December 1, 2011
Fixed and Flexible Cash Rent Agreements for Your Farm
Should You Be Using a Fixed Cash-Rent Arrangement?
Landowners and operators can choose from several types of rental arrangements. In addition to cash rent, the lease agreement can be a crop-share lease, fixed bushel lease or net share lease. Landowners who wish to retain management control but do not have the necessary equipment or labor may hire custom operators to conduct all or specific field operations. This type of custom farming arrangement leaves all risk with the landowner. Similarily, landowners can hire labor to operate their own equipment to conduct field operations. There are both advantages and disadvantages to cash rent arrangements. Some points to consider in deciding whether the fixed cash rental arrangement fits your situation are outlined in the following discussion.
Advantages of Cash Renting – Landowner
- Less (perhaps no) managerial input is required than with other leasing arrangements.
- Reduced involvement in management reduces the possibility of friction between the landowner and operator concerning management decisions.
- Concern over accurate division of crops and expenses is eliminated.
- The landowner does not have to handle the marketing of crops.
- Fixed cash rent lessens the landowner’s concern over variations in prices and yields. The operator bears all price, cost, and production risks.
- Income under the lease does not constitute self-employment income subject to Social Security tax and will not reduce Social Security benefits in retirement.
- Reduced paperwork requirements stemming from the fact that the landowner no longer is required to fulfill crop insurance and Farm Service Agency (FSA) obligations.
Disadvantages of Cash Renting – Landowner
- A cash-rent amount acceptable to both parties can be difficult to determine.
- Once a cash-rent rate is set, a change in the rental rate may be difficult to negotiate when changes in prices and costs take place.
- In average or above-average years, the landowner may receive less net income than from crop-share rent.
- The landowner has fewer opportunities for income tax management. Under a crop-share arrangement and cash reporting of taxable income, the amount of taxable income can be shifted from one year to another through timing of crop sales before or after the end of the year. Similarly, purchase of fertilizer, seed, or other inputs for the next growing season can be made in the closing months of the tax year to reduce taxable income.
- There may be an increased danger that the operator will not maintain the fertility of the land, or keep buildings in good repair, especially if the lease is for only one year. However, competition for land and appropriate requirements in a written lease can minimize this problem.
- The landowner has little opportunity to build a base for Social Security payments because of the difficulty in establishing acceptable evidence of material participation. This may not be a concern to retired landowners however.
- To value the farmland in the landowner’s estate at its use value rather than its fair-market value for estate tax purposes, the following two requirements must be met:
- Before the landowner dies, a cash-rent lease can be used only to a member of the landowner’s family as the operator.
- After death, the heirs must not rent out the use-value land under a cash lease, not even to a family member.
- Eligibility for paying federal estate tax in installments over 15 years after death could be jeopardized. Land rented under a cash-rent lease does not constitute an interest in a closely held business, which the decedent must have at the time of death to be eligible to pay federal estate tax in installments. Only crop-share or livestock-share leases qualify as an interest in a closely held business.
- Owner has financial risk of operator non-payment unless steps are taken to reduce this risk. Steps may include:
- Recording the written lease at the proper local government authority.
- Require all or a portion of the rent to be paid in advance.
Advantages of Cash Renting – Operator
- The operator has a relatively free hand in making management decisions.
- Potential for friction between the operator and landowner is minimized because of the landowner’s reduced participation in management.
- The operator has more incentive to strive for high yields.
- The operator can benefit from any windfall profits from unexpected crop price increases or unusually high yields.
- The operator does not need to divide crops or income from sale of crops nor keep special records on expenses for the landowner as required under a crop-share lease.
- Compared to land ownership, less capital is tied up in the land asset.
Disadvantages of Cash Renting – Operator
- Increased risk from price and yield variations. Cash rent is a fixed cash expense that may be very difficult to pay in a poor crop year or with very low crop prices.
- Increased risk from losing land base that may be critical to the financial security of the operator’s farm business. Owner may choose to rent farmland to another operator.
- Cash rental rates tend to trend upward as crop yields increase, even though most of the yield increases may be a result of managerial skills.
- The operator must supply all the operating capital needed to purchase crop inputs, as well as to pay any of the cash rent that is due in advance.
- No USDA payment limitation is created for the landowner (versus a crop share lease), possibly reducing the overall value of payments that can be received by the operator and landowner combined.
