark still thinks both land values and crop incomes are headed for a correction. "A soft landing is as good as we can expect," he says. "Grain commodity prices and margins were unsustainable. Production agriculture margins are normalizing."
"There is not a land bubble," argues Chad Hart, ag economist at Iowa State University. Historical data show that for every 2% change in farm income, land values change 1%. "The 30% decline in crop income would suggest a 15% correction in land values," he says. While significant, that’s less than the increase a number of states experienced in 2013 alone. In Hart’s view, the coming correction will not look much like the 1980s. He believes the past decade’s land boom and adjustment over the next few years will look a lot more like 1910-30, when the land boom corrected, but definitely no bust.
Also setting the current situation apart from the 1980s is that most—though not all—banks have been more conservative with lending limits. "Our lendable real estate limit is $6,000," Stark says. So much of the increase in values has been paid with cash. So why do farmers pay $20,000 per acre that crop prices alone don’t support? "Hope, optimism for the future," he says. "In my 30-year career, only one time could you cash flow an individual piece of land without an additional subsidy to make it work and that was the late 1980’s."
Stark says that 80% of Farm Credit of America loans have less than a 50% loan to value ratio and 95% have less than 65%. "You could have a 50% decline in land values and not have a problem with these loans." Not only that, 75% of real estate debt has long term fixed rates at low interest rates unparalleled in modern history. "They’re as low as they’ve been in 250 years on a real basis."
For 2015, a 15% correction in land values and cash rents appears likely, says Brian Newcomer, executive vice president of business development, Rabo AgriFinance. "As for this year, we have farmland buyers, but not sellers," he says. Because of that, values have been firm in most areas. FCS data supports this view. The number of auctions remained at 2013 levels in Iowa, Nebraska and South Dakota after dropping 25% from a historic high in 2012.
Working Capital Not Strong Across the Board
Some lenders are concerned that more producers do not appear to have cash reserves as large as you might expect following five years of strong crop incomes. "With cash corn at $3.50, we’re applying the worst case scenario we earlier developed for 2014," says Max Wake, president, Jones National Bank & Trust Co., Seward, Neb.
"We would have liked stronger levels of working capital than we’re seeing," he says. "Some (corn and soybean) cash flows don’t work." Lenders say that while a significant number of producers have created a cash war chest to enable them to weather several years of low prices, an equal group has pretty much spent all its income, in some cases, as a tax avoidance strategy.
One concern Wake has is that farmers have already used up deductions for capital purchases and have future tax liability while rolling income forward, but that tax liability is not frequently carried on balance sheets. As a result, some borrowers have $1 million lines of equipment that is fully depreciated. "Some borrowers who want to retire cannot because of future tax liabilities." These liabilities may occur at the same time crop income has declined.
While good operations have built up a cushion of working capital, "$3.50 corn will soak up much of this working capital," says Rabobank's Newcomer. Rabo’s portfolio remains strong, he says, with the majority of producers having more than sufficient collateral to secure credit lines. Never the less, if corn prices stay below $4, "over the next 24 to 36 months, we’ll see some financial stress."
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