July 19, 2021

By Ben Palen, Ag Management Partners 

Farmland has become an item on the menu of “investments du jour.” It is, perhaps, not especially surprising that investors have discovered the benefits of land ownership. Something else is surprising, though, and it has given this writer, a fifth generation farmer, some pause. The context for this article is my current efforts to evaluate potential farmland purchases in different parts of the United States for some clients.

Twenty-five years ago, Alan Greenspan, then chairman of the Federal Reserve Board, spoke about “irrational exuberance.”  He was referring to the stock market, where he believed that the fundamentals did not support asset values. Some might view it as heresy to suggest that the farmland market is showing signs of the same thing that Greenspan warned about. In my view, there are some reasons for concern. There are eerie parallels to the housing market, where in many parts of the country, homes are selling  above the asking price, and listings attract multiple bidders. At some point, such activity becomes unsustainable.  

I have spent much of my lifetime in agriculture, having acquired my first farm in 1979. The lessons of the 1980s have not been forgotten. Twenty percent interest, and selling wheat for $1.85 per bushel, tend to remain in one’s mind as we ponder the cycles in agriculture. One simple and hard lesson from that decade, sometimes forgotten,  is that asset prices do not always move in an upward trend.   Much has changed in agriculture in the past 40 some years, whether it be better crop varieties, the availability of ag tech tools to monitor so many aspects of crops, or the role of institutional investors in the farmland market. There is no doubt that data-based analysis of farms has allowed some buyers to find additional returns based on improved agronomy and/or capital expenditures.

In recent observations of land auctions, and private sales activity, some trends are apparent. First, annual returns on land not devoted to permanent crops have declined into the 2 to 2.5 percent range in a number of regions of the United States.  This is not because of low commodity prices—in fact they are generally much higher than they have been in many years—but it is due to buyers bidding up the price of land in such a manner that the rates of returns have diminished. One has to wonder what those buyers will think when commodity prices come back down to earth, and interest rates rise—and they will. It is not a question of if, but rather, when. The world looks different when corn is back to $4 a bushel, and interest rates are, say, 7 percent.  

There are regions of the country, notably portions of the Delta, where institutional investors own large swaths of row crop land. The same is true in California, for permanent crops. With the amount of capital available from funds focused on investing in farmland, there is, consciously or unconsciously, some pressure to invest capital in a reasonable period of time. This is not to suggest that the investing decisions are careless, but rather that this factor may enter into the equation when a price is determined for a piece of land. Where investors dominate the market in an area, be it row crops or permanent crops, it is a legitimate question to ask whether they are unduly influencing the market. For years, the first question I have always asked when seeing auction results is not the price, but who bought the land.    The same question is of increasing importance in the private sale context.

While the evidence is in part anecdotal, it is apparent that, in certain areas, farmland is selling almost as quickly as homes.  And, often it is not publicly listed before it is sold. It is hard not to view that scenario as concerning because it suggests, well, irrational exuberance.

One factor that may enter into the picture, and again it may be consciously or unconsciously considered, by a farmland buyer, is whether the price of a new acquisition can be averaged with the cost of other land already owned.  From the standpoint of a farmer who adds land, there is no doubt that this price averaging method has been used for years.  On the other hand, I have had many people involved with farmland investment funds tell me that they do not follow that practice.  If that is true, then that means the farmer should always be competitive against institutional buyers.  I am not certain that that is the case.  Stated another way, the price of entry into the farmland market for a new player is very high; either they accept a rate of return that is likely to be far less than that enjoyed by an existing farmland owner, or they simply accept the view that prices are going up, and they want to get in before prices continue to rise even more.   It is an odd situation, the inferences from which are not entirely clear cut.  

Does all of this point to a “new normal?”  That is hard to say. When commodity prices adjust downward, common sense indicates that either land prices will follow, or cap rates will fall even further.  History suggests, but does not absolutely prove, that the former will be the case. That said, the factor of price averaging cannot be overlooked. Neither can the factor of likely downward movement in the stock markets.  Inflation is an unknown at this point.  

 It would be erroneous to draw a conclusion from the above observations that farmland is a bad investment. Indeed, over the long term, the contrary has been the case. The intent here is to offer some historical perspective, and to reinforce the notion that caution in making investment decisions is always prudent. It is a time worn adage, but it is worth remembering that, for investments, timing is the key.

Read the update to this article, published April 26, 2022, here. 

ABOUT THE AUTHOR:

Ben Palen is a fifth generation farmer with experience in many aspects of agriculture, including projects in the United States, Africa, and the Middle East.  The focus on all projects is sustainable practices based on a mix of boots on the ground work and selected use of agtech tools.

** All views, data, opinions and declarations expressed are solely those of the author(s) and not of Global AgInvesting, GAI News, or parent company HighQuest Group.