Terraqua - Land Investment

The Land Investor

News and Commentary on Land-based Investment

Field Notes on U.S. Farmland Investment

Articles over the past several years have quoted gifted seers like Warren Buffet, Jim Rogers, Jeremy Grantham and Marc Faber with a positive outlook on the long term fundamentals of U.S. farmland.  But this is not a business or asset class for the non-specialist to jump in feet first.  In this market I see some great value investments that are being made, and also shake my head at some of the marginal deals that are going down.

According to the USDA, some 23 million acres of U.S. habitat were converted over into farmland between 2008-2011.  I even have seen two golf courses marketed as cropland.  One reason is the CRP leases that are expiring and not being renewed.  Another reason for this conversion is speculation on today’s high crop commodity values.  If I am looking at what is being offered as a “farm” today that wasn’t farmed 100 years ago, I am immediately suspect.

Also, we see some sale/leaseback deals that are based on a bloated payday to the farmer/seller with underlying leases that are not sustainable in the long run.  There is the incentive to pump up the promised rent with the investor buy-in at an unrealistic multiple.

Many of the good deals we see are based on local operators we have confidence in who want to grow their operation.  We have a good stable of regional farmers, in the some of the best proven, long term submarkets in the Midwest, who we believe in.   One has 6000 owned acres and another 6000 leased acres and can comfortably add 1000 acres a year to his leased land base.  He keeps his ear to the ground in his sweet spot, the area he feels comfortable in, that makes logical operational sense for expansion.  He is 5th a fifth generation farmer, all in this very submarket in southern Minnesota.   When a good local property, close to their base, comes up for sale, they are the first to hear about it.  They come to us and tell us, “I could make this work for the long haul, day in day out, at $350 per acre per year.”  Then we can make an offer at $7000 per acre based on a 5% sustainable yield that will hold up and we feel good about.  We have a good farmer tenant in place who really understands the asset, and base rents are paid in advance, annually in March.

With all of these ingredients in place you can start to feel good about a sound direct farmland investment, but only if you can put it all together with good farm management.

In this regard, the following article is from Covin & Company’s newsletter, Farmland Forecast, titled Importance of Farm Management. Without a good management team in your corner, I recommend that the non specialist stay away from direct investment in this asset class.  but with a good farm management team to help scout, vet, structure the investment and put it in place, monitor the investment with regular farm visits and good communication with the farmer/operator and you, the investor, you can have a positive long term outcome in a solid asset class that many do not know how to access.  We at Terraqua would be pleased to speak with you about U.S. farmland investment.

Importance of Farm Management

Colvin & Co. Proper management of farmland is vital for an investor to capitalize on the overall appreciation of the asset. Farming today is more than just producing crops, it requires farmers and landowners to address profitability, fertility, conservation, and tax issues to name just a few. The importance of a knowledgeable and professional farm manager is essential for maximizing the appreciation and income of investment farmland.

All farmland is not created equal and a customized farm management plan and oversight will align the interests of the farmer and landowner to optimize their return on investment (ROI). The key to proper farm management includes focusing on the following areas:

  • Profitability
  • Leasing
  • Production
  • Fertility
  • Conservation
  • Capital Improvements
  • Additional Revenue Opportunities
  • Insurance
  • Taxes
  • Communication

Overlooking just one of these key tasks can lead to a significant loss in the ROI or degradation of the farmland.

Farming over the last decade has become one of the most profitable industries, although the improvement in economics has not necessarily flowed back to the landowners. We estimate that on average, landowners across the U.S. are only receiving 50% of their potential rental income. This means that U.S. farmland owners are leaving $25 billion of rental income on the table.

Professional farm management services will not only allow investors to optimize their ROI, but own an asset that can be passed down for generations.

Profitability

Productive cropland is profitable on multiple levels by producing food to the growing population and also providing its owner with intermittent cash flow with stable appreciation upside. U.S. cropland has returned its investors 10.6% annually over the past 14 years via appreciation and rental contracts according to the USDA. Strong global demand for commodities grown in the U.S., including corn, soybeans, and wheat, has positioned U.S. farmland to continue to appreciate while returning annual rental rates of over 5% of the land’s value. Farmland deserves to be a part of every well diversified investor’s portfolio.

