Some Think Government Programs Cuts Might Drop Land Values Only Modestly

Proposals for the 1995 farm bill include reducing and perhaps eventually eliminating feed grain and other subsidies (deficiency payments). These payments in previous years have been an important source of farm earnings, so at least in the short run, reducing deficiency payments likely would lower farm earnings. In addition, farmers who own land may also suffer a reduction in net worth because of lower land values.

If land earnings decline, land values tend to decline, though not necessarily proportionally. Increased returns to land because of government payments tend to increase land values or keep them from falling as much as they otherwise would have. This is referred to as “capitalization of government payments into land values.”

Opinions of Farm Managers

To get an idea of the extent to which current government payments have been capitalized into land values, the judgement of members of the Indiana Society of Farm Managers and Rural Appraisers was solicited in April, 1995. They were asked this question: “If the 1995 farm bill eliminates government payments in 1996 and beyond, how much will farm land values in Indiana change as a result, with other things remaining the same?”

Ninety appraisers and managers responded. Seven percent thought land values would go up slightly, 37 percent said there would be no change and 56 percent felt values would decline – by an average of 10 percent. But the average of all respondents was a decrease of only 5.4 percent.

Then in June, as a part of Purdue’s annual land values and cash rents survey, estimates of cash rent per acre were obtained for a tract of average land with no feed grain program acreage versus identical land with a 60% corn acreage base. The average for land with a corn base was $100 per acre and for land with no base, $90 per acre. This small difference of $10 per acre may reflect the expectation that the market price of corn will be high enough so that deficiency payments will be low for the 1995 crop. Both of these estimates suggest that government program payments are not as significant a determinant of land values and rents as some might expect.

Some Economic Logic

A reasonable guess as to what deficiency payments might average over several years on 120 bushel, $1500 per acre land with 60% acreage base is $25 per acre. Is the market willing to pay only $81 (5.4 percent times $1500) for a net income of $25 per year? If so, perhaps the market already has substantially discounted the reduction or elimination of program payments.

An annual flow of income to land expected to continue indefinitely might be capitalized at 5 percent, a rate which is low because of other benefits to land ownership such as capital gains possibilities. Thus a permanent income flow of $25 per acre might be valued at $500. But if the flow is expected to continue for only 4 years and the discount rate is 9%, the $25 per acre payment would be worth $81 – the amount estimated by survey respondents.

Another April survey question had to do with the effect on land values of a reduction in the target price of corn by 3 percent per year for the next 5 years. On average, the group thought land values would decline by only 2.5 percent.

A third question was as follows: “Assume that a bare, all tillable tract of land has a corn acreage base equal to 60% of tillable acreage with an established yield equal to 85% of 10 year average actual yields. If this land has a market value now of $1500 per acre what would be the value now of an identical tract with no corn base?”

The average estimated value per acre of the land with no corn acreage base was $1415 – an $85 per acre discount. This is close to the $81 decline in value if government pro-grams were eliminated.

Another way to assess the value of the government program is how much it would cost to build an acre-age base. A 60% base could be established by planting continuous corn for 3 years. Costs would increase the second and third years (more nitrogen, perhaps insecticides) and yields might decline somewhat. In addition, compared to corn that qualifies for program payment, returns likely would be less, but that applies to only 60 percent of the land, assuming soybeans and non-program corn provide about the same net return.

The present value of program benefits of $25 per acre forgone for 3 years at 7% is $65, leaving $20 to cover the lower revenues and higher costs of corn-on-corn production in the second and third year. The $80-85 value of the government program thus appears to be reasonable in the terms of the cost of establishing an acreage base.

Other analyses have suggested a much greater reduction in land values from reducing or eliminating government subsidies. The most difficult unknown is the extent to which current land values reflect expectations of reductions in government payments. Are current estimates of payments being discounted at high rates and for short time periods? If so, program payment reductions may have a relatively small effect on land values. At least that’s what the survey respondents seem to think.