Farmland Values Have a Strong Base

October 23, 2011

PAER-2010-21

Craig Dobbins 

Over the last five years, farmland values have increased by 71%, which is even more than cash rents. From 2010 to 2011, average Indiana farmland increased 23.7%. The key factors behind the increasing cost of farmland are: 

  • Current high crop prices, 
  •  Rising yields, 
  •  High net farm income, 
  • Very low interest rates, 
  • Expectation for high crop prices, 
  •  Farmland as a relatively favorable investment, and 
  • A limited supply of land for sale. 

The expectations of farmland buyers about the above list of factors are critical. At the current time, the outlook associated with these factors remains bullish. The grain markets continue to wonder if there will be enough corn and soybeans to meet demand, keeping prices strong. Many people expect that it will take more than one year for supply to catch up with demand. Input prices are rising, but there continues to be an opportunity for farm profits to be above all costs. An increasing inflation rate and higher long-term interest rates are a concern, but there does not appear to be much evidence that either is likely in the short-run. 

The 2012 estimates in Table 3 indicate an estimated return to land and risk of $307 per acre for a corn-soybean rotation. What does a return of this amount say about farmland values? The 2011 Purdue Farmland Survey reports farmland is priced at 30-times gross rental income. The gross rental income is often used as a proxy for the return to land. If buyers expect the return to land to stay at $307 per acre, this level of income would support a value of $10,233 per acre for average farmland (assuming future returns stay at this level and they are capitalized at a 3.0% annual rate). It is very unlikely the return to farmland will remain at $307 per acre for a long period of time, but it does indicate that current conditions have the capability of pushing farmland values much higher. 

Dr. Scott Irwin, University of Illinois agricultural economist, has investigated where corn and soybean prices may settle after adjustments from the increased demand for grain commodities have worked their way through the agricultural economy. This price level is often referred to as the “new price plateau.” His research indicates corn is likely to average $4.60 per bushel and vary from $3.00 to $6.70 per bushel. His research indicates soybeans may average $10.58 per bushel and vary from $7.51 to $17.56. 

The new price plateau suggested by Irwin indicates that current expected 2012 prices are well above his averages. What are the implications for land values if prices are only at his averages? Using a corn and soybean rotation and prices of $4.60 and $10.58 per bushel, respectively, and the estimated costs in our budgets, corn-soybeans rotation provides a return to land and risk of $196. Using the value to income ratio of 30 indicates a farmland value of $5,868 for average farmland. This is just $400 per acre higher than the current 2011 value of $5,468 for average land. 

Is the Irwin scenario is correct? It is hard to know. If it is, it seems likely farmland values will overshoot the amount that will be supported by this new price plateau. What needs to happen to keep land values moving up? 

 

Here is a list of influences that will help farmland values move higher: 

  • Strong demand for corn from the ethanol industry because of biofuel mandates 
  • Strong soybean export demand 
  • 2011 U.S. corn and soybean crop that is average or below average 
  • Moderate increases in input costs for corn and soybeans, keeping crop production margins well above historic averages 
  • Low long-term interest rates 
  • Little change in the amount of land available for sale 
  • Influences that could result in steady or declining farmland values include the following: 
  • Sharp decline in corn and/or soybean export demand with falling prices 
  • Sudden change in the U.S. policy away from providing biofuel subsidies and mandating usage. Possible loss of direct payments and possible large acreage moving out of the Conservation Reserve Program and back into crop production 
  • Sharp rise in interest rates because of continued sovereign debt concerns or increased inflation fears 
  • Surprisingly large 2011 corn and soybean crop causing prices to fall sharply 
  • Sharp rise in crop input prices reducing crop production margins 
  • Slowing of world growth and threat of a U.S. or global recession 
  • Strong global supply response resulting from new capital investments in agricultural production 
  • Some combination of the above or some unknown development 

While the probability of events triggering a decline in farmland values seems low, the important thing is to assess how such an event would impact an individual’s business. In an economic environment with big uncertainties, a useful exercise is to perform a stress test. For example, how would the loss of 15% of the business equity affect the business? What would happen to the business if 15% of your free cash flow was lost? Can the business withstand a 15% decline in farmland values? After exploring these and similar questions it will be possible to develop a “Plan B.” 

It is the policy of the Purdue University Cooperative Extension Service that all persons have equal opportunity and access to its educational programs, services, activities, and facilities without regard to race, religion, color, sex, age, national origin or ancestry, marital status, parental status, sexual orientation, disability or status as a veteran. Purdue University is an Affirmative Action institution. 

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