Establishing an Equitable Fixed Cash Rental Rate
Factors Affecting Cash Rental Rates
Ultimately, supply and demand of cropland for rent will determine the cash rental rate for each parcel. The expected return from producing crops on a farm parcel is the overriding factor in determining the demand for a farm and is the primary driver in establishing an equitable rental rate. Local supply and demand of cropland will affect rental rates in any given community. Many of the following factors contribute to the expected crop return and the supply and demand of cropland. Other factors listed affect potential rental negotiations in different ways.
- Expected Crop Return – Rent will vary based on expected crop return. The higher the expected return the higher the rent will tend to be.
- Variability of Crop Return – Land that exhibits highly variable returns may have rents discounted for this quality. For example, land that is poorly drained may exhibit variability of returns due to late plantings from wet springs.
- Land Quality – Higher quality soils translate into higher rents.
- Fertility Levels – Higher fertility levels often result in higher cash rents.
- Drainage Capabilities – Better surface and sub-surface drainage of a farm often results in better yields and higher potential cash rent.
- Buildings and Grain Storage Availability – Access to machinery and grain storage may enhance the value of the cropland rental rate.
- Size of Farm – Large farms typically command higher average cash rent per acre due to the efficiencies gained by operators.
- Location of Farm (Including Road Access) – Proximity to prospective operators may determine how much operators are willing to bid for cash rents. Good road access will generally enhance cash rent amounts.
- Shape of Fields – Square fields with fewer “point rows” will generally translate into higher cash rents as operators gain efficiencies from farming fields that are square.
- Previous Tillage Systems or Crops – Previous crops and tillage systems that allow for an easy transition for new operators may enhance the cash rent value.
- USDA Farm Program Measurables – Farms that participate in the USDA Farm Program and have higher “program yields” may command higher cash rents than non-program farms.
- Services Provided by Operator – Operators that “go the extra mile” by providing services such as clearing fence rows, plowing snow in the winter, and other services may be valued by the landowner. This may even be a partial substitute for cash rent increases.
- Conditions of Lease – Conditions placed on the lease by the landowner may result in fewer prospective operators and a lower average cash rent.
- Payment Dates – Leases that require part or all of the rent to be paid early in the year (“up-front”) may result in lower rental rates due to higher borrowing or opportunity costs for the operator.
- Reputation of Landowner/Operator – Reputations of the parties may play a part in the cash rental negotiations. A landowner that has a reputation of being difficult to work with may see cash rents negatively affected by this reputation.
- Special contracts that are tied to the farm – Farms that have special contracts tied to them may restrict the operator from changing crops based on market conditions. This may negatively impact cash rents. There may also be contracts that positively affect cash rents such as high value crop contracts or contracts for receiving livestock manure.
If the decision is to rent for cash, how is an equitable rental rate determined for the farm or field in question? There are several methods that can be used to establish a fixed cash rent for a particular farm or field: 1) cash-rent market approach, 2) landowner’s ownership cost, 3) landowner’s adjusted net-share rent approach, 4) operator’s net return to land approach or the “the amount an operator can afford to pay”, 5) percent of land value approach, 6) percent of gross revenue approach, 7) dollars per bushel of production, and the 8) fixed bushel rent.
The following discussion and worksheet examples are related to cash renting a farm.
The concepts and approaches outlined in this publication are the same whether cash renting of a field or total farm is being considered. In some cases, the landowner and operator may only want to consider cash rent for a specific crop.
Cash-Rent Market Approach
This method requires knowledge of cash rents being paid for farms in the area. It assumes rents reflect an arm’s length negotiation between an informed landowner and a knowledgeable operator. Adjustments should be made for differences in the productivity of the farm and the amount and quality of improvements.
This approach has some disadvantages. It may be difficult to determine actual cash rents being paid for comparable farms as well as any adjustments that need to be made in the rental rates. Other approaches may be more complex, yet better reflect a specific situation. The rates determined by any method cannot deviate greatly from the prevailing market rates if those rates are to be seriously considered in the final bargaining process.
Prevailing rental rates may be available from surveys conducted by state Extension specialists or by the National Agricultural Statistics Service (NASS). Do not assume that informal reports or rumors of rental rates for specific farms are accurate or representative of all rented land in the area.
