Land Values and Cash Rents Financial Health of Farming and Land Values March 27, 2013 Brent Gloy and Craig Dobbins Purdue University Center for Commercial Agriculture [email protected] Twitter: @brentgloy [email protected]

In Real Terms, Today’s Farmland Value Increases on Par with those of the 70’s Region

Nominal Change Real Change and Annualized Growth Rate Annualized Growth Rate --------------------------------Percent ----------------------------

Iowa

1971-1981 2001-2011

399 17.4 248 13.3

122 8.3 176 10.7

343 16.1 149 9.6

97 7.0 97 7.0

381 17.0 104 7.4

114 7.9 62 4.9

Illinois 1971-1981 2001-2011 Indiana 1971-1981 2001-2011 a

Iowa farmland values from the Iowa State Farmland Survey (Duffy). Indiana, Illinois, and U.S. Values from National Agricultural Statistics Service. Real values calculated using the CPI index.

Are Land Values in a Bubble? • Probably not the right question – Economists say no bubble, but that doesn’t tell us much

• Right questions – What might trigger a change in direction (correction)? – How would a change in direction work through the system? – How would a change in direction impact equity & cash flow?

Frequency of Corrections • 10% or greater decline in prices in a short span of time? – Not frequent in our modern farmland markets – One exception when we had several in a row • Corn belt roughly 50-65% decline from 81-87

The Tenth District Includes Colorado, Kansas, Nebraska, Oklahoma, Wyoming, Northern New Mexico, and the Western third of Missouri

Long-Run Asset Values Tied to Income Potential • Asset’s value derive from expected value of future income • Expected income – May grow or shrink – Be viewed as more or less valuable in today’s $’s – Is evaluated against risk and opportunity costs – Is subject to individual forecasts, moods, feelings, etc.

Simple model of linkages Income Farmland Value  Discount Rate (%)  Income Growth Rate (%)

• Income = net return to farmland ownership • Discount rate = risk-free rate of return, inflation, and risk premium • Growth rate = growth rate in income or net return to farmland

• • •

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Will rates move up as slowly as they have moved down? Rate impact would likely felt on valuations today Cash flow impact will be secondary impact unlike 70’s Warning sign 1 – something changes to take us out of accommodation

Cap Rate Risk • • • • •

Monetary policy change = cap rate ↑ Economic recovery = cap rate ↑ Inflation = cap rate ↑ — ↓ Increased volatility/risk = cap rate ↑ Slowing income growth in ag = cap rate ↑

Land rent has averaged 35% of revenue over this period, high = 45%, low = 22%

So What About Corn Prices? • Darrel Good and Scott Irwin forecast the new plateau prices as follows: Corn Post Dec 2006 Monthly Price

Soybeans

Wheat

----------$’s per Bushel-----------

Average

4.60

11.50

5.80

High

6.70

19.10

10.15

Low

3.00

8.20

3.30

SOURCE: Good, D. and S. Irwin. “The New Era of Corn, Soybean, and Wheat Prices.” Marketing and Outlook Briefs, MOBR 08-04, September 2, 2008 Dept. of Agr. Cons. Econ, University of Illinois.

Box captures I&G’s price range if land receives 35% of gross revenue Current yield = 192bpa, current rent = $265/acre

Some Budgets Scenario 1 Yield Price Revenue Variable Costs Contribution Margin

Per Acre 196 $5.60 $1,098 $479 $619

Machinery Costs Family/Hired Labor Land rent Total Fixed Costs Profit

$104 $65 $265 $434 $185

Per Bushel

$5.60 $2.44 $3.16 $0.53 $0.33 $1.35 $2.21 $0.94

Lower Prices Lower Prices Yield Price Revenue Variable Costs Contribution Margin

Per Acre 196 $4.75 $931 $479 $452

Per Bushel

$4.75 $2.44 $2.31

Total Fixed Costs Economic Profit

$434 $18

$2.21 $0.09

Profit at $400 Rent

-$117

-$0.60

Higher Prices Lower Prices Yield Price Revenue Variable Costs Contribution Margin

Per Acre 196 $6.50 $1,274 $479 $795

Per Bushel

$6.50 $2.44 $4.06

Total Fixed Costs Economic Profit

$434 $361

$2.21 $1.85

Profit at $400 Rent

$226

$1.15

Crop Insurance Impact Per Acre Per Bu Revenue Guarantee 75% Rent for $0 profit @ Crop Ins Guarantee

Profit @ Crop Ins Guar. w/$400 acre rent

$823

$4.20

$175

$0.89

-$225

-$1.15

Conclusions • Rise in farmland values has been supported by increased profits • Owner’s operating return more variable • Changes in perceived market fundamentals can quickly changing expected profit • Declining profit likely to be accompanied with decline in value • Environment of steady or rising interest rates requires a different strategy than declining interest rates • Cash flows likely to tighten before land values