The Blogging Farmer

Alex Tiller’s Blog on Agriculture and Farming

Strong Fundamentals Continue in 2012 US Farm Industry

This past December I discussed how low interest rates and a sagging national economy were helping to fuel an expansion in farmland prices. Two factors are combining to cause this phenomenon. First, with poor returns in conventional investments, plus a continuing residential and commercial real estate bust and financial instruments paying almost nothing, investors have been pouring into the farmland sector as being one of the few good places to earn a solid return. Second, low interest rates make it possible for operating farmers to take out loans to expand their land holdings, and--despite the high prices of good land--make the investment pay, simply because the ongoing mortgage payments are relatively low.

That second factor can often cause some head scratching. How can a difference of just a few points on an interest rate make the difference between a profitable or unprofitable land investment? A quick back-of-the-envelope calculation should make it plain. If Farmer John takes out a 30-year loan for $1 million and uses that to buy prime land on which to expand, he's going to be making payments on that loan for 360 months. The size of the payments will depend on the interest rate. Not too many years ago, Farmer John would be lucky to get that million at 7% interest. At 7% interest, his amortized payment would be $6653 per month. But the current prime interest rate (the rate set by the Federal Reserve) is just 0.25%--about as close to zero as we can get. Farmer John doesn't get to borrow money at 0.25%; unfortunately for him, but if he's on good terms with his bank he can get a loan at 3%. And at 3%, his monthly payment on that land is only going to be $4216 per month, less than two thirds of what he would have had to pay a few years ago. A few percentage points of interest can mean a difference of hundreds of thousands--even millions--of dollars on the total price paid for the land.

Many farmers are also in an expansionary position because these low interest rates have allowed them to refinance old debt at the new rate, which can put thousands of dollars a month of cash flow into the operational stream. Since crop prices continue to do well overall, the best possible use for that cash flow is very often expanding existing operations - which again means buying more land. Even farmers who don't immediately expand are able to pay down old debt and improve their positioning for later land acquisition. (In fact, during 2011 total US farm debt declined from an estimated $246.9 billion to $242.5 billion, even as farmers were taking on new loans to fuel expansion, and an actual decline in total debt is a very unusual thing to have happen.)

And land values have continued to steadily appreciate--almost 6% in 2011. That means that the ongoing expansion of farmland prices is based on real accruals in equity via improvements in fundamental land values, not just on speculation and loan-driven expansions or acquisitions. (If a lot more investors are scrambling after the same, largely fixed, supply of farmland, then a "bubble" in farmland prices can begin to form...and bubbles tend to be bad for farmers and most investors alike. We are seeing an influx of investors, but we are not seeing an artificially inflationary rate of price growth on the land. (I'll discuss this more in some upcoming blog entries.)

‘…investors have been pouring into the farmland sector as being one of the few good places to earn a solid return.’

One key metric to look at in assessing the financial health of the farming industry, whether from the perspective of someone looking to farm or from the perspective of someone looking to invest in farming, is the overall debt to income ratio and debt to asset ratio of the sector as a whole--that is, how much do farms owe vs. how much do they bring in, and how much are they worth. Farm economists call these "solvency ratios" and they are very informative figures to track. The USDA's economic research service forecasts that from 2011 to 2012, total farm debt will go from $244 billion to $254 billion, but total farm assets will jump from $2.3 trillion to almost $2.5 trillion. That means the debt:asset ratio will fall to 10.3 (lower is better), continuing a multi-year steady decline in the ratio. Income for 2012 is projected to be $91.7 billion, a debt:income ratio of just over 27, another very solid figure.

These figures are the best they have been, not in years, but in decades. Farms haven't been so ahead of the debt game since the 1950s, while incomes continue to grow (for some sectors) or hold steady for others. This is the happy opposite of the farm crisis of the 1980s, when sky-high interest rates and flat commodity prices put many farmers out of business. There are many factors that farmland investors need to keep an eye on--and I will discuss some of those factors--but financially speaking the sector has not been on a sounder footing in living memory.

Sources
http://www.ers.usda.gov/briefing/farmincome/wealth.htm
http://www.ers.usda.gov/features/farmincome/
http://www.nationalaglawcenter.org/assets/crs/R40152.pdf

Hello, and thanks for checking out my blog.  My name is Alex Tiller and I grew up in rural Ohio (Clark County) where my family still owns farmland (corn and beans). I am a member of the American Society of Farm Managers and Rural Appraisers and am also an agribusiness author/blogger. I write about commercial farming, family farms, organic food production, sustainable agriculture, the local food movement, alternative renewable energy, hydroponics, agribusiness, farm entrepreneurship, and farm economics and farm policy. I visit lots of farms in different areas of the country (sometimes the world) that grow all kinds of different crops and share what I learn with you through this blog. You can contact me via email by clicking here: Email Alex at http://blog.alextiller.com/contact