PART THREE
THE ECONOMICS OF FARMLAND INVESTMENT
This next section is a close-up analysis of farmland investment by the numbers. It discusses several important concepts to consider when investing in farmland and some economic characteristics associated with farmland ownership.
ECONOMICS OF FARMLAND INVESTMENT
Investor interest in U.S. farmland on the rise.
As previously discussed, there are essentially two groups of farmland investors—the farm operator and the non-operator landlord. Both groups of investors are influenced by the present value of future net returns from farm operations and land appreciation expected over the life of the investment.
This suggests that an outlook predicting the rise of net returns from operations as well as appreciation will increase investor interest in acquiring farmland even more.
But...
This also suggests that a high interest rate environment could dampen investor interest. When making farmland investment decisions, it’s important to fully understand the various avenues of returns in order to make the most profitable decision for you and your portfolio.
In this section, we tackle the differences in returns for a non-operating landlord vs. an owner-operator and how revenue, cost, and debt impact both.
DID YOU KNOW?
More than half of U.S. cropland is rented. Commodities such as corn, soybeans, wheat, rice, and cotton are commonly grown in areas where 50 percent of cropland is rented. Only 25 percent of pastureland in the U.S. is rented.
ECONOMICS OF FARMLAND INVESTMENT
Advantages of Farmland Investment
Before discussing annual income and capital gains, it's important to point out that farmland offers several key advantages for investors that set this asset class apart from traditional real estate.
ECONOMICS OF FARMLAND INVESTMENT
Total Investment Returns
Total annual returns from investment in farmland can be partitioned into net cash farm income from the farm’s annual operations and annual appreciation of the value of the land, an unrealized capital gain. Farm owner-operators receive the total return on their investment. Non-operator landlords can share in the revenue and expenses associated with annual operations in one way or another with a tenant, but any change in the value of the farmland accrues to the landlord.
A Historical Timeline of U.S. Cropland Returns
The blue area in the graph below illustrates trends in total returns to cropland at the national level. The light yellow shaded area includes returns to passive cropland ownership from operations measured by cash rents only. As you can see, active cropland ownership provides the greatest return capacity.
Total Returns to Cropland Ownership
(dollar per acre by year)
- Total returns fell to -$20 per acre in 2009 during the Great Recession but rebounded sharply the following year.
- Total returns were also relatively flat during the middle of the last decade amind lackluster prices for major crop commodities such a corn and soybeans.
- Returns started to rebound in 2019 as China began to again be a major importer of U.S. commodities as the trade war between the two countries subsided.
- The COVID-19 pandemic disrupted input and product market supply chains in 2020.
- As bottlenecks in these supply chains were resolved and the economy rebounded from the pandemic, the farm sector achieved record level net farm incomes in 2021 and again in 2022.
Source: National Agricultural Statistics Service, USDA
Let’s look at these two forms of return to farmland ownership in more detail—annual income and capital gains.
Annual Income
Annual returns from farming operations consist of cash receipts from marketings, government payments, and other farm-related income minus expenses—including interest if the farmland acquisition is debt-financed. The level of these returns per acre varies depending on commodities produced and farm location. Unfortunately, this data is unavailable for public use.
However, cash rental rates per acre published by the USDA can be used as a proxy measure for annual returns to farm operations by state in farmland return studies. This data is helpful for both owner-operators and non-operator landlords to understand the difference in risk and rewards associated with these two different types of land ownership income.
Capital Gains
The potential for capital gains in farmland investment is influenced by several factors, including interest rates, government policies, farm commodity support programs, and parcel level factors. Analyzing these factors sheds light on the variation in capital gains potential between the debt-financed non-operator landlord and the debt-financed owner-operator.
While farmland values are influenced by changes in interest rates, they are less sensitive to them than commercial real estate sectors. This is because farm income is more highly correlated to income inflation than commercial real estate. In addition, owner operators have a higher capacity to absorb higher interest rates compared to non-operator landlords.
If we revisit the same South Dakota Corn case study example discussed earlier in part one, but compare returns when the non-operator landlord and the owner-operator are both debt-financed, you will see that debt-financed owner-operators carry a higher cap rate average (6.3%) than their non-operator counterparts (2.6%), due to the differing earning yield potential.
As cash rent increases tend to lag farm income gains, backward looking cap rates based on cash-rental properties take time to upwardly adjust in a rising rate environment. This is why farmland values display less correlation to short-run movements in interest rates compared to commercial real estate.
Government policy and farm commodity support programs can also directly influence farmland values and capital gains. For example, policies promoting renewable fuel growth have driven up prices for crops like soybeans and corn in recent years, subsequently driving up Midwest land values. Conservation incentive programs, such as the Environmental Quality Incentives Program (EQIP) and the Conservation Reserve Program (CRP), support practices that enhance soil quality and contribute to higher land valuations. Federal support programs like the Price Loss Coverage (PLC) and Agricultural Risk Coverage (ARC) programs provide a safety net for farm revenue, further supporting land values and capital gains for landowners.
Lastly, parcel level factors also influence the land valuation of farm real estate and associated capital gains for the non-operator and owner-operator landowners. For example, land with highly productive soil or land close to grain elevators or highways might be more highly valued. A contiguous track of land or one close by may lead an existing farmer to pay a premium for the additional land. Farmland closer to urban areas may also be more highly valued due to the prospects of urban development.
