Land Prices Start to Simmer

November 16, 2011 05:41 AM
Land Prices Start to Simmer

Market watchers see steady to single-digit growth in the year ahead

Land prices intensified to a rolling boil during the past few months, but market analysts expect the heat to die down to a simmer in the coming year.

"Farmland values won’t jump up quite as fast in 2012," says Howard Halderman, president of Halderman Farm Management Service, Wabash, Ind. He expects strong commodity prices to push land prices upward by another 5% to 10%.

Randy Hertz, vice president of Hertz Farm Management, Nevada, Iowa, predicts the 2012 land market will stay firm to flat. He notes that land prices still aren’t quite equal to the present value of corn and soybeans. Land today in Iowa is equal to $5 corn and $11 soybeans.

In Iowa, farmland values increased 32.6% from September 2010 to September 2011, according to a survey conducted by the Iowa Realtors Land Institute. That’s the largest increase or decrease since the survey was created in 1978.

Don McCabe, manager of Soy Capital Ag Services, Kankakee, Ill., saw high-quality Illinois farmland climb to $10,000 per acre in 2011. While that level makes most farmers’ teeth chatter, the largest percentage increase in Illinois farmland values came in 1977, when values rose 37.3%. Since 2004, Illinois farmland values have increased by an average of 10.8% annually.

Land prices start to simmer 1

It’s no secret that profitability is driving farmer interest in acquiring more land. Low interest rates are helping too. Halderman estimates that producers have purchased 75% of the farmland sold in his market area of Michigan, Ohio, Indiana and Illinois in recent months.

In Illinois, McCabe figures that half of farmland buyers in 2011 are actual farmers. He says another third are investment groups and regional investors, which includes some hedge funds.

Low returns on investments such as Treasury bills, certificates of deposit and the stock market have been the main factors stimulating investor interest in farmland. Unlike commercial real estate, farmland is attractive as an investment because it has a zero vacancy rate. McCabe adds that increasing cash rents for farmland are yet another reason for strong investor interest.

Reality Check. Land that brings top-drawer prices—such as the 120 acres in northwest Iowa that sold for $16,700 per acre in October—grabs headlines but doesn’t reflect the averages. The Iowa land value survey shows the state’s farmland averaged $6,000 per acre in 2011.

The land value bubble everyone likes to talk about might be overstated too, says Murray Wise of Murray Wise Associates, Champaign, Ill. "I don’t see land values going down, but 3% to 5% might be a large increase [in 2012] and the market might be flat," he says.

A September survey of Pro Farmer members found that 24% expect a 10% or greater increase in farmland values in 2012; 45% anticipate values to increase less than 10%; and 26% think values will remain unchanged. Half of respondents said they are actively seeking land.

"The strong rise in values is primarily a corn thing," says Mike Walsten, editor of the LandOwner newsletter. He says the big farmland value increases have been on corn ground in the heart of the Corn Belt and in some wheat areas. Farmland values declined in 2011 in parts of the South, Northeast and West.

Walsten doesn’t see investment and hedge funds gobbling up land. "Funds are getting knocked out of the bidding. It’s hard for funds to invest $100 million, 80 acres at a time," he says. Funds want at least a 5% return, while farmers are often comfortable with something lower because they benefit in other ways from adding ground to their existing operations.

Wise thinks that funds are interested in acquiring farmland, but agrees that they have a difficult time competing with neighboring farmers. In addition, he says, farmland is in very strong hands. "In Iowa, 75% of land has no mortgage associated with it."

Halderman adds that execution is tough for the funds. "It’s not like picking a stock and closing the deal within an hour," he says. "There’s also no exchange where funds can go to find a listing of farmland and the asking price. Furthermore, farmland is not a liquid asset."

In the Years Ahead. "When farm profits go down and interest rates go up, this run-up will come to an end," Walsten predicts. He doesn’t see that happening for at least a couple of years. The good news is that farm debt-to-equity levels are much lower than they were in the troubled 1980s.

"There could be a 20% setback in land values and it would not break the long-term uptrend," Walsten says.

A good share of land is either being purchased with cash or with farmers taking a large equity position on the purchase. Many lenders are requesting a 30% to 40% down payment on land purchases before they will agree to a loan.

Hertz sees proposed farm spending cuts and commodity prices as the most threatening clouds on the farmland horizon. "It’s not always going to be this good," he says. "Just one year ago, August corn prices were $3.50. Corn prices of $3, $4, $5 and $6 have a huge impact on producers’ bottom line, and, in turn, land values," he says.

Higher Cash Rents Merit Creative Plan

Cash rents are headed higher. How much, though, depends on how much they increased this past year, grain prices, rainfall and yields.

"Illinois cash rents were up 10% to 30% in 2011," says Don McCabe, manager of Soy Capital Ag Services in Kankakee, Ill. "For 2012, I think they’ll go up another 5% to 10%."

The Purdue Farmland Value Survey shows Indiana cash rents rose 13% in 2011, the third-largest increase in the 37-year history of the poll. Craig Dobbins, a Purdue University Extension economist, acknowledges that farmers are expected to pay more for fertilizer, pesticides, seed and fuel in the coming year. However, Dobbins says, the increase in grain prices has been larger and interest rates are likely to remain low.

"On average, I wouldn’t be surprised to see cash rents increase as much as they did in 2011," he says.

Rainfall variations around the state and the effect on yields will also drive cash rents. If cash rent has increased each year for the past five years and 2011 yields are poor, there might be only a small change in cash rent for 2012. But, Dobbins says, if cash rents have been stable because of a long-term lease or other reasons and yields are close to average, the increase could be large.

Be Flexible. McCabe says he’s seeing more flexible rental arrangements emerge as farmers search for ways to cope with higher cash rents. "We will see a push toward some type of variable cash rent—more tied to a variable bonus or kicker."

Flex cash leases have increased from 20% to 75% of all rental agreements, says Howard Halderman, president of Halderman Farm Management Service, Wabash, Ind. Flexible cash leases typically include a base payment plus a bonus payment based on yield, commodity price and production cost.

"Many landowners are more aware of the challenge with input costs and output prices," says Steve Johnson, a farm management specialist with Iowa State University Extension, who is also seeing a sharp increase in flex cash leases. "Flex leases that incorporate yield and price look a lot like crop revenue insurance."

However, Johnson adds, flex leases are usually more complicated than fixed cash rents. They require the tenant and the landowner to do their homework and communicate, he says, "because there is a yield ingredient, price, trigger of share of revenue and cost of production."

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