Farm management is essential for farmland owners to maximize annual ROI and long-term capital appreciation. Any farmland should increase in value and produce annual income to land owners, but with progressive farm management, landowners can expect much higher profitability.

Leasing

A key part of the farm manager’s duties are their relations with the tenant operator. Choosing the appropriate operator can make or break an investment in farmland. The operator will help determine the short and long-term fertility, production, conservation, and cosmetics of a property. Even one mismanaged year of farming can cause significant damage to a property.

To ensure the right tenant is chosen, managers will interview many qualified farmers, including a thorough inspection of the tenant’s operation. Background checks are also important as lenders and local contacts will give a better insight to the credit worthiness of the farmer.

The manager should have a large pool of potential tenants that are competing for a given property. Competition between operators for leasing a property will give the landlord the highest possible rent. A good manager will know what market rent is in the area and use that as a starting point for negotiating.

Identifying the right type of lease will differentiate a good farm manager from a great farm manager. Each lease presents different cash flow and risks. It is imperative that the owner and manager are on the same page and comfortable with the chosen lease and the amount of risk exposure to the landlord.

There are four commonly used leases:

• Cash Rent Lease: Tenant pays a specified amount of cash per acre per year to farm the property. The payment is made in full before any seed is planted; typically paid on March 1st of the leased year.

• Flex Lease: This lease is a variation of the Fixed Cash Lease. Rent will vary based on yields and crop prices throughout the year. This lease gives the landlord a share of the risks associated with farming in a given year.

• Crop-Share Lease: Tenant pays landlord with a percent of the crop or income that is produced. In a typical lease, the landlord would split the input farming costs of fertilizer, seed, pesticides, etc. In some instances, the landlord is responsible for marketing their share of the crop as well.

• Custom Farm Lease: This is the most involved an owner can be in a farming operation without actually farming. The owner takes on the input costs including fertilizer, seed, pesticides, herbicides, etc. while an operator is contracted out by the owner for performing farming tasks throughout the year. 100% of the production is retained by the owner.

Although each lease has its differences, there are two important aspects in common; price and length.

Price of rent can be the deciding factor on whether or not to purchase a property for investment. A good manager will not only use market averages, but also forecast an income statement for the property to estimate what the owner’s share of income should be.

The second part of negotiating a lease is the length. A long-term lease is not always in the landlord’s best interest. If a lease is signed for $100 per acre for five years, and after two years the market rent increased from $100 to $125, the landlord is missing out on $25 per acre. Negotiating a one to three year lease ensures the landlord will be receiving the current fair market rent.

Production

It is always important to track crop conditions, but for certain leases, including flex and custom farming where the landlord has upside potential in the production of the property, crop conditions are of utmost importance. Farm managers work with farmers to ensure planting was successful and the correct seed varieties were planted for the climate forecasted during the upcoming growing period.

Throughout the planting season, farm managers keep in contact with operators to note how the crops are progressing which will help build a strong historical file for the property. Farmland with consistent proven yields of 200 bushels of corn will have a higher value than a property that has a volatile production history of similar soil quality as future buyers prefer consistent yielding properties.

Harvest will produce yield data that farm managers record for the property’s historical file. Often operators will have a yield map that will be supplied to the farm manager, helping the manager understand where the strongest yielding areas of the field are located along with other features like compaction or poor drainage. Matching soil types from a soil map to the yield map often will reveal where the poorly drained areas of the property are located. A manager will then explore where additional drainage relief is needed, let it be tile, surface intakes, or a waterway.

Fertility

Once harvest is complete and farmers begin to plan their input purchases for the following year, farm managers will work with farmers to gauge the fertility of the property with the use of soil samples. Farmers test soil fertility via soil samples at least every other year to make sure the correct amount of fertilizer is used to achieve optimum yields.