Landowner’s Ownership Cost
Under this approach, the landowner calculates the cost of resource ownership from the property. Worksheet 1 provides an example of the required computations. Some points to remember in deriving these ownership costs are:
Land: Land is valued at its current fair-market value for agricultural purposes. The influence of location near cities and other nonagricultural influences on value should be ignored. That is, the value of land as it relates to its productivity in crop production is all that should be included as this is what is offered to the operator as rent.
Interest on land: The land value multiplied by an opportunity interest rate is a method of estimating the annual land charge. A practical starting point for negotiating the return to land is the rent-to-value ratio in the region (cash rent divided by market value), as this reflects the “opportunity cost” of not renting the land on a cash basis. Table 2 reports the rent-to-value ratios for average cropland in the various regions in the U.S. as reported by USDA NASS. It can be seen that the rent-to-value ratios vary considerably from region to region. Additionally, it can be seen that the ratios have been trending down in some regions and thus using a longer term historical average value may not be appropriate.
Real estate taxes: The actual taxes due annually is another contribution of the landowner.
Land development: The average dollars spent annually for lime, conservation practices, and other land improvements should be used.
Other: If capital has been invested to improve land productivity, such as tile drainage, then include a reasonable depreciation allowance for this investment.
This method may result in a high value, but the method does give the landowner a basis for setting the “asking price” in cash-rent negotiations.
Landowner’s Adjusted Net-Share Rent
This method for computing cash rent assumes the rent value should be comparable to the net return a landowner receives under a crop-share lease. Normally, fixed cash rents are expected to be lower than net crop-share rent since the operator incurs all price and weather risk. The difference represents the operator’s compensation for carrying the added risk.
Cash rents are not always less than crop-share rents, however. If there is a strong demand for land in an area, cash rents may exceed net crop-share rents. This explains why landowners are sometimes reluctant to change from cash rent to crop-share arrangements.
If this method is utilized, an average net crop share over a period of years should be used to allow for both good and bad yields. Landowners who have rented on a share basis in previous years are likely to know the percentage of crop share received.
Worksheet 2 will help the landowner estimate what the average net-share rent has been. Use yield and cost values that can be realistically expected for the current year and typical share arrangements for the community or area in determining the landowner’s share of income and expenses. Other income such as USDA payments should be added if they are a part of total gross income. No USDA income is included in the following example worksheet.
Once the net-share rent value has been determined or estimated, the landowner and operator must decide how to adjust this value for price and weather risk assumed by the operator. Determination of the risk value is a matter for negotiation. In the example, the risk value was set equal to 5 percent of total crop receipts.
Operator’s Net Return to Land
In the desire to farm more land, operators may at times bid more for land than they can actually afford. Hence, operators need to carefully budget how much money will be available to pay for the use of land after variable expenses, fixed costs on machinery, and a return to labor and management have been deducted from the gross value of crops. Worksheet 3 outlines a procedure to estimate how much can be paid for land in the form of cash rent.
The values for labor and management may be the most difficult to determine. The labor value used should reflect the amount of time used only for crop production and general farm maintenance. The hourly rate should equal what could be earned if working for other farmers in the area. Management is sometimes valued at 5 to 10 percent of gross value of crops, or 1.5 to 2.5 percent of the investment in land, equipment, and machinery.
Percent of Land Value
Land ownership may be viewed as just another type of asset in a portfolio of investment alternatives. Owners would likely be looking for a rate of return commensurate with other types of investments, adjusted for differences in risk. Comparable investments would include investments of a similar holding period. In the case of land, longer term investments should be used as comparisons. The landowner and the operator are exposed to different types of risk in this scenario. The landowner’s primary risk is the potential for land values to decline. The operator’s primary risk is the variability of yields, market prices and cost of inputs. Worksheet 4 provides an example.
Table 2 shows average cash rents as a percent of land value for several states over a decade. In recent years land values have been increasing faster than rents, causing rent as a percent of value to decline. A partial explanation for this trend is a general decrease in interest rates and returns on alternative investments during this time period. The values in Table 2 do not represent a net return on investment – ownership costs such as property taxes and upkeep of fences, terraces and tile lines must be paid from the cash rent received.
Percent of Gross Revenue
Another method of establishing a cash rental rate is to set it equal to a fixed percent of the expected gross revenue produced from the rented land. This would include income from the sale of grain or forage production as well as any secondary products such as straw or stover. This method would be similar to share renting except the landowner would not have a share of the crop to store and market, nor pay any input costs.
