~~The FarmDoc Daily issued a report earlier this week on how interest rates might affect farmland values. A rise in interest rates usually negatively impacts farmland values or other bond-like investments. For example, if a farm generates $300 per acre of net income and it is valued at $10,000, this equates to a 3% capitalization rate. If the investor now requires a 6% rate of return, the value of the farmland would drop from $10,000 to about $5,000 (over time).
The FarmDoc report's Figure 2 showed how farmland values in Illinois from 1970-2015 correlated to the "expected" farmland value based on interest rates for each year. During 1970-2011, the correlation between these values were very close. Actual values were higher in 1978-1985 when interest rates were high and crop returns were low. This same result also occurred in 2005-2009 when the ethanol boom first started and interest rates had started to rise and then dropped rapidly during the recession.
Beginning in 2011-12, actual farmland values dropped behind expected values based on actual interest rate expectations for values. For example, in 2012, the expected value of Illinois farmland was about $12,000 and actual values were about $7,000. Expected values bounced between $9,000 and $12,000 (where they are at now) from 2011-2016, whereas, actual values are currently around $7,000.
Therefore, this indicates that there may be a substantial cushion to farmland values if interest rates do rise. Investors may have already "built-in" an expected rise in future interest rates and farmland values may not change much until interest rates rise substantially. Again, this is a theory and only time will tell on the reality.
We will keep you posted.