Land As a Resource: When To Consider Farmland Investment

February 27, 2020

Land as a Resource: Diversifying Your Portfolio With Farmland Investment

Across the spectrum of real estate investments, agricultural land falls on the conservative side. The return expectations you can get with it are lower than in some other asset classes. But for the right amount of capital, or if you have significant cash holdings with a low rate of return, it can make a lot of sense.


Slow but Steady Capital Growth

By investing in quality farmland and lightly leveraging it, you can pick up probably 2% or 3% over what you can get on a 10-year Treasury security. If you approach it in a relatively diversified way, such as owning five or six farms, you can protect your entire investment in a down year. To get a similar yield otherwise, you would have to buy really low-quality junk bonds.

If the value is there, I prefer owning farm ground rather than allocating a sizeable percentage of my capital to traditional fixed income or bonds. If you purchased farm ground at the right price and haven’t over-leveraged it, I view it as a fixed income investment with built-in inflation protection. Above the yield potential that’s already over what you get on a 10-year Treasury bond, over the long term there’s an additional 1% or 2% increase in value on the land each year. That component keeps you ahead of inflation, and it’s a good thing to have as a balanced mix for a portfolio.

But how do you decide when to get into farmland investment?


Watching Market Signals

As with all cases in real estate, it always pays to find the very best asset you can buy at the best value possible. When Percipio has invested in farm ground we have sought to buy the highest quality land that we can get. But recently, the price has gotten to a point where it doesn’t make sense.

Over the last 10 years or so, we went through a period where the value of farmland went up very rapidly, much ahead of the rate of inflation. It came on the back of a commodity boom, and the rest of the increase was due to really low interest rates and investors looking for yield anywhere they could find it. As they bid the price of farm ground up, the value increased way ahead of the pace of inflation. And so with soft commodity prices and continuing low interest rates for the last five years, we’ve been in a situation where the asset values of farmland have stagnated.

What happens with illiquid assets like this is that people stop transacting, so you go through a period with normal turnover and you can see asset values going up a little bit over time — and then they started shooting way up. At that point, investors start to think, “Okay, we got ahead of ourselves.”

There aren’t a lot of sales right now that allow you to see if the prices are coming back down. We’re in a situation where there’s easy money still in the market, with no stress in the environment. But eventually if people get in trouble with their loans on farmland, the banks will start to impose sales. At that point, you will start to see the prices come down.

But even though the value has outpaced its typical, historical growth rate, those sales seem to be holding back. This is likely due to the large amount of transactional friction associated with selling farmland. That’s why, to this point, we haven’t strongly considered selling our farm ground assets — other than to high-grade our portfolio. Otherwise, selling to take advantage of high valuation would expose us to that high transactional friction, in the form of taxable gains or rolling gains into another asset that is likely also overvalued.


Maximizing the Investment’s Yield

If you decide to invest in farmland, you’ll find it is definitely more hands on than a traditional investment portfolio. But at Percipio, there are two ways we make sure we get the most out of our farm ground assets: using a farm manager and negotiating crop-sharing arrangements.

Rely on an Expert

There are a number of reasons why hiring a farm manager is a wise move for farmland investment.

  1. With farm ground, there’s a lot of complexity around reporting requirements with the government, because it’s somewhat subsidized. We get government payments each year for agricultural programs. But to be able to get those payments, you really need to know the system.
  2. Another area that is really complex is crop insurance — those are sold by a private company, but they are government controlled and each year the government decides what the program is. Every year they change, and they’re incredibly complicated. But a farm manager will stay up to date on those changes each year and be able to help an investor make a wise choice.
  3. A farm manager will act as an interface between the investor and the operator — the farmer. The manager’s relationship with the operator will typically be better than an investor would be able to have. He or she helps select the farmer and then works with the farmer on negotiating the lease for the land. The investor then typically defers to the operator, who then handles the day-to-day operation of the farm.

In addition to those factors, a good farm manager will tend to have geographical knowledge of the area you’re targeting for investment and be able to guide you in the process. An investor coming in without an agricultural background, or even a background in the specific geographical region under consideration, won’t have enough knowledge to make a smart decision. How nutrient-rich is the soil in that area? What are typical weather patterns? Is the terrain conducive or is there too much risk present in the land? Consulting with a farm manager who expertly understands the area is an invaluable aspect of any farmland investment decision.


Negotiating for the Highest Impact

As I said earlier, investing in farmland is pretty hands on. But the way Percipio has chosen to pursue this asset class takes that hands-on investment even further. Most farmland investors will just establish a cash rent relationship, with the farmer paying a set annual rate for each acre of land. But we wanted exposure to the commodities that were the inputs as well as what’s yielded off the farm each year. To that end, we’ve negotiated crop-sharing agreements with our operators.

In crop-sharing agreements, the owner of the land buys all of the inputs (seed, the fertilizer and chemicals, the energy needed to irrigate, etc.), pays the overhead (property taxes, etc.) and pays for the consultant and the farm manager. But in this model, instead of just getting cash rent, we get a share of the crop on the back end — roughly around 75% of the crop. The operator puts in his time, his equipment and the fuel to run his equipment, and he gets 25% of the crop for that.

Implementing a crop-sharing model is relatively intensive, with greater risk and variability. In doing that we are exposed to the price of the underlying inputs, and then the yield and the price of the commodities that are coming out at the back end. But through the arrangement, we pick up an additional 2% expected return.

If you’d like to learn more about farmland investing so you can strike when the market is right, get in touch today. Percipio is always looking for the right partnerships to pursue value-based investments.

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