On January 10, 2011, Purdue held a 1-hour webinar panel discussion by agricultural economists on the subject of farmland prices. Panelists included Mike Boehlje, Craig Dobbins, Brent Gloy, Chris Hurt, and moderator Bruce Erickson.
I listened to the discussion and thought I'd provide a quick overview.
First, they discussed what has been causing vertical up lines on the ag charts lately. Reasons mentioned were an added 25 million acres of production utilized for corn for ethanol and for increased soy demand from China. Additionally, the weaker dollar resulting from QE is pushing up commodity prices. Recent global weather problems resulted in less wheat from the Soviet Union and Canada, and less corn from the U.S. and Argentina. A factor for farmland prices going up is that of declining interest rates over the past 25 years.
A caution was issued for drawing conclusions on farmland price trends based upon the very thin market. There is a wide range of prices per acre in Iowa, for example, ranging between $3k-13k/acre.
The point was made that the interest rate is not risk free and that "we've underpriced risk for a long time". Prices depend upon farm incomes.
Right now we have a very unusual set of circumstances in the farmland values capitalization model which uses income potential, discount rate, and growth potential. All three factors are very high currently, which is remarkable.
Warning signs for farmland over-valuation were discussed which include the fundamentals of income levels and interest rates. There is denial that lenders are over-lending however most lenders say that they had a record year. The cost of production, or what's left after production is what matters. Input costs generally lag overall returns on the upside and on the downside. Land costs capture some of the higher inputs in cash rents, however, not all inputs go elsewhere.
Next, they took some viewer questions and the first was "What is the most likely devastating black swan event?
Answers to this question included: The ethanol policy debate will come back next year and right now ethanol policies are helping to support land prices. The direct payment policy could also be in jeopardy with budget cutbacks. There will be much political debate about subsidies given that farm incomes are at record levels. Biofuel government policy payments are, of course, huge compared to direct payments. One of the panelists stated that removal of these policies could take one dollar off corn prices. As for interest rates, 2013 was mentioned as the year the fed might start tightening. Chinese policy attempts to slow their growth rate could effect commodities as they have a current food inflation rate of 12%. The European debt crisis, a military event, or high oil prices throwing the world back into a recession were the last black swan possibilities mentioned.
The next audience question was "Is the demand from China and ethanol going to last and for how long?"
The answer was that we will be following the mandated ethanol standard dictated by Congress. In China and other developing economies there is positive demand growth but historically supplies have always caught up with demand. We are not the only supplier. Brazil can still expand, for example.
The next question brought up the subject of farmland investors such as REITs.
Institutional investors such as REITs, pension funds, insurance companies, and hedge funds in US and the rest of the world are interested in buying farmland. So far, in the Midwest, it seems that it's usually farmers bidding against farmers at the auctions. Institutions are looking overseas for larger tracts of land or buying companies which own land like TIAA-CREF has done. Plus, farmland is buy and hold, and not very liquid.
The fourth question dealt with California. The questioner stated that in California in the Central Valley, farmland rose so much for development that it was kept out of the hands of farmers. When a PE ratio tops 20 isn't that a sign of a bubble?
Rent multiples have gone up and are above 20 now and the last time was the crash in the 80's though you would have done OK in the early 90's at that level; if over 30 that would get more concerning.
We are below the 4% rate of return now. Everyone is betting that income will grow and push PE ratios down. The growth rate of cash rents is 3% a year over 20 years. Also the historic returns on land are 4-6%, but historically we accept long term risk versus short term risk. Land is illiquid and hard to get out of in a downturn. Why is everybody so optimistic?
- Land values are driven by returns.
- The land market is less liquid than other markets.
- Low interest rates are government policy driven.
- Demand factors for grains are key.
- Keep an eye on government policy.
Webpage for Purdue's January 10, 2011 Land Values Webinar and presentation slides.
To watch the one-hour webinar click here.
[PDF] of the report.