Farmland is often the first thing a producer wants to buy, but it might not be the best investment because it can account for a huge amount of debt. Experts advise farmers to keep total debt to 50% or less of the entire operation.
Farmland has been a solid long-term investment, but that doesn’t mean it pencils out
If you ask young farmers what their No. 1 need is, the overwhelming response will likely be land. Even during one of the worst droughts in history, farmland values are high and don’t show any sign of deflating.
"Record prices for corn and soybeans and low interest rates are putting a fire under land prices," says Joe Horner, University of Missouri Extension economist. Investors also provide price support. With limited growth in other sectors, farmland returns on investment look good.
Yet, Horner warns, these high prices could spell trouble, especially for young producers.
Kevin Dhuyvetter, Kansas State University farm management Extension specialist, says that when buying land, farmers should ask, What can I expect for my rate of return?
"If I’m buying land, I would target a 9% to 10% rate of return on assets," Dhuyvetter says. "For the past 50 to 60 years, that’s the kind of return land has brought. Returns have been higher or lower for individual tracts and for shorter time periods, but that’s a rate I would target."
To determine your rate-of-return potential, use this formula: (return + growth) ÷ price × 100%. Return is annual income earned from the land. Growth is expected annual growth in land price, and price is what you paid for the land.
"There is tremendous pride in ownership," Dhuyvetter says. "People often want to own the land
they farm, but you don’t have to. Ask yourself, Where can I get the best rate of return on my capital?"
Horner agrees. "Land is a good long-term investment, but not fast turning. Young producers should look for quick-turning investments with high margins," he says.
Producers should not commit too much of their debt-servicing capacity to buying long-term assets.
"With current costs, it doesn’t take many acres to consume the leveraging capacity of a young
farmer. People need to think about the time commitments they are willing to make on investments," Horner says.
When Not to Own. Farmland is a valuable asset, but it can account for a huge amount of debt. Horner and Dhuyvetter advise farmers to keep total debt to 50% or less of their entire operation.
Dhuyvetter says that when defining debt, you must include all debt, farm and personal. "People tend to look at debt loan by loan, but you need to think about debt for your operation. Bankers want to know your living expenses when you’re getting a farm loan because it’s another draw on your cash."
Another way to judge farmland investments is in terms of the repayment level. Horner says principal and interest payments should not exceed 15% of long-term average gross income. "That is an easy number to calculate and typically keeps people out of trouble."
Since many young producers have limited capital resources, Horner says, they might be able to grow their operation in areas other than land. He says a good option is running an existing machinery base over more acreage via cash renting or custom farming.
- December 2012