Land Prices to Rise Again in 2011; Case Building for Downward Pressure Later
The Progressive Farmer
By Linda H. Smith, DTN Markets Editor
OMAHA (DTN) — Few investments can match farmland’s returns in the past five years — it has increased as much as 50% depending on location.
The strongest growth has been in regions with intensive field crops or livestock production, especially the Midwest. The Chicago Federal Reserve reported farmland in its district was 16% higher in the first quarter of 2011 than a year earlier, the largest year-over-year increase since 2007.
The Kansas City Federal Reserve also reported first-quarter values up strongly. The areas with slower growth include those with varied agriculture, environmental restrictions or limited water.
“I think we will continue to see prices gradually move up,” Jeff Waddell of Martin, Goodrich & Waddell (MGW), a major agricultural real estate firm in Illinois and several other states, told DTN. He doesn’t expect to see the 20% to 30% growth some predict for the next several years. “I don’t think the market is firmly established at the $11,000 to $13,000 prices that are grabbing headlines on some sales, but I think we will see more $10,000 and above sales in the next year or two.”
Waddell said there have not been many properties for sale — although he has seen rising numbers in the past month or so — at higher prices.
Current agricultural land values appear to be consistent with economic conditions and commodity prices, according to Rabobank economist Vernon Crowder. “There is little sign of a land price bubble at present,” he said.
THREE MAJOR DRIVERS FOR LAND VALUE
The three major drivers of recent agricultural land value increases are high prices for commodities, low interest rates and a limited amount of land for sale, Crowder said.
“The outlook for commodity prices is positive,” he said. “While volatility is expected, substantial price drops are not anticipated until global stocks can be rebuilt.”
However, producer profits are likely to be squeezed by rising input costs, he noted. “The result should be a slowing in U.S. ag land value growth, accompanied by occasional sharp decreases from year to year,” according to Crowder.
Risks related to commodity prices include the possibility of the U.S. government relaxing renewable fuel mandates and discontinuing tax credits for ethanol, long-term disruption of fertilizer supplies, an aggressive inflation control program that includes higher interest rates, or disruptions to global trade.
Waddell doesn’t expect any crash in the foreseeable future either. “The land is in very strong hands,” he said. He believes the loss of ethanol credits is already priced into the market.
“As long at oil is in the $90 to $100/barrel range, ethanol is profitable without them,” he explained. “However, if we lost the mandate, then we would see corn prices and therefore land, make a downward adjustment.”
Higher interest rates are the risk most likely to be realized over the next three to seven years, he believes. “Rates will need to increase from historic lows as the economy strengthens,” he said.
Iowa State University reported that farmers were the buyers in 70% of farmland sales in the state last year, versus 56% in 2004.
Citing the annual “Land Scan” report from the Realtor’s Land Institute, Crowder said the economic downturn and tight credit conditions had driven speculative buyers out of the market at the end of last year. “Agricultural land markets became very localized, with a buyer pool more familiar with local conditions and values.”
Outside funds remain a small proportion of farmland asset value, estimated in the range of $5 billion to $15 billion out of $1.7 trillion, Crowder said. Pension funds are the leading source of investment money, followed by endowments, hedge funds and wealthy individuals, according to the American Society of Farm Managers and Rural Appraisers. They are looking for reliable income even more than asset appreciation, he added.
The fact that farmers are the major buyers indicates farming is profitable. Farmers’ financial health is excellent right now, and although record prices have been logged on some sales, it does not appear producers are plunging into debt to make purchases. USDA reports that in the past five years, real estate debt has averaged slightly above 7% of the value of farm real estate assets, down from 10% in the 1990s and 13% in the 1980s.
FARMERS IN FOR LONG HAUL
Crowder said when producers purchase land, it is less likely to come back on the market, because farmers are in it for the long haul and not as influenced by other investment returns.
This will keep the supply of land available for purchase relatively tight, even though competition for non-agricultural uses has slowed since the financial crisis. “We have seen interest for commercial and residential building drop precipitously,” Waddell said.
Farmer domination of the land market does not of itself preclude a bubble, however, Terry Kastens, Kansas State University emeritus ag economist, told DTN. “After all, farmers were heavy buyers just ahead of the 1980s’ crash. The problem then was that farmers had become highly leveraged by the time of the crash and interest rates had jumped precipitously just prior to the crash, a double-whammy for landowning farmers at the time,” Kastens said.
“If we see a scenario similar to the 1970s, when high farming profit, low leverage, and low interest rates eventually gave way to low profits, high leverage, and high interest rates, then a bubble could indeed occur even without outside speculative monies involved,” said Kastens.
“It all depends upon how potential landowners, especially farmers, react over the next few years,” said Kastens. “If they allow their leverage ratios to increase at the same time that land values increase, we could still see a farmer-driven crash, especially if interest rates start jumping dramatically. After all, even modest declines in land values in the face of high leverage ratios can quickly turn those ratios into unsustainable leverage ratios as lenders restrict credit and induce land sales. So, the real question is: ‘Are farmers and lenders ‘smarter’ this time around, or will they again induce a bubble by their actions as farm profitability wanes and interest rates rise?’ Time will tell.”
DOWNWARD PRESSURE AHEAD
“Speculative bubbles are formed when asset values dramatically diverge from their fundamental economic value,” Crowder said. “Drivers of bubbles tend to be panic buying and selling, substantial short-term speculative interest and high levels of liquidity. This is not the case in farmland right now.”
However, although Crowder expects land values to increase again this year, he believes some downward pressure could be seen in the next three to seven years as the probability of negative factors builds. Possible threats to continued higher prices include a correction in field crop values in the Midwest, rising interest rates, a stronger dollar, and a moderation in global demand.
For USDA’s land value tables:
Linda Smith can be reached at [email protected]
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