Farmland Values: Current and Future Prospects
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Farmland is a critical asset in the agricultural sector. Recent increases in farmland prices have generated considerable discussion of the level of farmland values. This paper describes some of the key characteristics of the farmland market, the market forces impacting farmland values, and how farmland values are determined.
There are several unique characteristics of the farmland market. The market is much less liquid than agricultural product markets, meaning that transactions take longer to occur and are often more complex than most agricultural products. One key factor driving the farmland market is the return to agricultural production. However, some land markets can also be influenced by a number of factors such as the potential conversion to urban development, qualification as like-kind property in section-1031 tax exchanges, and capital gain tax policy. It is important to recognize that the amount of total farmland transacted is typically small and uncertainty around future earnings potential can significantly reduce the amount of transactions that take place in the market.
Because farmland will generate returns for many years into the future, the perceived future income potential associated with the land has an important impact on the price that people are willing to pay for farmland. Crop production has been quite profitable in recent years. This has been driven by increased demand associated with biofuels, a weak U.S. dollar, and increasing demand for agricultural commodities from developing countries. These strong fundamental factors have helped to significantly increase the value of farmland.
High agricultural returns have coincided with low interest rates which support capital asset prices. Lower interest rates reduce the rate at which expected future returns are capitalized. This decline in the capitalization rate means that every dollar of future income is worth more today. This can be seen in the farmland market where the ratio of farmland value to cash rent has steadily increased since the late 1980s. Today, the value to rent ratio for average quality Indiana farmland is at an all-time high, slightly over 27.
Whether such values are warranted will ultimately depend on future events. The analysis in the paper suggests that at their current levels, farmland values indicate investors expect continued high levels of earnings, strong growth in crop returns, and interest rates to remain relatively low.