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DAVID KRUSE

By Staff | Jul 3, 2015

The best farmland sold for approximately $15,000 per acre locally near the top before commodities dropped and farmland prices faded as net farm incomes declined.

A 20-30 percent correction would take $3000-4500 acre off the top. That would mean that the best land would be supported near $10,000 acre here in Clay County, Iowa. I don’t know about others, but I never valued my land at market highs. I have top quality land, but used the Iowa average price on my balance sheet on all, but a new purchase. That way my net worth is buffered from falling even though the price of farmland sells off. I have always strongly believed in owning the highest quality farmland, but I would have to credit my late grandfather or even his father with choosing the ground.

When the bull market for farmland got rolling, there were buyers who, looking for bargains, bought second cut land because it was “cheaper”. I have never understood that. I would rather have the best 40 than a second cut flawed 80 acres. It costs as much for input costs to farm poorer land and the yield and returns are never as good or as dependable. Locally what you are buying when you get a better farm is 3-4 weeks more staying power to survive a summer drought.

I think that some of the precision agriculture tools from mapped farms are showing that there are inputs wasted as portions of poorer farms lose money every year. You will never get your money back out of those acres. The rest have to make up for the poor acres which dilutes the ability for the whole farm to be profitable. There are technological advances such as variable rate planters or shut offs that allow farmers to match inputs to production history and even fallow portions of fields that produce poorly.

The decline from $7 bushel corn also changed some perspectives. There is no extra margin anymore. Second cut farms that made money when commodity values were high will not any more. There is typically more crop risk with those types of farms and crop insurance coverage will no longer guarantee break evens. One of the objectives of the market as low prices cure low prices is to fallow some land. There are farms where if you didn’t plant 20 percent of the acres you would make more money.

While farmland values may decline 20-30 percent on average overall, a top end farm may just fall 15 percent with the poorer farms dropping 40 percent. Still, by comparison the poorer farms may be too expensive.

If you are going to buy farmland in a correction, buy the best farmland. It is an opportunity. There are some farms where tile or investment can improve them, but you can’t change the soil or the creek running through it that floods. The ability to discern through precision analysis which parts of farms do not perform can be extrapolated into what farms are worth.

There was some surprise this spring as more tenants than usual gave up leases because they had the data from farming the farms to know whether the productivity could pay the rent and profit. Farmers who waltzed in and paid the high rent to get the farm may find out what the previous tenant already knew … the farm would lose money. Farmland prices will be impacted by net farm income and interest rates.

The 2015 estimated 32 percent decline in net farm income looks like a record drop. This loss was a combination of precipitous declines in crop revenue against stubbornly high input costs that resisted dropping. That combination is unlikely to be repeated next year. Crop prices should stabilize albeit at lower levels and costs should fall with the resulting combination allowing some improvement in net farm incomes.

The other major factor for farmland values is interest rates. Banks don’t pay much interest to depositors and even after the Fed gets around to a couple quarter point rate hikes, cash rents will still be very competitive with CDs at the bank. Interest rates have to go considerably higher in order to compete against farmland returns.

If interest rates go up that much, the U.S. economy frankly, would not abide that well which will limit the Fed’s scope for rate hikes well into the future. Farm managers and realtors note that farmland transactions have slowed considerably (-40 percent). Unlike the 1980s, farms are owned by strong hands and the leverage is much lower so that we are not seeing land bought recently at higher prices flow back onto the market pressuring values further in a cascading market.

I will go out on a limb and say that there are virtually no farms that are upside down in terms of equity. There are farms that have been bought at a higher price than today’s market but there is still a substantial equity cushion in those farms. Fifty-five percent was about the most leverage lenders would accept and many farms traded for cash. Investors are reportedly coming back into the farmland market today looking for the “best” land and good cash rent return. I think that net farm incomes will begin to stabilize and even improve as the cost structure adjusts and that the interest rate outlook will still allow cash rent to be competitive with CDs for some time to come.

I don’t recommend over leveraging to buy a farm, but if the neighboring farm comes up for sale, the weakness seen in farmland prices is opportunity. Farmland is a long term investment. In all the previous cycles where farmland prices have gone up to levels where many farmers said they didn’t or couldn’t work as they “were too high” . . . well, they are higher than any of those prices today even after the top has come off this market this cycle.

David Kruse is president of CommStock Investments Inc., author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet.

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