Land Prices: Should I Buy That Farm or Not?
(Dairy Herd Network) If the neighboring farm came up for auction, what would you do? You have no current long term debt. You have cash in the bank from recent profitability, and you have an opportunity to expand which has never before been offered. With good commodity prices in the foreseeable future which will help quickly pay for the land, what should you know before you make your decision?
You have undoubted heard the anecdotal reports of Central Illinois farmland edging into the five digit range. Nebraska farmland rose 22% from February 2010 to February 2011. Iowa farmland was up 25% from March 2010 to March 2011. The Chicago and Omaha Fed have reported double digit increases in farmland values across the Cornbelt and Great Plains. Farmland is not increasing in availability, but decreasing. Should you make your move now?
Writing in the current issue of Choices Magazine Iowa State economist Mike Duffy says there is great debate over whether farmland prices are forming a bubble, and cannot be supported. He says there are many reasons for today’s farmland values, among them the strong net farm incomes over the past decade, which have provided farmers the wealth to purchase land at the declining number of farmland sales. However he says current times are unprecedented with respect to federal monetary and fiscal policies, but those have also lead to low interest rates and encouraged borrowing.
If you bid on land, who are you bidding against? Duffy says there is anecdotal evidence that many buyers have been institutions and investment funds, but an Illinois survey says 56% of sales in the past year have been farmer purchases. So your neighbor may be bidding against you, and what will that do to the final sale price? After all, Duffy says, “Farmers buy land to own it, not to sell it. The land becomes part of their business, part of their retirement plan, and a part of their legacy.”
If there is emotion at land sales, is there any economic basis for the price of farmland? Purdue economists Brent A. Gloy, Michael D. Boehlje, Craig L. Dobbins, Christopher Hurt, and Timothy G. Baker, all believe there are economic fundamentals driving farmland values. Writing in the current issue of Choices Magazine, they report there is great concern about the potential for unsupported and inflated prices for farmland as noted by Duffy. They rhetorically ask what factors are driving prices and whether current farmland values are reasonable. To answer the first, they say future earnings and the expected opportunity cost of funds are the driving forces. The first is clearer than the second, which they explain, “An opportunity cost is created because funds used to purchase farmland could be invested in other assets.” Their formula for the value of farmland is income, divided by the discount rate minus the income growth rate, which may be easy for an economist to solve.
The Purdue economists say something that aggravates the calculation is the relatively small amount of farmland being sold. A Nebraska survey recently reported only1.5% of farmland turns over in a given year, while half that amount of Wall Street equity stocks turnover in a given day.
Farmland earnings, which have attracted you and others to the auction, continue to rise, fostered by increased commodity prices that are a function of Chinese hunger for better food and the voracious appetite for corn at ethanol plants. Strong prices resulting from low stocks to use ratios have continued to support farmland values, particularly in higher cash rents that are attractive to non-farming investors. Some of them have even been willing to pay more for land to be able to capture the cash rent income stream. In Indiana, farmland is worth $28 for each dollar of cash rent that it will earn. That is an all time high, and the same is nearly true in Iowa and Illinois.
The income capitalization model offered by the Purdue economists utilizes an interest rate as part of the formula, which reflects the lower “opportunity cost of capital, reducing the discount applied to future earnings received from the farmland and increasing its valuation multiple.” With low interest rates the economists say the impact on land values can be dramatic. A capitalization rate of 4% which is about the current rate, would multiply every dollar of earnings by 25, while an 8% capitalization rate would only have a multiple of 12.5 for every dollar of earnings.
A recent Purdue survey found average Indiana farmland at $4400 and cash rent averaging $161, which produce a capitalization rate of 3.64%, higher than the 3.25% Treasury bond, which means farmland purchasers would rather keep their investment with the hope that it will result in income growth. Increased interest rates would put downward pressure on both cash rents and farmland values, reducing the dollar-multiplying effect of the lower interest rates. They warn against expectations of farmland values growing faster than the rate of inflation and productivity growth in agriculture. Their bottom line is that “one could make the case that average sale prices are reasonable and could even support higher prices; but one could also argue that, given the extreme price volatility in agricultural markets, price moves to the downside are also quite likely.” They also warn against the use of reasons unrelated to market fundamentals to guide decisions on buying farmland, which can reduce the strength of the current farmland value foundation.
Summary:
Farmland prices are edging higher, driven in part by higher commodity prices, which are a function of Chinese demand and the ethanol economy. However, fewer parcels of farmland are being sold, and farmers are buying over half of farms being sold. Current prices have a strong foundation based on earnings and lower rates of interest that increase its dollar value. Increased interest rates will reduce its value along with cash rents of farmland.
http://www.dairyherd.com/dairy-news/Land-Prices--Should-I-buy-that-farm-or-not-126760993.html?ref=993
You have undoubted heard the anecdotal reports of Central Illinois farmland edging into the five digit range. Nebraska farmland rose 22% from February 2010 to February 2011. Iowa farmland was up 25% from March 2010 to March 2011. The Chicago and Omaha Fed have reported double digit increases in farmland values across the Cornbelt and Great Plains. Farmland is not increasing in availability, but decreasing. Should you make your move now?
