PART FOUR
FINANCING THE FARMER
Now that we’ve established the value of the American Farmer and opportunity available right now in farmland investment, let’s dive into the “how”. In this section, we provide an in-depth look into the financial gaps that exist in farmland investment and the solutions required to navigate a path forward.
FINANCING THE FARMER
We need to rethink the way we invest in American agriculture if we want it to survive.
Successful owner-operators with the highest growth potential require flexible debt and growth equity solutions to make acquisitions. Unfortunately for growth-minded farmers, there is a lack of acquisition capital available to them.
Conversely, for capital allocators seeking to invest with successful owner-operators, generating deal flow is a challenge. To put it simply, there is a relational gap between farmers and institutional investors.
For the future of American agriculture to succeed, we must fill this gap—and here’s how we can do it.
FINANCING THE FARMER
A Relationship-Driven Approach
First, agricultural finance needs to be relationship-driven to succeed. The “Buy land. Sign lease. Collect rent.” approach perpetuates a transactional mindset. Attempting to helicopter into a community with a suitcase full of money, outbid local farmers on the best plots of land, then turn around and rent it to them as a landlord, while retaining a good reputation, is a futile endeavor.
A relationship-driven mindset starts with meeting the farmer where they are, listening to assess their needs, and providing them with a full spectrum of financial solutions to support them. It is crucial for investors to actively listen to farmers and demonstrate genuine empathy and respect for their way of life. Building relationships based on transparency, open communication, and shared values can help bridge the gap and foster trust.
While it is true that farmland is a high-quality asset for farmers to obtain financing against, it is also true that profitability varies year-over-year. An owner-operator farmer may have a stable, low volatility asset that tends to appreciate, but it is also the main source of their wealth and legacy. For reasons completely outside of their control, an asset-rich farmer can easily find themselves cash-poor, sometimes sufficiently so that they are pushed into forced sale situations, especially whenever imprudent leverage is involved.
According to the latest ag census, 43 percent of farms had positive net cash farm income in 2022.
Given everything at stake, bankers and outside investors can be seen by farmers as a potential threat that might take advantage of them. Agriculture has a long history of self-sufficiency and independence. Many farming communities have developed their own practices and ways of doing things over generations, creating a sense of pride and ownership.
Outsiders, who may lack an understanding of the complexities and challenges of farming, can be seen as intruders or individuals who don't fully appreciate the farmer's way of life. When outsiders lack this specific knowledge and experience, farmers may be skeptical of their ability to understand their unique circumstances and provide appropriate guidance or support.
This is somewhat of an irony, as financial guidance and support is something most farmers have a high need for. Unfortunately, the typical farmer does not have ready access to a quality certified financial planner in their local communities.
Because of this, farmers often turn to their lender to act as their financial advisor. Having a financial partner who can effectively walk in both worlds as a trusted partner and advocate for the farmer through a relationship-driven approach could be the bridge both sides need to succeed.
FINANCING THE FARMER
Flexible Debt
On the debt side, the market for loans on agricultural real estate is highly fragmented across institutions, geographies, and products. The debt market is largely comprised of the Farm Credit System/GSEs and commercial banks.
Agricultural Long-Term Debt Market Share
(percentage by lender type)
Source: USDA, 2022
The Farm Credit System (FCS)
The FCS is a collection of 58 geographically distinct agencies and co-ops and 4 funding banks, which collectively represent roughly half of the total debt market. FCS lenders have good cost of funds but stringent lending requirements, heavy annual documentation and covenant review requirements, and lack incentive to innovate on product.
Farm Credit System Institution Territories
(ACAs and FLCAs by Districts, abbreviated names)
Source: Farm Credit System, Agricultural Credit Association, Federal Land Credit Association, as of January 1, 2016
Commercial Banks
Commercial banks represent about 32 percent of the market—down from 38 percent in 2018 and falling. Mainly comprised of local community and regional banks, they are also highly geographically fragmented and highly regulated. Many have limited understanding of the agricultural land market and face a high mismatch between their assets and liabilities, as the recent spate of bank failures demonstrated yet again. Only two commercial banks have over $1bn in farm real estate loans.
Insurance Companies
Insurance companies have better ability to hold long-duration assets such as real estate debt. But whereas they have distributed channels for selling insurance policies, they typically lack the relationships to generate direct agricultural debt or equity deal flow at a national scale.
Ultimately, this fragmentation and lack of flexible financing options has led to inefficient access to capital for farmers and loan pricing frequently excessive relative to credit risk.
The AgAmerica Approach
At AgAmerica, we believe that there is no great value to the lender of requiring a conventional quality borrower with low to moderate LTV to follow a long-term amortization schedule if the loan will mature/balloon in five years anyway. On the other hand, an interest-only (I/O) loan can preserve working capital for the borrower when they need it. By taking a less rigid attitude toward offering products like 3 and 5 year I/O loans to conventional quality borrowers, we have captured market share from traditional lenders by being one of the few lenders to offer I/O without the stigma.
FINANCING THE FARMER
Pro-Farmer Equity and Debt
There is also a need for growth equity structures that can substitute for the instability of mezzanine debt. Multi-year lease option structures can offer such a pro-farmer structure by providing a path to ownership but that also have appropriate downside protection for the equity provider.
While debt is an important source of financing the farm, it has its limits. Despite stable land values, high LTV loans are not a great fit for farmer operations due to the volatility of farm income. This is partly why loss rates on farm loans are so low, as AgAmerica and other farm lenders generally make loans at conservative LTVs of 65 percent or lower.
This means that a farmer must put 35 to 40 percent down to acquire new farmland, while retaining enough working capital to operate. But when it comes to the farmer balance sheet, on average real estate makes up about 80 percent of the assets, meaning there is often limited working capital available. This creates a big capital barrier for growth-oriented farmers looking to expand.
What farmers need is an equity partner to help them acquire land that they can part ways with once they have enough capital.
Unfortunately, that type of partner is in short supply. Most institutional investment mandates have a long-term buy and lease strategy, and do not offer expanding operators growth equity. They are non-operator landlords. While the debt market is fragmented with limited participation by private credit investors, the market for pro-farmer growth equity is essentially non-existent. This ties back to deal flow and the comparative ease of a transactional approach versus a relationship-driven one.
Lastly, the superior owner-operators will also need partners who can serially back them with both debt and equity as they reinvest retained earnings to expand their operations over time. Indeed, there is growing demand from highly successful farmers for financing partners who can provide both equity and debt on deals and do it in size. As there are few who can provide this, these farmers have turned to raising single-asset funds to finance themselves.
