Although home values have gone down, the value of Illinois farmland is up by 18%. According to an August 4th report released by the U.S. Department of Agriculture, the price of Illinois farmland averaged $5,800 per acre in 2011, an increase of 18% over the 2010 level of $4,900.
“The 2011 increase continues a string of large increases that began in 2004,” said University of Illinois agricultural economist and farm management specialist Gary Schnitkey. “Since 2004, Illinois farmland prices have increased by 222%. Or, another way of putting it, farmland is 2.2 times higher in 2011 than in 2004. The last seven-year period in which land prices increased an equivalent amount was from 1975 through 1981. During this period, Illinois farmland increased from $846 per acre in 1975 to $2,188 per acre in 1981, resulting in farmland prices being 2.6 times higher in 1981 than in 1977.”
Have prices gone too high?
Schnitkey evaluated this question using capitalized values calculated for each year from 1970 through 2011. He explained that a capitalized value equals all future returns discounted to the present. Higher returns increase the capitalized value. Lower interest rates lead to higher capitalized value.
The equation: capitalized value equals average cash rent divided by an interest rate.
“If the farmland price is above the capitalized value, then farmland is overpriced relative to its discounted returns,” Schnitkey said. “Conversely, farmland is underpriced if farmland prices are below capitalized values.”
The average cash rent in Illinois was $183 per acre in 2011, an increase of 8% over the 2010 level of $169 per acre and 45% higher than the 2004 rent, an increase rate that lags the farmland price increase rate, Schnitkey noted. “Since 1981, interest rates have generally fallen, providing support for increasing farmland prices.”
In his evaluation, Schnitkey saw that capitalized values closely tracked actual farmland prices since the mid-1980s. “In 2010, farmland prices were below the capitalized value by $438,” he said. “In 2011, the $5,800 per acre farmland price was $221 above the capitalized value of $5,579 per acre. The switch to price being above the capitalized values suggests that farmland prices are increasing quicker than their discounted returns. However, the $221 higher farmland price in 2011 is not without historical precedents. Between 2005 through 2008, the average farmland price in Illinois exceeded capitalized value.”
Historically speaking, Schnitkey said, the last time farmland price exceeded capitalized value by a large margin was in the early 1980s, immediately prior to the large decline in Illinois farmland prices that occurred from 1982 through 1987.
“Currently, the situation in 2011 is not like the 1980s. This suggests that either farmland returns have to decrease or interest rates have to increase before farmland prices fall,” Schnitkey said.
Schnitkey admits that these are disquieting economic times. Economic data suggest sluggish economic growth, raising the possibilities of a double-dip recession, he said. The Federal Reserve has pursued policies that increased the money supply, leading to concerns of inflation in the future. The inability of the United States, European Union countries, and several states within the United States to come to grips with fiscal imbalances and entitlement spending poses risks to the long-run economic future of Western countries, he said.
“These economic headwinds likely provide support for U.S. farmland prices,” Schnitkey said. “An economic downturn likely would reduce non-farm asset returns compared to farmland returns. The threat of inflation in the future places pressure on farmland prices as farmland and other real assets are perceived as safer stores of wealth than financial assets during inflationary times. The threat of long-run instability places a premium on real assets over financial assets. This suggests that a more stable general economic outlook would lead to less aggressive growth in farmland prices.”
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