When Does A Large Price Increase Spell Trouble?

Published on: 18:19PM May 13, 2013

The Kansas City Federal Reserve 4th quarter survey of Ag conditions spotlighted an ever upward trend in farm land prices.  On a year-over-year basis, irrigiated farmland in Kansas, Nebraska and the Mountain states all saw increases over 30% and non-irrigated land increased by more than 20% in all states.

For the last two plus years, land prices on a year-over-year basis in most corn belt states have increased 15% or more.  We are starting to see the Federal Reserve discuss how to reduce and then eliminate the fiscal stimulas (QE 1, 2, 3 .....).  Once this stimulas is removed, interest rates should start to revert to their norm.  The question is what the norm will be.  If we end up like Japan, we may still have very low interest rates.  If we end up like previous recoveries from recessions, long-term interest rates should range around 3% plus inflation.  Currently, this would suggest rates in the 5-6% range.  How would this effect farm land prices.

If cash rents are at $350 per acre and land is trading for $15,000, then the cash return is about 2.3%.  In today's very low interest rate environment, this may be acceptable.  But if rates rise to 5% and a farm investor wants a cash rate of return of 4% on their land, this suggests a value of $8,750 per acre.  Also, there are certain expectations built into land right now (the price is going up, I need to grab that quarter section before the neighbor does) that "gooses" land values.

What happens when these "gooses" fly away.  Does the mentality revert back to the 1980s or will we see something in between. 

We shall see.