Is Farmland in A Bubble?
Oct 31, 2011
Recent sales of Midwestern farmland have been reaching prices of $10,000, $12,000, and even $16,000 an acre. The media and well-known market pundits have been highlighting these high dollar sales and making an argument that farmland is in a bubble.
Rising grain prices and strong farm income over the last few years have driven strong interest in agriculture and the farmland market. Farmers and investors have allocated capital to farmland and prices in the Midwest have increased 17% in the last twelve months and 12% in 2010 according to the Federal Reserve Bank of Chicago.
Below are a few points to think about when analyzing farmland values and deciding whether or not prices are in a bubble:
Agriculture fundamentals are the best in decades. Grain supplies in the U.S. and globally are at decade lows, driven by emerging-market demand, disappointing U.S. yields in the last two years, and demand for biofuels. The USDA estimates that farm income rose 28% in 2010 and will rise by 31% in 2011, allowing farmers to reinvest their cash flows back into farmland to expand their operations.
Balance sheets are still conservative. Strong agricultural fundamentals and minimal use of debt have allowed the U.S. farm sector to maintain conservative balance sheets as current debt to assets ratios are at 40 year lows. According to Iowa State University, 72% of the land in Iowa has no money borrowed against it. New banking regulations have constricted the access to capital for farmland buyers and loans secured by farmland are typically limited to 50% of the purchase/appraised price.
Farmland is a long-term investment. Farmland is illiquid and based on long-term commodity prices. Farmers buy land thinking about two to three generations down the road. Investors buy farmland for its cash flows and appreciation potential based on the global agriculture story. Farmland buyers are not thinking about prices next year but rather ten years from now.
The agriculture thesis hasn’t even played out yet. Most agriculture investors are attracted to the sector because of the wealth creation and the transfer to a protein based diet in emerging markets. China is expected to increase corn imports from 1 million tons in 2010 to 15 million tons by 2014. Emerging market demand for grain has not even occurred yet.
Farmland has different values to different people. The majority of farmland buyers are farmers, who comprise roughly 70% of all purchases. Farmers on average have a roughly 30 mile radius to buy farmland in. Farmland in their radius is worth much more to them than outside buyers. There are economies of scale in farming and each additional acre under management lowers their fixed costs and increases their negotiating power for inputs.
The witch hunt for the next bubble. After the housing bubble, investors and regulators are making sure to not overlook the next bubble and may be too quick in their use of this term.
Is farmland in a bubble? No. We think it is unfair and inaccurate to take a few data points and assign these assumptions to the whole market. Yes there have been some irrational sales that may take years to realize their value, but the market average is rationally priced and represents its fair market value based on near-term commodity expectations.
Farmland investors still need to be cautious and take a value oriented approach to acquiring farmland. The long-term outlook for agriculture has never looked better, but global economic concerns, potential changes in government regulation, and the unexpected may provide some speed bumps along the way.
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