Since 2000, U.S. farmland values have roughly doubled in nominal terms and have risen a whopping 58 percent after factoring in inflation, according to the Federal Deposit Insurance Corporation (FDIC), which recently hosted a symposium, “Don’t Bet the Farm — Assessing the Boom in U.S. Farmland Prices.”
A favored asset class in an era of high commodity prices, low interest rates, and ample liquidity, the agency says, farmland is attracting increased interest on the part of U.S. farmers and investors, as well as international investors. This has pushed farmland prices to all-time highs.
Does this pose a danger of farmland becoming another asset bubble similar to the one that brought the residential real estate market crashing down, or dot-com equities before that?
Or does it simply represent a reordering of relative asset prices that reflects long-term changes in global economic fundamentals? Private sector risk management and governmental financial stability policy both require answers to these questions, said Sheila Bair, FDIC chairman.
“While we don’t see a credit problem in agriculture at this time, the steep rise in farmland prices we have seen in recent years creates the potential for an agricultural credit problem sometime down the road,” she said. “And that’s precisely the sort of long-term risk that farm operators, lenders, and regulators need to stay attuned to as they carry out their day-to-day business.”
But the contrast Bair cited in loans gone sour in the commercial real estate sector as opposed to farmland is striking.
“Since the onset of the recession in December 2007, FDIC-insured institutions have charged off just under half a trillion dollars in loans and leases,” she said. These included credit card loans, family mortgage loans, commercial and industrial loans, and loans for the construction and development of real estate.
“Over this same period, net charge-offs in loans secured by farmland have amounted to just $573 million, and for agricultural production loans, $812 million.” Ag-related loans made up just under 2 percent of total industry loans and leases at the end of 2010, she said.
“Recently, times have been very good in farm country,” Bair said. “U.S. net farm income rose 27 percent in 2010 on the strength of high commodity prices and good harvests.”
And, she noted, U.S. farm exports set a new record of $116 billion. “This strong performance comes on the heels of a string of recent years in which inflation-adjusted earnings in the farm sector were the highest since the 1970s.”
Pointing to a corresponding jump in farmland values, Bair said “Farmland has clearly been a preferred asset class in an era when many other asset classes have stumbled as a result of the financial crisis.
“But the key question is, what lies ahead after this historic boom?”
Farm sector and volatility
The U.S. farm sector “has historically been associated with a significant amount of volatility,” she said. And, “a boom period can give way to a reversal that can result in falling commodity prices, falling incomes, and falling land prices. Under such a scenario, farm operators can suddenly find it very difficult to make ends meet and service their outstanding debt.”
The boom years of the 1970s were followed by just such a downturn in the 1980s, Bair noted, and nearly 300 farm banks failed between 1987 and 1993.
With low capitalization rates and higher farm income, farmland values have surged, said Brian Briggeman, economist for the Federal Reserve Bank of Kansas City.
From fourth quarter 2009 to fourth quarter 2010, farmland values surged in the Chicago, Minneapolis, Kansas City, and Dallas Federal Reserve Bank regions, ranging from 4 percent to 23.7 percent.
“Historically low capitalization rates help support these cropland values,” he said.
Research by the bank indicates that rising interest rates and a return to higher capitalization rates could bring a reduction in farmland values of nearly one-third.
If farmland values should fall by one-third, Briggeman said, “farmers could lose a significant amount of wealth. This would impair farmers’ balance sheets by eroding farm wealth.”
Joseph W. Glauber, chief economist for the USDA, noted that while farmland values have risen sharply over the past five years, “increases appear to be generally consistent with the rise in farm income and low interest rates, and comparisons to the 1970s seem unfounded.”
The agricultural sector is in better financial shape than in the 1980s, he said, and long-term factors for farm income remain positive, with strong domestic and foreign demand for ag products.
Though real interest rates are expected to rise, they likely will remain below levels of the 1980s and 1990s, he said. Net farm income has been volatile, which could lead to volatility in farmland values.
While budget cuts could affect land values, “payments are a small portion of net cash income,” Glauber said.
Current land values appear to reflect current high returns in agriculture, said Brent Gloy, director of the Center for Commercial Agriculture at Purdue University.
Farmland “is not obviously overvalued, and values don’t appear to have diverged from reality,” he said. But at the same time, “this doesn’t mean that a downward movement is impossible.”
Values are dependent upon interest rates remaining low and/or sustained growth in agricultural income, Gloy said. “It is possible that a bubble is in the early stages of formation.”
Substantial increases in farmland values from this point would be based upon optimistic scenarios for future growth and/or reduced real rates of interest.
Factors fueling bubbles
Bubbles tend to be fueled, he said, by (1) easy access to credit for purchasing capital assets, with someone willing to accept lots of risk; (2) widespread uncertainty about the level of economic fundamentals and their future outlook, and the magnitude of risk misunderstood by market participants; (3) markets that allow participants to easily capture capital gains along the way and/or roll capital gains into ever bigger bets; and (4) new demand (uninformed market participants wanting to enter the market.
“The risks to farmland values are highly non-linear,” Gloy said, “and there is great uncertainty about the level at which farmland will trade in five years.
“While it is not clear to me that, on balance, land is dramatically overvalued at present, that can change rapidly.”
Shonda Warner, representing Chess Ag Full Harvest Partners LLC, a privately-owned farmland real estate investment trust, said investors have seen a number of benefits from direct investment in farmland:
• Farmland investment shows returns similar to the stock market, with less risk.
• Returns are not correlated to the stock market or other commercial real estate markets.
• In inflationary periods, returns tend to correlate positively to inflation.
• Farmland is a ‘hard’ asset, not subject to the vagaries of price fluctuations for securitized assets.
• Farmland is not heavily leveraged as a sector.
• Farmland is the ultimate residual claimant of returns to agriculture.
• There are many years of data for farmland, making statistical and risk analysis more robust.
Changes in production agriculture create opportunities, Warner said.
“There are large economies of size in farming. We’ll soon see rapid consolidation in production. Dramatic reductions in per-unit production costs will ensue. As they push for growth, farmers will prefer to rent, not own, an increasing portion of the land they farm, thus increasing rents.”
Large economies of size could spark rapid growth, Warner said. “Intergenerational wealth transfer, coupled ith debt, will not keep up with the growing demand for capital, and both demand and supply of capital will commercialize.”
The rough average for rent to value yields in the U.S. over the last 50 years is around 5 percent, Warner noted. “Intelligent investment might suggest you’d want to buy around that level or better.”
Suitability for agriculture is “always important,” and the landowner/tenant relationship “is critical.” The suitability of land for non-ag benefits, such as home sites, hunting/recreation, water/wind/carbon credits, and minerals value is also important.
Some “warning bells and possible pitfalls,” Warner said:
• Extreme runup in commodity prices due to massive index fund investment. “Once investors are no longer in love with these liquid instruments, and supply/demand economics in global production stabilize, prices for both grains and, ultimately, farmland could come down in a more volatile fashion than they would normally do if no futures speculation existed.
• Vastly increased institutional ownership could cause land prices to rise faster than theny should, or normally would, given that farmers and experienced investors are aware of the volatility of commodities and know not to pay too much attention to short-term volatility — factors inexperienced new investors in the agricultural sector do not understand so well.
• A fast jump in interest rates or inflation could destabilize the sector, probably more due to the levels of operating leverage than leverage of farmland itself.
• Input costs rise even faster than grain prices.