The expected yield can be based on actual yields obtained from the farm in recent years, if such information is available. Expected prices for major commodities can be found by adjusting the relevant harvest time futures prices for typical basis values, or checking to see what forward contract prices are being offered by local buyers at the time the rent is being determined. Some products such as forages and straw are more difficult to assign a market value to, due to less market data being available.
The appropriate percentage of the gross income to use to establish the cash rent can be a typical share of the crop received by the landowner under a crop share lease in which the operator pays all the production costs. This share will vary by region. Worksheet 5 shows an example of this approach to setting a cash rent.
Dollars per Bushel of Production
This method calculates rent based on a fixed value per bushel. The rate may be based on the dominant crop and applied to all acres or may be based on all crops produced. If this method uses actual yields, it would become a variable rent from year to year, as discussed in Part IV. If it is based on a constant or expected yield, such as a productivity index, it is a fixed cash rent. This is a reasonable approach when selling prices are relatively stable over time. It is also useful for adjusting the rental rate for differences in productivity among farms in a county or region.
Fixed Bushel Rent
A fixed bushel rent would the pay the landowner a rent based on the value of an agreed on quantity of production each year. If the expected selling price at the time the rent is negotiated is used, the rental rate is considered a fixed cash rent. If the actual value of the rental payment is based on the current market value of a fixed number of bushels after harvest, this method becomes a variable cash rental agreement, as discussed in Part III. See Worksheet 7 for an example based on the sample farm listed in previous examples.
What is an Equitable Cash Rent? – The Bargaining Process
A final cash rent figure acceptable to both operator and landowner can be derived from more than one of the methods outlined in this publication. They should identify areas of agreement and differences based on the values each has independently developed. To aid in this process, Table 2 summarizes the example values derived from the different methods.
Negotiation provides a means of arriving at a rate that is acceptable to both parties and is an opportunity for them to understand each other’s point of view. Negotiations should begin only after the contributions of each party are known and information is provided on local leasing arrangements.
Both parties need to recognize that pressing an advantage too far can result in an inequitable arrangement for one or the other. A lease that is inequitable to either party is unlikely to last. An inequitable, lopsided arrangement tends to discourage good management and cooperation from the disadvantaged party.
In addition to one-on-one negotiation between landowner and operator, landowners have other options for securing an operator farmer and determining a cash rental rate. The landowner should have the fundamental terms of their leases (i.e. the portions that are, from their point of view, non-negotiable) in place so that potential bidders can be aware of those terms and take them into consideration when formulating their bids.
Bid Process – A landowner may request bids from targeted farmers or may open the bid process to any and all prospective operators. The landowner should include whatever provisions he/she likes in the request for proposals. The landowner can evaluate each bid on its own merits to determine the best fit for his or her farm. There are even commercial services that allow landowners to offer farms for rent over the Internet.
Auction Process – Farms may be offered for rent at a public auction, just like a land sale. Cash rent auctions are not widely used, but are a way to attract very high rents. However, the highest bidder may not be the best operator in the long run when it comes to caring for the property, and it is difficult to negotiate other conditions of the lease after an auction is held.
Professional Farm Manager – Many landowners employ a professional farm manager as their agent. The manager will locate an acceptable operator, negotiate the rental rate, and oversee the owner’s interest in the property. Management firms may conduct sealed bid auctions to attract favorable rental rates. Landowners who live far from their farm and/or who have little knowledge of rental rates and customs will benefit the most from employing a professional manager.
Negotiating Rental Payment Timing
The time and method of payment for the rent should be established in advance and recorded in the lease. Local customs for the timing of lease payments vary widely. Some landowners require part or all of the rent to be paid in advance (when the lease begins) in order to reduce the risk that the operator may be financially unable to pay the rent later. Others may allow the rent to be paid in several installments or after the crop is harvested. The payment stream should be adjusted to fit the operator’s income flow as well as the landowner’s need for cash to cover expenses.
The timing of the rental payments should be considered when setting the rental rate. For example, if a $200 rental payment is required to be made 8 months prior to harvest, and the operator is paying a 6% annual interest rate (0.5% per month) on borrowed operating capital, he or she will incur an extra financing cost of $200 × 0.5% × 8 months = $8. In this case the rental rate should be $8 lower than for a lease that allows rent to be paid at harvest.