Writing in the current issue of Choices Magazine Iowa State economist Mike Duffy says there is great debate over whether farmland prices are forming a bubble, and cannot be supported. He says there are many reasons for today’s farmland values, among them the strong net farm incomes over the past decade, which have provided farmers the wealth to purchase land at the declining number of farmland sales. However he says current times are unprecedented with respect to federal monetary and fiscal policies, but those have also lead to low interest rates and encouraged borrowing.
If you bid on land, who are you bidding against? Duffy says there is anecdotal evidence that many buyers have been institutions and investment funds, but an Illinois survey says 56% of sales in the past year have been farmer purchases. So your neighbor may be bidding against you, and what will that do to the final sale price? After all, Duffy says, “Farmers buy land to own it, not to sell it. The land becomes part of their business, part of their retirement plan, and a part of their legacy.”
If there is emotion at land sales, is there any economic basis for the price of farmland? Purdue economists Brent A. Gloy, Michael D. Boehlje, Craig L. Dobbins, Christopher Hurt, and Timothy G. Baker, all believe there are economic fundamentals driving farmland values. Writing in the current issue of Choices Magazine, they report there is great concern about the potential for unsupported and inflated prices for farmland as noted by Duffy. They rhetorically ask what factors are driving prices and whether current farmland values are reasonable. To answer the first, they say future earnings and the expected opportunity cost of funds are the driving forces. The first is clearer than the second, which they explain, “An opportunity cost is created because funds used to purchase farmland could be invested in other assets.” Their formula for the value of farmland is income, divided by the discount rate minus the income growth rate, which may be easy for an economist to solve.
The Purdue economists say something that aggravates the calculation is the relatively small amount of farmland being sold. A Nebraska survey recently reported only1.5% of farmland turns over in a given year, while half that amount of Wall Street equity stocks turnover in a given day.
Farmland earnings, which have attracted you and others to the auction, continue to rise, fostered by increased commodity prices that are a function of Chinese hunger for better food and the voracious appetite for corn at ethanol plants. Strong prices resulting from low stocks to use ratios have continued to support farmland values, particularly in higher cash rents that are attractive to non-farming investors. Some of them have even been willing to pay more for land to be able to capture the cash rent income stream. In Indiana, farmland is worth $28 for each dollar of cash rent that it will earn. That is an all time high, and the same is nearly true in Iowa and Illinois.
The income capitalization model offered by the Purdue economists utilizes an interest rate as part of the formula, which reflects the lower “opportunity cost of capital, reducing the discount applied to future earnings received from the farmland and increasing its valuation multiple.” With low interest rates the economists say the impact on land values can be dramatic. A capitalization rate of 4% which is about the current rate, would multiply every dollar of earnings by 25, while an 8% capitalization rate would only have a multiple of 12.5 for every dollar of earnings.
A recent Purdue survey found average Indiana farmland at $4400 and cash rent averaging $161, which produce a capitalization rate of 3.64%, higher than the 3.25% Treasury bond, which means farmland purchasers would rather keep their investment with the hope that it will result in income growth. Increased interest rates would put downward pressure on both cash rents and farmland values, reducing the dollar-multiplying effect of the lower interest rates. They warn against expectations of farmland values growing faster than the rate of inflation and productivity growth in agriculture. Their bottom line is that “one could make the case that average sale prices are reasonable and could even support higher prices; but one could also argue that, given the extreme price volatility in agricultural markets, price moves to the downside are also quite likely.” They also warn against the use of reasons unrelated to market fundamentals to guide decisions on buying farmland, which can reduce the strength of the current farmland value foundation.
Summary:
Farmland prices are edging higher, driven in part by higher commodity prices, which are a function of Chinese demand and the ethanol economy. However, fewer parcels of farmland are being sold, and farmers are buying over half of farms being sold. Current prices have a strong foundation based on earnings and lower rates of interest that increase its dollar value. Increased interest rates will reduce its value along with cash rents of farmland.
http://www.dairyherd.com/dairy-news/Land-Prices--Should-I-buy-that-farm-or-not-126760993.html?ref=993
Posted by Colvin & Co. at 8/8/2011 5:11 AM 
Categories: Farmland
Tags: commodities dollar farmland farming food Illinois Iowa inflation Land Value Nebraska exports
Categories: Farmland
Tags: commodities dollar farmland farming food Illinois Iowa inflation Land Value Nebraska exports
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