Many farmers plan to rent out their ground to fund retirement years. But, should you do so now to improve your financial standing?
In most areas, average operator returns exceed rental returns for farmland. But, with declines in farmer profitability, the scales are tipping in some areas, says Jackson Takach, Farmer Mac economist.
For example, Takach says, the inflation-adjusted net operating income (NOI) in Illinois peaked in 2012 at more than $440 per acre (6.6% of average land values in the state) but hit just $223 in 2017 (3% of average land values). Meanwhile, the real operator returns in the region averaged more than 2.5% higher than average real after-tax rental returns from 2008 to 2013.
Most farmers think of profitability in terms of cost per acre, says Paul Neiffer, CPA and principal at CliftonLarsonAllen. Instead, they should focus on another key financial metric: contribution margin.
“Your contribution margin is the difference between revenues and variable costs,” he says. “It determines the amount of available income that can service fixed costs."
Do the Math
Neiffer suggests farmers rank fields based on contribution margin. This analysis will reveal which acres yield the best return and which acres could be rented out.
Assume a farmer has four farms relatively equal in size with the following contribution margins:
- Farm 1: $450
- Farm 2: $325
- Farm 3: $225
- Farm 4: $100
In this case, the farmer should consider replacing the fourth farm. “He might even shrink in size and be better off,” Neiffer says.
When doing this analysis, Neiffer says, consider how far a field is from your home base and the quality of the farmland. Also factor in how a decrease or increase in total acres will affect your labor, machinery and grain storage needs.
“The bottom line is to look at your total contribution margin and make financial management decisions based on this metric and not just cost per acre,” he says. “If you’re making $150 per acre farming it but could rent it for $300 per acre, consider your opportunity cost.”
Operating Versus Rental Returns
Which states offer farmers the biggest operating profits? This map plots each state’s average real operating profit against its average after-tax cash rental return from 1994 to 2017. The size of each bubble is related to the state’s total value of agricultural real estate. Most states fall near the middle, where operating returns are near or slightly higher than rental returns.