The contrarian view is a difficult one to take, but often worth considering, especially in this case. There seems to be a prevailing mentality that farmland is a great investment right now. It has some well known and very vocal advocates such as Jim Rogers, George Soros, Marc Faber, Fortune magazine, BlackRock, and a number of hedge funds. It is thought to be something secure during this time when little appears to be secure. People assume it will continue to rise in value because the world’s population is growing and “people have to eat”. It has corporate and political clout because of corn ethanol mandates as well as current agricultural policies and subsidy programs.
I don’t agree with any of the reasons people promote agricultural land as an investment right now. To prove my point, I’ll use a “myth buster” approach.
Myth #1. As world population expands, the demand for arable land will soar.
Just because population increases, doesn’t mean food will be produced and evenly distributed to everyone, and at a price to cover expenses of production. This has been proven many times over during this past century. Commodity prices, like the oil story we are now witnessing, are directly related to the economic health of individual nations throughout the world. Major global food distribution agencies are already seeing decreased revenues in contributions from developed nations due to this global economic downturn. Exports of our U.S. agriculture commodities are lower, except to China, which will likely decrease importing them soon, with its rising unemployment and decreasing export income.
Myth #2. Farmland is proving that it can hold its value through these tough economic times.
Much of recent year price stability has been due to speculation. Many of the investor class have driven farmland values. If farmland values start to go down, or, if commodity prices make farming unprofitable, expect some dumping to occur, because that’s what investors do. If we didn’t have this investment occurring, we’d have already seen greater price reductions.
According to one source, land values have gone down 20% already in other countries, which would suggest the U.S. is lagging in a farmland price correction. Prices are down 18% in Brazil, 12% on the Canadian prairies, 20-35% in Russia and Bulgaria, and 70% in the Ukraine.
Myth #3. Farmland year-over-year value increased the first quarter of '09 according to Chicago Federal Reserve figures.
The increase for the entire year ended up 2% in the Chicago Fed's region. The price trend started downward towards the end of '08. The Illinois, Indiana, Iowa, Michigan and Wisconsin district was down 6% in the first quarter of 2009, the steepest drop in 24 years.
In a survey, thirty percent of bankers in this district of most productive farmland expected farmland values to drop further, while the remainder expected them to be stable.
Myth #4. There is a limited and dwindling supply of land to farm because of climate change.
This statement may or may not be true for the U.S., and only time will tell. Erratic weather and rainfall may certainly cause production problems. Zones are also changing, and we have yet to know how this may help or hurt overall production. Warmer climates generally produce more food. Production has been strong, so far.
Myth #5. Ag land is a great inflation hedge.
Ben Bernanke, the European Union, Bill Gross, and Paul Krugman are worried about deflation. Why are you worried about inflation? Deflation causes assets to decrease in value and this unwinding process is far from over. We all know what this has done to the housing and commercial real estate prices. The process has barely begun in the sector of farmland real estate.
Furthermore, if you consider the rapid increase of input costs, especially when the energy crunch hits a few years from now due to the current decrease of investment in maintenance and new drilling projects, this statement might not even hold up in an inflationary environment.
Myth #6. Ethanol needs will cause farmland values to continue to appreciate, requiring 33% of corn production by 2010.
In 2009, projected corn use for ethanol production will actually go down by 100 million bushels, according to recently released data. This is a very surprising and interesting statistic, given all previously forecasted predictions. Why? Once again, it comes down to the economics of ethanol production. Twenty or more plants have gone bankrupt and around 30% have reduced or stopped production.
When this political product fails, we will have a huge corn surplus. This factor is huge, since ethanol has been the driver of the Midwest’s farm economy in recent years.
Myth #7. Agricultural commodities are headed towards a bull market.
Large corn acreage numbers released a week ago surprised everyone and caused a steep drop in price. The latest commodity figures show corn, soybean, and wheat prices all down this year due to increased production forecasts. Corn must return $4/bushel to break even and it is predicted that it may fall below $3/bushel this season. Inflation-adjusted corn prices are much lower than in the 1970’s, when they would have been the equivalent of $11/bushel. Higher and higher input costs increase risk. Monsanto’s (MON) corn seed price increased 20% this year, and soybean seed 35%. Corn seed prices can be $150-$240 per bag. I'd expect this year to be the final year of increased production, because agriculture production mirrors the economy.
All previous recessions have meant decreased crop production. It seems possible that the dairy model could be a harbinger for the grain model going forward. That is, the cost of producing milk has exceeded its price and many dairy farmers are going out of business.
Myth #8. Urbanization will continue to eat up the best farmland across America.
In the past this has been true, but it won't be going forward. This housing expansion has come to a near halt, due to the credit bubble popping. We have been left with a glut of houses which will take years to assimilate. The current trend is away from suburbs into higher density urban living. Two thirds of American's live in urban areas.
While total acreage numbers may not be impressive, we are experiencing the biggest urban agricultural movement since the Great Depression. Church grounds, empty lots, home yards, and balconies everywhere are being turned into urban gardens. In the rural areas, the opposite is happening. Abandoned farms are still being bulldozed to add acreage, as our industrial farms consolidate and get ever larger.
Myth #9. Land grabs by China, Japan, and "sovereign wealth nations" will be the biggest purchasers of Ag land over these next few years.
While this would be desirable to certain nations, I doubt that governments will sit idly by and watch this happen. This is what wars and takeovers are made of. Who controls a nation’s food supply controls that nation, doesn’t it? I don’t see productive farmland as a politically palatable saleable good. The saleable good is what that land produces. I predict this to be a short lived happening, especially given future energy constraints.
Myth #10. An investor can rent the land to get a high return on his or her investment.
Farmland prices peaked in 2008. Cropland rental rates increased again this year. This year's rental rates are still based upon last years commodity prices and land values. Now, with the higher input costs and lower commodity prices, rental rates will be forced lower. Renters are feeling squeezed.
Myth #11. Good Ag land is ever scarcer and hard to come by.
If you consider the average age of the Midwestern farmer (and elsewhere), there will be a large amount of acreage turning over in the next decade (perhaps 1/6 to 1/3 of the land). If farm profit margins become tight or negative, much additional land will come on the market.
Myth #12. We need to continue to increase our Ag commodity output.
There is a large amount of overproduction right now due to current agricultural policy. If you’ve ever read anything by Michael Pollan or seen movies such as “King Corn” or “Food, Inc.” you know that corn and cattle production aren’t optimizing land use for food growing, but rather are responding to agricultural policy, which is politics.
Our nation has been blessed with a vast amount of rich agricultural land. If crop choices changed to essential grains, beans, fruits, and vegetables, we could feed many more people. It would become less industrialized, however, because real food is more labor intensive. This would employ more people, have lower profit margins, and, consequently, lower land values.
Myth #13. Farmland never participated in the recent bubble that housing did in the U.S.
According to an inflation-adjusted Shiller graph, the average U.S. house price went up 85% from the start in 1997 of $110,000 to a high in 2006 of $205,000. According to a Calculated Risk blog graph of the nominal average U.S. Agland price per acre from 1999 through 2008, farmland increased 100% from $600 to $1200 per acre.
The same chart, inflation-adjusted, shows an increase of 60%. If you take just the state of Iowa, according to an inflation-adjusted graph from ISU, the increase in price per acre was 100%, from 2200/acre to 4400/acre during the same years of 1999-2008.
Disclosure: No farmland, hedge funds, commodities, or stocks owned.