Throughout time, farmland ownership has provided a good opportunity to build wealth. Historically, farmland ownership was a way of life not well understood by outside investors who often neglected farmland as an investment. This is quickly changing as people are now looking at farmland as an investment vehicle not unlike stocks and bonds.
In evaluating farmland as an investment, it is necessary to compare it to other investment choices in the marketplace. There are four specific areas to evaluate to determine if farmland is a good investment vehicle. These four keys are: income, appreciation, risk, and diversification.
Income
Income is the opportunity for an annual cash return to an investment. For farmland, income is a function of the crop production and can rise and fall with projected commodity prices. The ability to cash rent lease farmland provides an opportunity to ensure a positive cash flow on an annual basis. Historically, farmland in the Midwest returns 3% to 5.5% annually. In comparison to other investments, farmland has low volatility with very little risk of negative returns.
Income produced by Midwestern farmland continues
to be strong. Even with commodity prices fluctuating
over the past twelve months, the worldwide
population continues to grow, increasing the need
for food. The expanding use of alternative fuels, made
with corn and soybeans, also helps increase the need
for commodities from farmland. Machinery technology
and improved crop genetics increases productivity and
yield potential from every farmland acre, fueling farmer
competition and increasing rental rates. These factors
will continue to provide strength in farmland income
into the foreseeable future.
Appreciation
The graph below shows the average value of Class A farmland in Macon County, Illinois over the past seventy-five years. There has been a relatively stable pattern of growth over that time, with only one period of negative growth during the early 80’s. The crash in the 80’s followed a period of steep gains in the late 70’s was fueled by high inflation and highly leveraged buying. The annually compounded rate of appreciation for Illinois farmland from 1910 to 2009 is 5.9%.
he most recent gains are based on economic
fundamentals and are well supported by a large
number of cash buyers. The lessons of the late
70’s have helped create a more fundamentally
sound footing for the land market, which has
been mostly unfazed by the problems seen in the
rest of the U.S. and world economies.
Risk
In light of the recent economic downturn, the risk associated with an investment has become more important to potential investors. Historically, farmland has performed very well relative to other equity categories and fixed income alternatives. In general, Midwest farmland involves less risk than other equity market alternatives.
Farmland is tangible, making it unique as an investment. With farmland, it can be seen, used and touched by the owner if so desired. It cannot be embezzled or stolen and cash rent can be paid in advance insuring the annual income.
Agriculture in the U.S. is well capitalized, with the U.S. agricultural balance sheet showing only 5.4 cents of debt for every dollar in assets. As the population continues to grow worldwide, the need for productive farmland will remain strong.
Diversification
When evaluating the investment performance
of an asset, it is important to understand the
role of diversification of a portfolio and its
relationship to inflation and other factors that
affect future purchasing power. Farmland has a
positive correlation with the Consumer Price Index
(CPI), better known as inflation. Farmland has a
negative correlation to U.S. Treasuries, corporate
bonds and the Dow Jones, making a good
addition to diversify any investment portfolio.
The current economic situation in the U.S. has
increased the concern for inflation. Farmland acts
as an inflation hedge which helps to preserve
purchasing power in the future. As defined by
Wikipedia, an inflation hedge is an investment
with intrinsic value such as oil, natural gas, gold,
or farmland. Of these choices, farmland is the
only investment that also provides an annual cash
return. Academic studies looking back over 100
years indicate farmland value is more than 90%
correlated with inflation.
Summary
In summary, historical research shows that farmland returns have displayed low risk, high inflation hedging potential and good diversification benefits. The past year and a half has shown the importance of evaluating all factors in any investment. In correlation to the low or negative returns of many other investments, farmland has provided a good diversification in any investment portfolio. Farmland has shown positive returns in both cash and appreciation and also shows positive correlation with inflation, providing a good hedge against future possible inflation. Overall, farmland compares favorably when compared to other investments when judging its income, appreciation, risk, and diversification.
Our team of farmland specialists has a wealth
of experience in farmland brokerage, farmland
appraisals and farm management. We can
provide the background to assist in evaluating
how your investment in farmland is performing
or to evaluate a contemplated investment in
farmland. Please feel free to contact us with
your farmland as an investment questions and
concerns.