Additionally, farmers do not want to apply too much fertilizer than their soil Cation-Exchange Capability (CEC) can handle which would lead to wasted fertilizer and money. Soil CEC refers to the amount of nutrients a soil can absorb efficiently at a given pH level. If a soil has a low CEC, then over fertilizing can lead to fertilizer runoff and waste.

Farm managers work with the farm operator after comparing yields maps, soil maps, and soil sample maps to discuss the property’s nutrient program moving forward to meet fertility goals while maximizing yields.

Tracking soil fertility through soil samples is essential for future property value increases. Typically, purchasers do not want to buy a property with poor nutrient levels. Although poor fertility is not typically permanent, application of macro and micro nutrients along with lime are required to bring fertility up to adequate levels over a period of multiple years which can carry significantly high costs and lead to lower rents. If a landowner currently holds a property with poor fertility, it is important to have a farm manager work with the operator to build a nutrient program to rebuild the property’s fertility.

Conservation Management

Farmland is arguably the most important asset to sustaining life on an ever growing planet. World population is growing at an exponential rate, and taking care of and conserving farmland is essential to feeding the growing population. In order to conserve our precious asset, the USDA developed the Natural Resource Conservation Service (NRCS). The NRCS helps land owners reduce soil erosion, enhance water supplies, improve water quality, increase wildlife habitat, and reduce damages from floods and other natural disasters.

There are a variety of programs a farmland owner could sign up for; the programs most used by farmland owners include the Conservation Reserve Program (CRP), Grassland Reserve Program (GRP), Water Bank Program (WBP), Wetland Reserve Program (WRP), and Emergency Watershed Program (EWP). Each has its own unique characteristics, but in general when land is enrolled in these programs, the owner receives yearly payments and the contracts typically last 10 to 15 years.

In order to sign up for these programs, the farm manager must put in a considerable amount of work and due diligence. Having a good relationship with the local NRCS office can help simplify signing up for a conservation program. Depending on when a landowner starts to sign up for a program, communication with the NRCS office will last for one to two months. Weekly interactions via phone or e-mail are a must and having a good relationship with an NRCS representative is essential for a smooth process.

To start the process of signing up for a conservation program, a manager must first have detailed knowledge of the land and what areas they would like to have signed into a program. Aerial maps showing outlines of possible areas will need to be procured and presented to the NRCS. Upon review of maps and physical examination by the NRCS, they will determine what type of conservation program the land falls under. Each program has its own due dates for signing up. It is crucial that the work and due diligence be done in a timely manner as these sign ups typically only come once a year.

Upon approval of the conservation program, a manager will have to work with the current operator to make sure they meet all the requirements the NRCS has set forth. This may include seeding grass, plugging drains, spraying for weeds, or excavating. Getting these requirements completed correctly and in a timely manner is essential as the NRCS does periodic, onsite, evaluations. If the requirements are not met or part of the agreement is breached, it could result in fines or payment stoppage. This should not happen if the manager has done their due diligence and seen the process through to the end.

Adding Value Through Capital Improvements

In order to maximize appreciation, ideal farmability should be targeted by the farm manager and owner which will include capital improvement projects. By taking a diverse approach to capital improvements, farm managers can present projects that can fit any landowner’s budget. Common capital improvements cover drainage, erosion, and access.

Adding drain tile is one of the single best additions one can make to a property. The primary reason to install drainage tile in a farm field is to increase productivity through healthier crops. Ideal soil is made up of 50% soil, 25% water, and 25% air. When a heavy rain elevates the water table, the soil loses its 25% air make-up, which will hurt crop growth and increase soil pH levels. Fixing drainage issues by installing drainage tile typically pays for itself through increased yields within five years of installation by farmers paying higher rent. Tile projects have a wide range of cost from small localized projects totaling $1,000 to $2,000 to large scale parallel pattern tile projects running upwards of $750 per acre.

The cost of adding drainage tile can often be immediately added on to a property’s value. Since drainage tile is eligible for accelerated depreciation, farm managers work with accountants, farmers, excavators, and previous owners to assign a value to any tile in a property so the landowner can write off the cost as a 100% tax deduction. An accurate tile depreciation valuation can save landowners tens of thousands of dollars on taxable income. Additionally, working installation of drainage tile into a lease can provide opportunity for a landowner to get discounted tile if their operator installs the tile at a reduced rental price.

