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Wednesday, February 05, 2014

Watch Interest Rates For Clues On The Land Value And Cash Rent Relationship



 

Buyers and sellers of farmland and those who are paying cash rents for farmland may only have to look at the interest rates of the 10-year Treasury note to determine the direction of cash rents and their rate of increase or decrease.  While farmland owners and farm operators do an interesting dance to negotiate cash rents, the outcome is quite relative to the Treasury yield.  How would it know?

 

Regardless of whether farmland prices are going through a boom or bust period, the relationship between land value and cash rents, in terms of a percentage, is nearly parallel to the interest paid on Treasury notes by the US government.  While rent negotiations may be more of a challenge than looking up the latest interest rate, the entire process could be made much simpler if land owners and farm operators went into a rent meeting with a copy of the latest Wall Street Journal which indicates the T-bill interest rates.

 

That theory is outlined by Alan Barkema, formerly head of the Ag Econ Dept. at Oklahoma State and more recently retired from the Federal Reserve Bank at Kansas City.   Writing in the Ag Decision Maker for Iowa State University, Dr. Barkema says, “Investors are willing to pay more for assets with higher earnings and, as expected, a close and strongly positive relationship between earnings - measured by annual cash rent paid to land­owners.”  Consequently, recent higher values for farmland have been accompanied by higher cash rents charged to operators, but he says that is not always the case.

 

Barkema says the relationship between land values and rents is not constant. “The ratio of cash rent to farmland value - a measure of the financial yield on a farmland investment - has varied widely through time. The rent-to-value ratio edged down from about 8 percent to 4.5 percent as farmland value soared in the 1970s. Then the rent-to-value ratio shot up to a peak of about 10.5 percent as farmland value plunged to the 1986 low. Since then, the rent-to-value ratio has generally declined to the current level of about 3 percent.”   When that relationship is matched with the yield on Treasuries, Barkema says that is the key to the relationship.

 

Both land value and cash rents have a responding relationship to commodity prices, which are lower.  He says, “Big crops in 2013, however, have rebuilt crop supplies and pushed crop prices down, pointing to weaker farm earnings for the immediate future and clouding the longer-term outlook.”  Three projections for real cash rent are developed by Barkema:

 

1) a gradual increase during the next five years to a level 10 percent above the 2013 average, 
2) no change from 2013, and 
3) a gradual five-year decrease to 10 percent below the 2013 average.


He says these potential changes in interest rates illustrate potential trends in farm land values and their relationships with cash rents.  According to Barkema’s findings, a five year climb for Treasury note interest rates would suggest farmland values would rise about 4% and real cash rents would rise about 10%,.  If there is no change in interest rates from 2013, then farmland values would decline about 10%, however cash rents would hold steady. And if there is a gradual five year decrease in interest rates by some 10%, then farm land values could drop some 23% and cash rents would drop about 10%.

 

Summary:

Farmland earnings and the level of interest rates, which describes investment returns available in other parts of the economy, are key factors determining farmland value. In today’s economy, interest rates in national financial markets and the rent-to-value ratio in the farmland market are unusually low. Prospects for an eventual return of these key factors to historic norms are at the root of downside risk for farmland values.”

Posted by Stu Ellis on 02/05 at 11:21 PM | Permalink

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