After go-go decade, farmland faces threats

December 26, 2013

Dec 26 (Reuters) – The rise and rise of farmland values
faces two tough challenges: falling crop prices and rising
interest rates.

Because farmland is not a widely-held investment, with the
exception of large institutions, its remarkable rise gets
comparatively little attention.

Illinois average farmland prices more than doubled, to
$7,900 per acre in the six years to 2013, according to one
Department of Agriculture measure.

A separate survey of Iowa farmland, by Iowa State
University, found a 5.1 percent gain in the last year alone to
$8,716, taking prices up by 168 percent in the past decade in
inflation adjusted terms. ( here
)

Much of this rise has had a fundamental basis. The trend
over the medium term in agricultural commodity prices has been
higher, with strong demand from emerging markets, better
management techniques and falling prices for inputs like
fertilizer.

Some of the demand for farmland, though is driven by new
investors, eager to diversify into so-called real assets and
dissatisfied with low-yields and volatile returns in more
traditional areas.

At least some of this was driven by investors who reasoned
that the Federal Reserve’s easy money policy, or “quantitative
easing”, would create a destructive inflation, and that a real
asset like farmland producing a salable commodity would tend to
outperform.

While opinions about the outlook over the medium term for
agricultural products vary widely, several changes in the
investing atmosphere argue that farmland values may find the
going tough in the coming year.

First, if not most importantly, the Federal Reserve is
beginning to withdraw from quantitative easing, but is doing so
without any evidence at all to support the thesis that “QE” will
devalue the U.S. dollar.

That is bad for farmland in two ways. A tightening of
financing conditions will raise the cost of borrowing to fund
purchases, and will create possibly more attractive investments
elsewhere, as bond yields rise. That which was helped by QE’s
advent should be hurt by QE’s death, and farmland fits the bill.
And while investors are sitting on gains in farmland, the lack
of inflation does undermine a part of the argument for real
assets.

FALLING CROP VALUES

More fundamentally, crop prices are falling, driven in part
by a run of good harvests. Iowa corn prices dropped by 33
percent in the year to October, during which soybean prices fell
11 percent.

Using Department of Agriculture estimates for lower prices
yet next year, economists at the University of Illinois cooked
up some estimates for farm profitability. The results are
sobering.

Highly productive farmland planted in a mix of corn and
soybeans might turn a $333 dollar profit per acre next year. ( here
)

Compare that to the $7900 per acre average value and you
have a yield a bit above 4.0 percent. With longer term fixed
rate loans ranging up to 6.0 percent, you have an asset with
negative carry even with 25 percent down. And that’s before what
is almost certainly going to be a rise in interest rates as QE
winds down.

That is the kind of things investors see as sustainable when
capital values and prices are going the right way, but just a
bit of momentum the wrong way and you could see a bit of a
correction in farmland prices.

To be sure, it doesn’t have to work out this way.
Agricultural prices might recover, economic growth might take
off. Added to this is the fact that most of the new entrants
aren’t exactly hot money. They tend to have taken a reasonably
long-term view of the sector. Indeed, it might be
owner-operators rather than investors who are more vulnerable to
a downturn in capital values.

On the positive side debts held by the farm sector are low
by recent historical standards. Debts within the farm sector are
now barely above 10 percent of assets, compared to 15 percent
through much of the 1990s and a peak of more than 20 percent in
the mid-1980s. That implies a bit of a cushion should income
drop and capital values recede.

Banking data also shows quite low write-offs and
delinquencies in agricultural lending, as you would expect after
a strong rise in prices.

Of course, U.S. farmland is not the only one to have risen
during the age of QE. Farmland in Britain has tripled in value
over a decade.

The unwinding of QE is going to be the biggest investment
story of the coming year, perhaps the coming two or three years.
Plans made for a world of QE won’t make sense anymore, and
assets bought when liquidity was ample and risk-taking the order
of the day will suffer.

Farmland, like housing and like junk bonds, is just one more
example. A bit puffed up and a bit vulnerable.

(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Jim Saft)

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