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Although 2013 has been a good year for farmers, they should carefully review their current and expected farmland purchases in case the market changes.


Where Are Farm Land Prices Headed?

  • 10/30/2013

This year has been a good time to be a farmer in the United States. Grain and livestock prices have been firm and although input costs are rising, most farmers are still enjoying profitable margins. The USDA estimates the 2013 farm net income will exceed $100 billion.

When times are good, farmers need even more diligence in stress testing their land purchases. I remember the late 1970s and early 1980s when farming was in a similar situation. Prices were good, input costs were stable, and everything appeared rosy — then short-term interest rates shot to over 20 percent, the oil crisis hit again, and grain prices took a tumble. In that environment, farmland prices crashed and took many years to recover.

I am not predicting the same thing will happen now, although any investment with at least a 10-year history of gains each year — such as farmland has had since 2001 — usually has a correction at some point. And corrections are healthy for the marketplace, but are you ready for it?

Investment income and rate of return

Let’s do a quick review of how the market price for farmland is determined. There are two financial components and one emotional component.

The first financial component is the investment income generated. As actual and expected cash rents increase, the price a farm investor is willing to pay increases. If cash rents decline or are expected to decline, the value of farmland will decrease. The second financial component is the rate of return that the investor requires to make the investment. As this required rate of return decreases, the value of farmland will increase. Conversely, as the required rate of return increases, value will drop.

Required rates of return were at an all-time low at the beginning of this year, according to the IRS’s monthly publication of market interest rates. From about 2000 until 2008, long-term rates ranged from a low of about 4 percent to over 8 percent. During the early 1980s, these rates substantially exceeded 15 percent. The long-term rate bottomed out in the last 12 months near 2 percent, however, the October 2013 numbers were near 3.5 percent. We have already seen long-term interest rates start to tick up.

These two financial components have an inverse relationship on farmland values. As income increases and the required rate of return decreases, farmland prices will go up.

For example, prime corn ground in Iowa recently sold in the $15,000 range. Farmers or investors paying this price were most likely expecting long-term average cash rents of $450 with a required rate of return of 3 percent. If cash rents eventually trend down to $300 and their required rate of return trends up to 6 percent, then the expected value of farmland will adjust to $5,000. With just these two changes in expectations, the value of farmland goes from $15,000 to $5,000.

Market attitudes

The third and final component of farmland prices is the adjustment for market euphoria or despair. If the market has an equal number of willing buyers and sellers, values will be fairly consistent. However, as “euphoria” enters the market and the supply of willing sellers decreases and the demand of willing buyers increase, these values will have to be adjusted.

It is my estimate that euphoria in farmland prices was near an all-time high during late 2012 and early 2013, before corn prices started their drop into the mid-$4 range. During this time period, a euphoria adjustment of positive 25 percent was probably the norm. This would lead to a sales price of $12,500 on $10,000 per acre land.

When euphoria decreases toward neutral (which I think we are at, or perhaps slightly negative now), farmland will gradually trend back to $10,000. If despair comes into play due to an excess of sellers and a dearth of buyers, the adjustment will trend toward a negative 25 percent, resulting in a farmland value of $7,500.

As you can see, the two financial components may indicate a value of $10,000, but the third non-financial component can create a $5,000 difference in price.

Review farmland purchases

The bottom line is that it is extremely important to carefully review your current and expected farmland purchases. If your assumption is an expected cash rent equivalent of $500 based upon current prices, how do $200, $250, and $300 equivalent cash rents affect your farm cash flow? Does a decrease in value from $12,500 back to $5,000 create violations of financial covenants that may either crimp your farm operation and/or your relationship with your bankers — or perhaps put you out of business?

Make sure you analyze your farmland prices now, and take any appropriate action to prepare for changes in the marketplace.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment or tax advice or opinion provided by CliftonLarsonAllen LLP