Last week, I wrote an article called The Bull Thesis on Farmland in which I presented the asset class and explained why I believe it to be a good idea to add some farmland to your portfolio. I was happily surprised to see that the article received lots of attention from Seeking Alpha readers and that lots of constructive and thoughtful conversations took place in the comment section.
One comment that I received from several different investors is that it is too late to invest in farmland. According to their theses, the good days of farmland are behind us and the timing for an investment today is bad. They believe the asset class to be overvalued and not worth considering at this point. I thought it could be interesting to address these points in a new article and invite you to engage in the comment section to share your opinion on the topic.
I don't believe it to be "too late" to invest in farmland. I don't believe farmland to be overvalued given the very low interest rate environment and the good long-term fundamentals of the asset class. I don't think that the timing is bad for a new investment.
When assessing the attractiveness of an asset class, it must be compared to other asset classes in order to verify if its expected returns compensate you well for the risk undertaken.
How attractive is farmland relative to bonds and stocks at current valuations?
Bonds are very overvalued today
Bonds are today trading at some of the lowest yields ever and are generally considered as being very overvalued.
In many cases, they do not provide any real return after inflation and taxes to their investors and provide no protection in case of severe unexpected inflation. While we are today in a more deflationary environment, it is still something to consider when all major central banks keep on printing new money very aggressively.
I think that bonds are very overvalued. If I had an easy way, and a non-risk way, of shorting a whole lot of 20- or 30-year bonds, I'd do it. But that's not my game, and it can't be done in the kind of quantity that would make sense for us. But I think that bonds are very overvalued. I'll put it that way. Warren Buffett
Buffett made this statement not long ago; it was on May 4th 2015 on CNBC. Since then, rates have gone down further and even achieved the negative zone in Europe where you now lose money by lending it. Buffett is not famous for taking short positions, but in this interview, he revealed that he would short this one asset class: bonds.
So relative to bonds-which make up the largest segment of the financial market, farmland seems pretty attractive to me. Farmland still trades at around 4-5% cap rates, which provide pretty good cash returns in today's environment. Farmland has strong fundamentals for long-term value appreciation, it produces a necessity that cannot easily be substituted, and enjoys inflation protection.
Stocks are not cheap either…
While bonds are extremely overvalued, you could argue that stocks present a better alternative at current valuations. I would agree on that one, however, remark that stocks are also expensive relative to their historical average valuations. Its P/E multiple is today way beyond its average. The market is currently pricing the S&P 500 at over 25 times its earnings. The historical mean is only 15.6 times or 40% cheaper than today.
You will note that historically, every single time the P/E ratio passed 25, it was later followed by a crash in the market. Every single time. Ray Dalio, founder and co-chief investment officer of the world's largest hedge fund, Bridgewater Associates, believes that the expected returns for stocks is about 4% at current high valuations and that volatility will be above average.
Get ready for lower than normal returns with greater than normal risk. Take current bond yield (less than 2%) and cash (0%) and compare that to something like a 4% expected return on equities. Because of volatility, the 4% expected annual return pick up of equities over cash, or 2% over bonds, can be lost in a day or two. Ray Dalio
So this does not sound too good to me either. The fundamentals of the global economy are not very strong, earnings are flattening, we risk a new recession, a potential new stock market crash and the expected returns do not compensate for the risk undertaken at current high valuations.
Don't get me wrong, I am very long on stocks, but I am just trying to point out that it is not only farmland that has increased in value in the recent years. While I agree that there would have been better times to invest in farmland, you could say exactly the same for other major asset classes.
Cap rates of farmland have gone down over time and valuations up, but which asset class has not experienced the same trend? Stocks trades at very high multiples of earnings, which equate to a low expected return, bonds yield close to nothing and even commercial real estate properties have seen their cap rates go down significantly over time.
It is not too late...
My bull thesis on farmland was suggested to long-term investors that want to diversify away from mainstream asset classes to reduce the risk of their portfolios and possibly achieve superior long-term returns. I don't try to guess in which direction the market will go next year or even the next 3 years. I invest with the mindset that what I put in the market will remain there forever and I will never spend the principal, only the cash returns when needed. It has been demonstrated over and over again that individual investors that seek to "time the market" fail at it and end up significantly underperforming investors that stay in the market in all market conditions.
Farmland like any other asset class will periodically lose value and go through a downcycle, but what matters to me is that long-term fundamentals are very strong. Agricultural commodity prices will periodically go down due to temporary oversupply, but the long-term trend suggests that the world will suffer a large undersupply of these commodities, which will result in farmland value appreciation.
We will be close to 10 billion people on earth by 2050 and emerging countries keeps on increasing their consumption of proteins as their income increase. These trends are well researched and proven. The demand for agricultural commodities will in consequence increase, but the supply growth will remain limited.
Additionally, I like that the returns of farmland are uncorrelated to returns from stocks or bonds. Note that even during the last major financial crisis, values of farmland went up. It reduces the volatility of the portfolio and increases your risk-adjusted returns.
Today, you can invest in Farmland REITs such as Farmland Partners (NYSE:FPI) and get paid a 4.5% dividend yearly while you wait for the long-term value appreciation. This cash return coupled with the positive market fundamentals makes farmland an attractive asset class in today's market environment relative to other asset classes. Just remember to hold on to it despite the volatility and enjoy your cash returns.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FPI over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.