Bidders at farmland auctions have their winks and nods on the accelerator. From 1994 to 2004 farm real estate values increased from 2 percent to 4 percent annually. In 2005 and 2006, the acceleration was 10 percent to 16 percent. The brakes were slightly applied in 2008 and 2009, but since then farmland buyers have put the pedal to the metal and have left residential and commercial real estate in a cloud of dust. As the farm sale season approaches quickly, USDA economists set the stage for speed records to be broken.
Farmland is the heart of agriculture, with a value of $1.85 trillion, representing 85 percent of the total value of farming assets. In a newly-published article in USDA’s Amber Waves economic newsletter, economists say farmland, “represents the major asset for most U.S. farm businesses and is the largest single investment in a typical farmer's portfolio, changes in farm real estate values affect the financial well-being of agricultural producers. In addition, farm real estate serves as the principal source of collateral for farm loans--enabling farm operators to purchase additional farmland and equipment, finance current operating expenses, and meet household needs.”
The article, indicates that recent increases in value represent the bubble of the early 1980’s, but, “Current farmland values, at least for the farm sector as a whole, appear to be supportable given recent trends in farm earnings and interest rates.” Interesting, the USDA economists say farmland values and farm incomes are not in lockstep with each other. They say many non agricultural factors have lead to the separation:
- In areas close to urban centers, the value of farmland reflects the returns it could earn from being developed for housing or commercial use when those returns exceed those for agricultural use alone.
- Even in relatively remote areas heavily dominated by agriculture, nonagricultural factors, such as income from hunting leases, may push farmland values higher than could be justified from farming alone.
- In addition, a substantial number of farm operators--about 1.2 million of the Nation's 2 million principal farm operators--do not engage in farming as their primary occupation (for example, operators can meet the minimum criteria for being considered a farm--generating $1,000 in sales of agricultural products in a typical year--by grazing cattle and selling some each year.
- Low levels of farming activity can leave time for working off-farm jobs). While this group of operators controls a significant amount of farmland, it does not generate much income from farming, on average.
- For these farm operators, owning and living on a farm may have less to do with the economic returns to the farm business than with the lifestyle and recreational benefits farmland provides.
To demonstrate the weak link between land values and farm income, the economists use a rent to value ratio, which is the average cash rent per acre divided by the average per acre value of land. And they say the relationship has been decreasing over the past 45 years, pointing to the influence of the non-agricultural factors.
The economists say farm operators who depend on farming for their livelihood and who are interested in buying farmland should answer two questions:
- Is farmland still affordable?
- How vulnerable are farmland values to unexpected changes in interest rates and the residential housing market, both of which have experienced significant changes in the last 10 years?
Not many years ago, any farmer who contacted a lender wanting financing to buy land, would be asked whether the land would cash flow enough to pay the debt service. But those questions are becoming fewer and further between, say the USDA economists, “In recent years, farm incomes have increased and interest rates have declined, and these two trends have combined to increase the maximum value of farmland that can be supported by current farm incomes. In 2009 and 2010 and between 1986 and 2004, farm real estate values were closely aligned with farm income. However, during two periods in particular--1978-85 and 2005-08--income from farming alone was insufficient to service the debt on farm real estate purchases. Nonagricultural factors likely had a large role in buoying farmland values during these two periods.”
While land sales typically restrict about 0.5 percent of the land from changing hands in a given year, changes in farm earnings may influence the rate of turnover. Currently the demand for crops as sources of food and energy has kept stocks tight and commodity values high. The termination of farm program payments may also have an impact on the desire to own farmland and the price that investors are willing to pay.
Farmland sales have been subject to interest rates, and with rates at historically low levels, land values have increased due to the low cost of borrowing. USDA data indicates that land purchases in 2008 and 2009 were financed predominately by credit. If interest rates had been at 6 percent over the past decade, the cash flow stream from farmland would have been unable to service the debt. But with low interest rates land values have been allowed to rise to current values. Should interest raise rapidly rise, most farm operators would not be weighted down in debt that interest would be a problem in making land purchases.
The USDA economists also report that farmland values are higher around urban areas because it is typically purchased for housing development. But with the sluggish market for new homes, and reduced expansion of subdivisions around cities, land values have been more driven by their income producing ability than by their potential for development. However, residential development still has the potential to drive up values in the vicinity of urban areas.
What about the future? The USDA economists believe that demand for commodities will support farm income, and the combination of farm income and low interest rates will keep land values at or above their current levels. However, increased interest rates, increased market volatility, and elimination of government payments could lead to reductions in land values. While interest on farm loans continues to be low, rates are subject to outside influences. And while farmers are not highly leveraged, any rapid rise in rates could make debt service difficult.
Mark Your Calendar
A conference on farmland values and cash rents for 2013 is scheduled for Wednesday, November 7, at the Decatur (IL) Conference Center and Hotel, presented by AgEngage and sponsored by Farm Credit. Speakers will address many issues of importance to land owners, prospective buyers, cash rent operators, lenders, farm managers and others. Details on the conference and registration information are available here.
Farmland values have increased at an accelerated rate over the past 12 years, and as long as commodity prices remain strong and interest rates remain low, land prices are expected to rise and be supported by stable financial pillars. Many non-agricultural factors are influencing land values, but stable returns, low interest and increased demand to participate will keep pushing prices higher.
Source: FarmGate blog