The Question: To Rent or Not to Rent?

August 20, 2018 01:58 PM
 
farmland michigan

Land lease terminations on Sept. 1 initiated by the farmer/operator are becoming more common. For many producers, cash rents have been very slow to adjust in comparison to some of the other inputs over the last few years. Consequently, more and more producers have terminated an existing land lease to have an opportunity for negotiating a lower rental rate.

In extreme cases, some producers have burned through so much working capital that current rental rates simply do not cash flow and can no longer be subsidized from other portions of their operation. Conversely, there are still just as many producers unwilling to terminate a lease for fear that the land could then be up for bid by other farmers. It’s just easier to leave well enough alone in hopes that the combination of price and yield will get better in the future, even if the rent is a too high. This is especially true if a producer has enough working capital and can cost average a high cash rent farm with a lower cash rent farm or against owned land with little or no payments.

The Right Questions. So what approach should be used in determining whether a land rental opportunity is feasible? Does cost averaging all your land expenses make sense? Should each individual farm stand on its own merit? There are always lots of questions when considering land rental properties.

Let’s start with cost averaging rental farms. There are some benefits to spreading fixed costs, such as equipment and labor, over more acres. Although additional acres may help lower your fixed costs, generally just one individual farm relative to your equipment fleet and overhead labor costs has minimal margin contribution benefits. On the other hand, large land parcels relative to your equipment fleet, labor and other overhead costs can bring significant benefits to your bottom line.

Cash rent levels can be at a premium, if other line item costs are controlled, productivity is high, and your marketing is disciplined. This is one of the reasons why land rental values still tend to be relatively high in many areas. There are still just enough producers with adequate working capital, larger than needed equipment fleets, unwillingness to part with any land and adequate labor forces, which usually includes family members with long-term plans of farming. Also, many of these operations with the capacity to pay higher rent levels tend to have additional off-farm income. This supplemental income provides a distinct competitive advantage when it comes to rent level payment capacity. However, this strategy does not work for everyone.

Cost averaging your expenses can be a dangerous endeavor. Failure to calculate each individual farm as its own profit center can create a blind spot in measuring risk. Just because you’re spreading fixed costs over more acres doesn’t necessarily mean that productivity or revenue will be higher. With more acres comes more challenges and the need for more intensive management. More land does not always equal more profit.

Analyzing each farm on its own merit is by far the safest approach. This is not to say that a farm which lays right next to you, that you will have the opportunity purchase in the next several years, must be profitable to farm. In fact, you may have distinct reasoning why a specific farm is justifiable in subsidizing over a number of years, if it’s affordable and not detrimental to the bottom line long-term. This is fine so long as you know exactly what you’re subsidizing, have the cash to support it and you can calculate an eventual economic benefit.

Be cautious however, as oftentimes these anticipated opportunities take almost twice as long as we think to achieve. In a tight margin environment, you can burn through significant amounts of cash quickly. If you are interested in some analysis tools for measuring cost of production and rental payment capacity check out our website at agviewsolutions.com/profit-manager.

The chart on this page is an additional tool you can use to grade each of your land rental properties. If any of your farms grade at a level below 3/C you may want to seriously consider whether that property is beneficial enough for your operation. When cash flows are tight and profit margins are difficult to achieve, any additional analysis can benefit your decision-making process.

Grade Your Land Rental Property

Click below to download the file and grade your land rental property. 
RentGradeDownload

 

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