Minding Ag's Business

"Help, I'm about to set a county land record," amiddle-aged Iowa farmer called to confess late last year. The heirs to a farm estate next door to his home farm had turned down his private offer of $13,500 per acre and were putting the parcel up for public auction. He later spent over $15,000/acre outbidding other aggressive neighbors, but he justified it since he paid cash out of this year's profits, it abutted his land and it hadn't exchanged hands in more than a generation.

Emotions can override economics at auctions, sometime for good reason. But rational investors can brace themselves by using the same benchmark analysis farm lenders and professional farm managers use when assessing real estate investments.

Calculating the "capitalization rate" on any particular parcel will help you determine what you can afford to pay, recommends Danny Klinefelter, Texas A&M economist and DTN farm business adviser. He defines that as the potential investment's required rate of return given its sustainable income -- a fair-market cash rent, in this case.

Lenders across the country use this kind of assessment. "The problem in the 1980s was that lenders fed the real estate market up because they relied too heavily on comparable sales and mortgaged to that level,"Klinefelter said."They found you can't service debt with land values and forced sales don't bring anywhere what you'd get on an open market."

Since 2008, Farm Credit Services of America has implemented its own sustainable lending policy for land owners in Iowa, Nebraska, South Dakota and Wyoming. That policy is attempting to prevent over-extension of credit in a rapidly increasing land market, CEO Doug Stark told attendees of the DTN-Progressive Farmer Ag Summit in Chicago in December.

In the key farm states where FCS of America operates, cap rates have averaged 4.62% over the last 20 years but are hovering at about 3.5% or under now, according to Stark.

Assuming the farmland consistently yields 200 bpa, the long-term corn price is $4.50 and the operator's costs match those of Iowa State University budgets, cash rents should run about $320 to $350/acre. By that measure, the "sustainable" market value of the land is about $9,100/acre in Stark's example.

If an operator is willing to accept a rate of return of only 2%, the land's sustainable value would jump to $15,931. On the other hand, if cap rates returned to 1992 levels of 6%, the same farmland would be worth only one-third of that price.

Conservative lenders like FCS of America add further restraint by only financing 65% of that sustainable level.

"For the most part, when the market is over $12,000/acre at auctions these days in Iowa, Illinois or Minnesota, professional investors are bystanders," Klinefelter says. "They don't see that much upside potential and they need to justify a higher rate of return than individual farmers."

Well-heeled farm operators who are 35yearsold may have time to correct for overpayments on individual properties, Klinefelter added. But those who are closer to 65 might want to pay close attention to a farm's long-term income potential.

Read and comment on all DTN Ag Business Benchmarks on the Minding Ag's Business blog.

Follow Marcia Taylor on Twitter@MarciaZTaylor.

Marcia Zarley Taylor can be reached at marcia.taylor@telventdtn.com

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