Wednesday, September 24, 2014

What's old is new; why farmland is the next great real estate investment.

Savvy investors are doubling down on an unexpected class of real estate that may just be the next big thing – farmland. While we’ve seen institutional investors, REITS, and builder’s focus on condominiums, shopping malls, and office spaces in the past, the winds of change have definitely shifted toward farmland and agricultural property.

While we may not think of owning vast tracks of tillable soil in the boonies as a sound investment, the facts paint quite the opposite picture. Since the end of World War II, farmland and agricultural land has risen steadily in value – even outpacing conventional home real estate – without the bubble-bursting downside. In fact, farmland has appreciated in value every year since WWII except for four – 1983, 1985, 1986, and 1987. According to the latest USDA figures, average Midwest farmland values have risen 128% over the past decade.

Why is dirt such a prolific appreciator? There are many benefits to owning rural or farmable agricultural property. But investors seem to be intrigued by hands-in-the-soil wisdom you might find in the Farmer’s Almanac; farm land is tangible, not some over-inflated balloon of tech concepts in Silicon Valley. You can walk the rows and touch the stalks. They aren’t making any more of it. And the population is growing – which means there’s an ever-increasing demand for food. 

According to the Food and Agriculture Organization of the United Nations, “the rise in local land prices has been fueled mainly by a worldwide agricultural commodity boom that has driven food prices up by more than 100 percent since 2003.” That’s a thirsty market for the most basic of necessities, and smart money wants in.

The farmland boom isn’t just in the United States – from Bulgaria to China to Africa (especially Africa,) huge institutional investors, sovereign wealth funds, and even the Mormon Church have been snatching up tillable acreage in the last few years with the ferocity of those betting on a sure thing.

The data confirms; farmland has outclassed the stock market since the late 1990s.  Iowa State University recently reported that someone who bought in 2000 and sold last year would have earned a 12.6 percent annualized return on his investment. While that’s remarkable in its own right, the lure of agricultural land goes further because it’s income-producing property.

Me, a farmer? But I kill all my houseplants, and I don’t even own a pair of overalls,” you may be saying right about now. Of course we don’t recommend moving out into the country and dropping your briefcase for a pitchfork. Instead, agricultural land can easily be leased out to a farmer who does know what he or she is doing. Once investors acquire the farmland, they rent it out to a tenant like any other income producing property, but this tenant plants soybeans or corn or wheat and split the profit with the landowner. In areas where large plots of agricultural land sit, there are plenty of farm-management companies who place landowners with eager farmers, based on the prevailing rent-to-value ratio of the land.

Thanks to the tornado of investors that have touched down in farmland, the amount of owner-operated farms in places like Iowa and the Midwest have dropped from 55% in 1982 to less than 40% in 2012.

What else makes agricultural land so attractive?

The sheer enormity of supply and demand based on our rising population is hard to ignore. Land is, of course, the definition of a fixed supply. A population in developing countries is expected to rise to 9 billion by 2050, up from our current 7 billion. Even in wealthy and developed countries like the U.S., higher demands for meat require more grazable acres and livestock grain supplies. Therefore, on a per capita basis, the amount of arable land available will decline over the next few decades, from 0.218 hectares per person today to 0.181 hectares per person in 2050.

But just like residential real estate, farmland allows leveraged buying; the bank is your partner. Your debt to income ratio will be lower than typical residential real estate, where you traditionally put 20% or less down, but farm owners and operators can also get loans for operational costs at low interest rates.

No different than the duplex you buy and rent out to tenants, your farmland can be leased to a professional farmer. But there are far more ways to generate revenue streams on agricultural land – including crops, livestock, hunting leases, recreational leases, marketable timber, water rights, or mineral rights.

Despite what you’ve seen in all the cliché farm movies, the government is actually your biggest ally when it comes to keeping your investment fertile. There are numerous of State and Federal programs to cost share, subsidize, and offer cash flow assistance to farmers. (Think about it – the government wants to incentivize food production and keep real consumer costs as low as possible.) They even have conservation programs for wildlife habitats or water filtration practices that could put cash in an owner’s ever-expanding wallet.

On top of all that, the demand for biofuels is skyrocketing. According to the Renewable Fuels Association, ethanol production now accounts for 23% of all corn crops in the U.S. That’s one of the reasons why corn prices have more than tripled between 2005 and 20012. So with farmland, you have an appreciating asset used to produce an appreciating asset.

Similarly, the tax benefits are profound. Mortgage interest for your farmland is deductible, but that’s just the start. Farm leases, improvements, planting costs, and equipment purchases are all tax-beneficial, and farmland  - as a class of commercial property – is eligible for 1031 exchanges, where it can be sold and exchanged for like-kind property without capital gains tax hits.

Investors also love the fact that farmland is a fantastic asset to diversify their portfolio. In fact, agricultural income-producing land is negatively correlated with assets like stocks and bonds and even run on different tracks than residential income properties, which means farmland is a major hedge against rising inflation.

Of course there are concerns and drawbacks. For instance, farmland is extremely illiquid, so an investor should plan for the long term when formulating an exit strategy. Value of the land and income is also volatile in the short term, as it’s tied to crops that can be affected by draughts, floods, climate, insect infestation, disease, consumer trends, and global-macro events.

The good news is that we’re not just taking about hundreds of acres in places like Kansas, where the downside is that…well, that you’d have to live in Kansas. Virtually every state has agricultural and farmland available, based on localized crops. Napa Valley’s grape production is a good example of that, as well as the various orchards, ranches, and dairy farms in Northern California. 

Contact us to find out more about available farmland in your area!

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