Precious soil can erode away via the wind, rain, or other weather elements thus striping a landowner of their asset. Farm managers are aware of erosion issues and should be constantly monitoring every property for signs of erosion so they may act fast to limit any soil loss. Simple solutions to localized erosion including installing a berm or retaining wall and extreme measures including installation of waterways, ditches, terraces, or other major excavation work which would be administered by the farm manager.

Another excellent way to increase property value is by adding field access points. On a yield map managers will note poor yields that were caused by soil compaction. Often soil compaction is caused by heavy machinery running over the same area repetitively; often near field access points. By adding multiple points of access, farmers can cut down their traffic on compaction areas, thus increase total production over time.

In years of drought, any farmland would benefit from an irrigation system. Farm managers will work with irrigation outfitters to price an irrigation system and generate a long-term economic analysis of installing an irrigation system. Depending on the property’s location and soil makeup, irrigation can substantially increase yields, cash rents, and position the property for ultimate appreciation.

Additional Revenue Opportunities

Revenue can be created on farmland, not just via farming operations, but also through other means including wind easements, hunting rights, and advertisements.

Landowners can benefit from having a wind farm a part of their property by leasing the property’s wind rights. These contracts are created in the first process of building a wind farm, so land owners get paid prior to any building. When the wind farm is finalized and constructed, land owners will receive fixed and variable payments based on electricity production. Landowners could receive up to $15,000 per year on a 160 acre parcel, although each wind company’s contract will differ. Farm managers will handle agricultural impact and economic research behind any such wind project, keeping in mind the property’s future for appreciation at all times.

Midwest farmland produces the best corn yields in the world, but also some of the best hunting as well. Upland birds, waterfowl, and deer hunting are some of the most sought after hunting experiences that outdoorsmen demand. By leasing out farmland to hunters for hunting rights, landowners can generate increased annual ROI on top of their crop production lease. Farm managers will source tenants, work with an attorney to draft a proper lease, recommend insurance protection, and manage the hunting rights lease on farmland.

Often farmland is located on a desolate gravel road upwards of 15 miles from the nearest housing development or town, but sometimes farmland will be located on a busy highway or interstate with high amounts of traffic. Roadways with high traffic levels lead way for advertisement potential on neighboring farmland. Progressive farm managers will investigate advertisement potential of property and work with a billboard company to put together an investment proposal to see if billboard advertisement would generate additional ROI via rent payments and increased land value.

Insurance

A good farm manager will go above and beyond standard management to insure a client has protection against liability. Farming can be a dangerous job with many hazards as large machinery will be used on a given property throughout the year. Accidents can happen, and making sure a client is protected from liability is important. Typically a farm manager will not administer insurance, but pointing the client in the right direction and helping with the process is a duty a manager should embrace.

Taxes

Property taxes are paid each year, due on specific dates that vary by state. A manager will need to be familiar with each state’s due dates to ensure their client is compliant as clients might have multiple properties across several states. Failure to pay property taxes could result in fines on the property, so educating a client on property taxes is essential to a manager’s duties.

Communication

Communicating with clients is vital throughout the management process to ensure the client and managers are in collaboration to meet shared goals. As described in detail in the paragraphs above, each management duty is conducted for a reason. Communicating why certain duties are performed will keep all parties on the same page.

Typically, the farm manager will provide a written annual report, highlighting the previous farming season, the outlook for the coming season, and potential capital improvement projects. This will assist the client in documenting the farming operation and better understanding the economics of their investment.

Essential Management

The unique investment opportunity farmland provides to investors requires hands on management unlike other asset classes. Farmland is exposed to not only economic elements, but the tangible weather elements as well, making oversight of the asset more important and strenuous. High-quality farm management will help add value and maximize ROI by providing proactive guidance and supervision to farmland property.

– Colvin

 

 

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