Minding Ag's Business

Avoid Land Buyer's Remorse

Evidence seems to point that farmland is at a tipping point. No-sale land auctions are becoming more common. In November, opinion surveys by two of the three Federal Reserve Bank districts reported a dip in values. Ditto a recent Creighton University survey which pegged its farmland value index the lowest in four years.

In fact, Purdue University economists estimate Midwest farmland values could tumble 15% to 25% if corn futures hover near $4.50 and soybeans $11 for the next three years, and interest rates inch up about half a point. That's not a swan dive, but it could wipe out a lot of equity going forward.

So if you're in the market to acquire land now, how do you avoid buyer's remorse later?

Play by the numbers, Kansas State University Economist Kevin Dhuyvetter and former economist-turned-farmer Terry Kastens believe. The pair has refined their own personal ag investment strategy over the last decade and remain selective buyers even now. They target 9% return on assets, using moderate leverage of 50% with fixed rate mortgages. Having a long-term horizon on land ownership--say 30 years or longer--also helps correct for short-term mistakes.

Over history, farmland has provided decent returns for investors and owner-operators. Between 1951-2013, non-irrigated farmland from 39 states averaged annual returns from rent of 5% plus 6.5% capital gains, for a total return of 11.5%, they found. The stock market generated 8.5% annual gains, plus 3.2% dividends, or a total of 11.7% during this same time period, but it subjected owners to far more volatility.

Besides sticking to those guidelines, the most important principle is to make good buys rather than trying to time the market, they say. Routinely land changes hands anywhere from 70% to 130% of the going market, so it's important to know your local trends, Dhuyvetter says. Don't get caught in the emotion of bidding, the fallacy of comp sales or over valuing attributes like distance from your home base.

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Surprisingly, their top recommendaion was to disregard some conventional wisdom. For example, current corn markets turn out to be poor barometers of farmland returns 5 years in the future. If you'd followed a buying model based on corn price, you'd have earned 7.8% returns on average Iowa farmland since 1966 versus 14.8% with a model of buying every year.

Likewise, using another common economic indicator--capitalized value--is no better than "gut instrinct" they say. In its simple form, it capitalizes rent by dividing by interest rates. Market land values haven't been below the capitalized value since about 1970, however. Think of the capital gains you would have missed as Kansas land ballooned tenfold or Iowa zoomed from a few hundred dollar an acre to almost $9,000.

Using rent-to-value ratios as a buying signal worked better. Buying Iowa land when the ratio is below its 5-year average yielded12.3% since 1957, but still less than buying land every year.

The method preferred by Dhuyvetter and Kastens is an online spreadsheet, KSU-Landbuy, which automates future value calculations of cash rent and capital gains after taxes for you. Find it at http://cwww.agmanager.info/…

"If you still want to purchase land, use a mechanical procedure such as KSU-Landbuy to ensure decent buys," they say. Park the emotions back home. This is the way to "beat" the market.

Over history, farmland has provided decent returns for investors and owner-operators. Between 1951-2013, non-irrigated farmland from 39 states averaged annual returns from rent of 5% plus 6.5% capital gains, for a total return of 11.5%, they found. The stock market generated 8.5% annual gains, plus 3.2% dividends, or a total of 11.7% during this same time period, although it subjected owners to far more volatility. Still, all over-heated markets are subject to correction.

"Like other ag economists, we'd say we're darn close to a tipping point in farmland," says Kastens. "But is it merely going to slow down? Flatten or will it drop? If you're a farmer rather than an outside inventor, and are worried about where we are, just rent the land you need for your operation."

To see Dhuyvetter and Kastens' presentation from the DTN Ag Summit on this subject, go to http://www.agmanager.info/…

Follow me on Twitter@MarciaZTaylor

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