Farm Real Estate Sector Headed into a Decline?

According to the data from Economic Research Service, farm real estate comprises nearly 79% of total U.S. farm assets in 2000. Since much of the current attention is focused on the residential real estate and subsequent credit crisis, it is high time to look at another important market, farm real estate. Agricultural land values typically vary from state to state, depending on the quality of soil and demand for its use.

In this article, I compared the average farm real estate values for three states, Iowa, Illinois and Indiana for the period between 1970 and 2008 (see the figure below). These three states together are responsible for more than one third of total corn and soybean acreage in 2008.

Data Source: USDA

The average farm real estate value for these three states in 2008 was $4,485 per acre, an increase of 14.65% when compared to the previous year. Since 1970, farm real estate values have declined only five times during the period 1982 to 1987. Starting from 1991, farm real estate values have increased continuously in all these three states without registering even a single year drop in prices.

Between 1991 and 2004, average increase in farm real estate value was 5% where as the last four years have witnessed, an average increase of approximately 15% per year. If you look at the current agricultural commodity prices, both corn and soybeans have declined nearly 50% from their peak in 2008.

Given the current weakness in financial markets including the commodity sector, are we heading into the first decline in farm real estate sector in recent years?   

Disclosure: no positions

Comments

[CLH:]

Farm real estate seems to be another bubble.

2008 Nov 13 09:22 AM

[Agcapita:]

Farmland where is the key question? Canadian farmland is still the cheapest in the world by a large margin.

The equity and bond markets have benefited from a long period of low inflation, but ongoing and massive central bank liquidity injections point to a far less benign environment of elevated inflation ahead. Research by our firm, Agcapita Farmland Investment Partnership (farmlandinvestmentpart..., Calgary, Canada based agriculture private equity firm) shows investors must be prepared to rotate into asset classes with different characteristics. During the last commodity bull market & high inflation period in the 1970’s, equities materially underperformed farmland.
- Western Canadian farmland went from around $100/acre to $550/acre (550% total return and 176% in inflation adjusted terms);
- Cash held in a money market account barely kept ahead of inflation (6% inflation adjusted return); and the
- S&P 500 index returned less than 2% per year (a loss of almost 50% in inflation in adjusted terms)

We believe the world is still in the early stages of this current commodity bull market. When agriculture commodities prices are compared against their previous inflation adjusted highs they are significantly discounted implying scope for further increases:
- Corn is US$ 4/bushel currently compared to US$16/bushel in 1974,
- Wheat is US$ 6/bushel currently compared to US$27/bushel in 1974
- Canadian farmland is C$ 660/acre currently compared to C$1,100/acre in 1981

Another interesting metric is the long-term average ratio of the Commodities Research Bureau Index versus the S&P 500 which is currently around 1.5 times. Simplistically, this ratio indicates how much S&P 500 stock you can buy with a fixed basket of commodities. Some important points:
- During the commodity bull market of the 1970s, the ratio was consistently higher than 2 times for over 10 years – it peaked at almost 4 times.
- The ratio is currently at around 0.5 times - significantly below the 1.5 times long-term average, just slightly above the 0.15 all time low reached in 1999/2000 and still very far below the almost 4 times multiple reached in the last commodity bull market. We still appear to be at an all time low relative valuation between “hard assets" versus "stocks.”
- If history is a guide, the ratio of hard assets to stocks will have moved much higher before this commodity bull market is over.
- How? Stocks will continue to fall and/or commodities will continue to climb – most likely a serious combination of both as investors, fearing inflation, rotate out of stocks into commodities – the cycle of “inflation, rotation, hard assets”.

Agcapita allows farmland investors to cost effectively allocate a portion of their portfolios to hard assets in the form of Canadian farmland via its professionally managed Agcapita Farmland Investment Partnership. Agcapita Farmland Investment Partnership is the third in a family of private equity funds which has grown to almost $100 million in assets under management.

Agcapita’s investment team has over 40 years private equity and fund management experience and over $1 billion in total career transactions and previously managed a group of emerging market funds with almost C$500 million in assets for one of the largest banks in Europe.

Agcapita’s advisory Board is composed of accomplished agriculture entrepreneurs and academics, high profile political figures and investment experts including the former UK Chancellor of the Exchequer, Rt. Hon. Ken Clarke and Jim Rogers, co-founder of Quantum Fund. Our members bring a deep knowledge of the factors driving agriculture and farmland values – including rapidly growing emerging economy food demand and inflation.

2008 Nov 13 11:31 AM

[Nick Gogerty:]

value is a function of yield. It would be interesting to see the cash rent plugged into this equation or effective returns from cash crops.

2008 Nov 14 12:02 PM

[law1985:]

Farmland is far from being a bubble but it needs to correct. Recently investors have poured a lot of money into the sector, including farmland in Brazil, Argentina and Russia. Even in Canada, new investment vehicles have been created in order to play the farmland market.

With regards to Canadian farmland, far from being the cheapest in the world, it has risen dramatically in Alberta, Manitoba and Saskatchewan. As oil money dries up, so will the demand for western Canadian farmland.
For your information, per acre prices in Ontario (roughly $3500 per acre) are not that much lower than in Iowa.

Furthermore, Canadian farm debt is much higher than in the US, so there is significant risk that financing will be restricted and that will translate into lower prices per acre. As the cost of carrying the land increases, the net return shrinks.

Falling crop prices are less of an issue because inputs, such as fertlizer and fuel, have also declined dramtically.

Crop land is a solid long term investment but its value is linked to the capital markets and cannot be expected to be immune from the chaos...

2008 Nov 14 07:48 PM