- 100% paid by May 1
- 50% paid by February 1 and 50% paid by December 1
- 100% paid by December 1
USDA Farm Program Participation
USDA farm commodity payment programs contain a multitude of provisions that provide a level of risk protection for producers who enroll in them. Land rental arrangements may impact how program payments are distributed. Under USDA regulations, if the rental agreement is determined to be a cash lease by the Farm Service Agency (FSA), the operator is entitled to receive 100 percent of farm program payments. If the lease is interpreted by FSA to be a share lease, then neither the landowner nor the operator may receive 100 percent of the farm program payments. Customarily, payments are divided in the same percentage as the crop.
Beginning in 2009, FSA adjusted the interpretation of flexible or variable cash rental arrangements, such that most of these leases will now be considered cash leases. If a lease provides for the greater of a guaranteed amount or share of the crop or crop proceeds, the lease will be considered a cash lease if the lease provides for both:
- A guaranteed amount such as a fixed dollar amount or quantity; and
- A share of the crop proceeds.
Putting Flexibility in the Cash-Rent Arrangement
Farm commodity prices, yields and operating expenses are often uncertain. Therefore, operators and landowners may hesitate to commit to a fixed cash rent, especially for more than one year. Operators fear a fixed cash rent could pose a real hardship if commodity prices decline, if poor growing conditions reduce yields, or if input costs increase substantially. Landowners believe they should share in the benefits from a sharp rise in crop prices or higher than expected yields. At the same time, neither party may desire a crop-share leasing arrangement. Therefore, the operator and landowner may turn to the use of a flexible cash rent of one kind or another. The idea of a flexible cash rent usually pertains only to the rent charged for cropland. Rents for buildings, for other farmstead facilities, or for comparatively minor acreages of pasture, hay, and woodland are usually fixed even when the rent for cropland varies. Both landowner and operator need to agree on the amount of “non-flexible” rent at the beginning of the lease period.
Advantages and Disadvantages of Flexible Cash Renting
A flexible cash-rent arrangement for cropland has certain advantages and disadvantages.
- Flexible cash rent enables the landowner to share in the additional income that results from unexpected increases in the prices of crops considered in the rent-adjustment clause. If the cash rent also is flexed for changes in yields, the landowner will benefit from above-normal yields regardless of the cause.
- For the operator, risk is reduced. Cash-rent expense is lower if crop prices or yields are less than normal.
- Calculating flexible cash rent requires more communication from both parties.
- For the landowner, flexible cash rent increases risk.
- Windfall profits that may be realized by the operator from unexpected price increases are reduced.
- If cash rent is flexed according to yield, the landowner becomes more concerned with the level of crop yields as well as the accuracy of reported yields. Yields must be verifiable and segregated for each land unit in the lease.
- If cash rent is flexed according to yield, the operator may give up part of the benefits from higher yields resulting from managerial input, thus possibly reducing incentives to maximize profits.
- Calculating flexible cash rent requires more management from both parties. There must be agreement on how to verify the factors that are used to set the rent each year.
Different Methods of Flexing Cash Rent
Cash rents are flexed primarily by: 1) flexing for changes in crop price only 2) flexing for changes in crop yields only or 3) flexing for both crop price changes and yield variations. Few, if any, methods provide for flexing cash rents in response to sharp, unexpected changes in the cost of purchased inputs. Thus, flexible cash rents should be examined periodically to determine if adjustments are needed due to changes in input costs.
Flexing for Crop Price Only
One flexible cash rent approach allows for flexing the cash rent only for changes in the crop price. Several “price only” options are available with four different methods outlined in the following discussion. Rents that flex only on price increase risk substantially for operators. A short crop that leads to higher prices and higher rent may leave the operator with less ability to pay.
Base rent multiplied by ratio of current year’s price to base price. The operator and landowner should agree at the beginning of the leasing period on a base rent and a base price if this method is used. For example, the operator and landowner might agree that the base cash rent would be $175.00 per acre and the “base price” of corn is $3.50 a bushel. If the “current year’s price,” equal to the average closing price at Anytown Elevator during the period September 15 to November 1, is $3.80, the current year’s cash rent would be calculated as follows:
base rent × (current year’s price ÷ base price) = current year’s rent
$175.00 × ($3.80 ÷ $3.50) = $190.00
Rent equal to the value of a fixed amount of commodity. An example of this method of flexing cash rent is to set the rent equal to the value of a given quantity (bushels, tons, pounds, etc.) of the primary crop. The price used for determining this value would be based on price quotations at a particular location and period available to the operator. For example, if the primary crop were corn, the lease might state the following: “The amount of the cash rent shall be equal to the value of 56 bushels of corn per acre based on the average daily closing price at the Anytown Elevator during the period September 15 to November 1.” The location and time period to be used for determining the price should be agreed upon in advance and stated in the lease agreement. With this method, cash rent flexes as crop price changes. (This method is similar to the Fixed Bushel Rent method cited in Part II “Establishing an Equitable Fixed Cash Rental Rate”. The method discussed in this section differs by not setting the price at the beginning of the lease period.)
