Can you make money owning farmland? Think for a moment and answer carefully. Some answers will be, yes you can make money because of commodity profitability. Others may say the only way is to hold it until prices rise and make a profit on the capital gain. So which is it, if it is either one?

When you try to evaluate the potential for making money with farmland ownership, the only two ways is to either benefit from its appreciation in value or from its annual return, whether that might be commodity profits or cash rental rates. Iowa State Economists William Edwards and Don Hofstrand used USDA data for whole farm rents and value, not just Iowa State data, and went as far back as 1970. Their research was divided into several periods. From 1970 to 1981 was a farming boom period which saw income and land values increase. From 1982 to 1987 the farm crisis recorded a decline in income and land values. The recovery period began in 1988 and continued to 2003. Annual income increased on a per year basis and land values more than doubled. Finally the ethanol boom saw annual income rise and values increase at a healthy pace.

The economists characterize cash rental rates as the returns to farmland and they computed the percentage rate by dividing the cash rental rate by the value of the land. Their cash rental rates were a gross calculation. The land values were reported by USDA, and were not Iowa State numbers.

The change in cash returns was 3.8% in 2008 because values were increasing at a faster rate than rental rates. However the rate was 9.6% in 1987 at the end of the farm crisis period because land values declined faster than rental rates. Over the 40 year period the average rental rate was 7%.

The change in land values was more volatile with a nearly 37% change in 1977 to a negative 28% in 1985. Over the 40 years the average was 6.7% per year.

When combined, the total return, which was the annual cash return plus the change in land value, averaged 13.6% per year, but swung from a low of a minus 19.1% in 1985 to a high of 43.1% in 1977.

During the entire 40 year period the best times to either be an owner or a renter were mixed between two periods. The boom period of 1970 to 1981 saw a 15% increase in land values, and the crisis period of 1982 to 1987 saw the best cash rental rate of 8%, but it was certainly not a time to own farmland with a more than 13% depreciation in value.

If farmland was purchased in 1970 at the beginning of the boom period, it would have recorded an 882% increase in value, boosting the average annual rent to 24% as a percent of the purchase price. From the beginning of the ethanol period in 2004 to the present, land values have pushed upward by 75% with the average gross cash return over the period of 6%.

Over the years farmland investments have yielded a very competitive rate of return. However, about half of the return comes from appreciation in land value, which can be highly unpredictable. Moreover, it does not provide any cash for making mortgage payments or paying other ownership costs.

Source: Stu Ellis, University of Illinois