Tips for Riding the Roller Coaster
As farmland prices set new records, Ray Gaesser, an American Soybean Association director from Corning, is worried.
“I was adding up some budgets and looking at the cost of production for next year,” he says. “Recent rent auctions are alarming, and land sale prices are scary.”
Gaesser, who survived the farm crisis of the 1980s, wants his fellow growers to keep in mind the cyclical nature of agriculture.
“I’m optimistic about the future for agriculture, but at the same time, there will be ups and downs. You have to be prepared for the down cycles. That’s how we survive,” he says.
Being prepared includes keeping a tight rein on land costs.
“If you look at the cash rents at some of these auctions, you could have a thousand dollars per acre invested in a corn crop or $800 in a soybean crop. From my viewpoint, you don’t have to be very highly leveraged today to be at high risk,” Gaesser argues.
At Farm Credit Services of America, Jim Knuth, senior vice president, believes land prices may correct themselves based on commodity grain supply and demand: “The moment our ending stocks start to go back up, it will be a clear market signal that supply has exceeded demand, and at that point, it’s likely grain prices will soften and land values will follow.”
Some analysts now say the inflation in farmland prices constitutes the latest economic “bubble.” Moe Russell, Russell Consulting Group, agrees with the “bubble” argument but sees it differing from the inflated land prices of 30 years ago.
“I believe it’s true we are in a ‘bubble’ but I don’t think we will see the precipitate drops we had in the 1980s,” he says. “There are three reasons: First, there’s a lot less debt on the land. Second, interest rates are much lower. Third, we can lock in those lower rates, which we couldn’t do back then.”
Russell sees a big change in how heavily farmers are leveraged and gives part of the credit for that to agricultural lenders.
“In general, we encourage those buying land to have a good equity in it, and the ag lenders have the same philosophy. They are usually willing to lend up to $5,000 per acre, and the buyer must come up with the rest.”
He offers several suggestions for growers intent on controlling risk in the current environment.
“A real good way to manage the risk of land prices going forward is to lock in long-term interest rates while they are so low.
“I would suggest using current grain prices to lock in enough sales in 2012 and 2013 to cover the three major production expenses – cash rent, seed, and fertilizer,” he advises. “Margins are higher than they’ve been for 40 years, and history shows things won’t stay this way long. Margins will narrow, so this is a good opportunity to lock in profits.”
Russell also recommends renters have an agreement in place with their landlords to renegotiate cash rents if profit margins change dramatically.
For Knuth, how high land prices will go is the wrong question for growers to ask when considering
“There are four questions to answer,” he says. “What is your financial position? What is your land cost per acre? What is your interest rate risk profile – are you locked in or variable rate? And, what is the correlation between the price and the quality of the land?”
His bottom line: “Can you purchase the land without significantly increasing the leverage in your balance sheet or significantly increasing your over-all land cost per acre?”
The goal for an operation’s land cost per acre should be equal to or less than normal cash rents. To calculate it, total all real estate costs (debt service, principal, interest, taxes, and rental agreements) and divide that by the number of acres farmed.
In general, Knuth reports, producers are purchasing from a position of strength. “They are typically taking ‘small bites’ so they aren’t over-leveraging their balance sheets.”
Like Russell, he also sees farm lenders being more cautious than financial institutions in the U.S. housing sector were.
“Our portfolio data show most lenders have increased equity requirements. Almost all of them have learned the lesson of what happens in extending too much credit in a rapidly rising market.”
Still, he warns producers, “If you’re entering into very high cash rents and entering into purchases, that’s going to mean a higher cost of operation, and that means you’re more susceptible to risk and volatility, especially if interest rates start to go up.”
Gaesser makes the same point with an example: “If you are paying $10,000 per acre, those interest and principal payments are terrific, and if you borrow at four percent for 20 years, you’re amortizing your purchase at $735 per acre. That’s a real concern when you consider how fast the market for corn and soybeans could go down 30% and how fast people would lose money.”