56 bushels × $3.80 per bushel = $212.80 per acre
Base rent with stated adjustments for prices outside a specified range. Under this approach, the operator and landowner agree on a base cash rent that applies as long as the current year’s price is within a specified range. For example, the operator and the landowner might agree on a cash rent of $175.00 per acre if the current year’s corn price is in a $3.40 to $3.60 range. For each $0.10 change in the corn price above or below the stated range of prices, the cash rent would increase or decrease correspondingly by a stated number of dollars such as $5.00 per acre. Thus, if the price of corn for the current year (determined in the same manner as for the first two methods) was $3.80 per bushel, the cash rent would be $175.00 + (2 × $5) or $185.00 per acre. If the price of corn for the current year were $3.10 per bushel, then the cash rent would be $175.00 − (3 × $5) or $160.00 per acre. A variation of this method would allow for an adjustment for any change in the price of corn or other crops above or below the base prices agreed upon.
Minimum base rent with upward adjustments. With this method, the operator and landowner agree on a minimum cash rent for normal yields and a relatively low crop price. For example, both parties might agree that with an average yield of 170 bushels per acre and a $3.00 per bushel corn price, the cash rent would be $150.00 per acre. Also, the cash rent would increase by an agreed-upon amount (such as $5) for each $0.10 per bushel increase in price. Thus, if the current year’s price was $3.75 per bushel, then the cash rent would be $150 + (7.5 × $5) or $187.50.
Flexing for Yield Only
In some states or for certain commodities crop yields are highly uncertain. In other cases, the crop that is grown may only be fed to livestock, so no relevant market price exists. In such cases producers may prefer to negotiate a flexible lease agreement that bases the annual rent solely on the actual yield achieved. The same general approaches shown above for flexing the rent based on price can be used for flexing on yield, as well.
- A base yield equal to a long-term average or expected yield can be established, along with a base cash rent. The actual rent is then equal to the base rent multiplied by the ratio of the actual yield to the base yield. For example, the base rent is $175.00 and the base yield is 170 bushels of corn. If the actual yield is only 150 bushels, the cash rent calculation would be as follows:
- $175.00 × (150 bu. / 170 bu.) = $154.41
- The actual yield can be multiplied by a fixed dollar value per bushel or ton, which would be agreed on in advance. For example, the rent for land planted to wheat is set at $2.00 per bushel of wheat produced. A yield of 75 bushels per acre would result in a rent of $150 per acre, but a yield of only 35 bushels would result in a rent of $70 per acre.
It is important to specify in the lease a standard quality grade and/or moisture level to which yields will be corrected. In both cases a minimum rent may be agreed on, especially if the producer is able to purchase crop insurance based on a guaranteed level of production and a fixed indemnity rate.
Flexing for Price and Yield
Ultimately, the value of what a particular farm produces and the operator’s ability to pay a equitable compensation to the owner depend on both actual prices and yields. Moreover, market prices may be inversely correlated with yields in a given year. A flexible rent based only on price or only on yield may not accurately reflect the economic return the operator has derived from the farm that year. For these reasons the most popular flexible lease contracts take into account year-to-year variations in both prices and yields.
This method requires the operator and landowner to agree on a base cash rent tied to a base yield (average or expected yield) and a base expected price for each crop being considered. If only one crop is grown, this is the only crop considered. If several crops are grown and all are considered equally important, all crops may be considered in determining the current year’s cash rent. If one crop accounts for most of the income or is planted on most of the land, the cash rent might be adjusted according to changes in price and yield of the main crop even though other minor crops are produced.
The adjustment for yield changes should be based on the yields actually obtained on the particular farm being leased. Sales records, warehouse receipts, or crop insurance yields are reliable evidence of production. If crops have not yet been delivered to a buyer or commercial storage, on-farm bin measurements can be used. Data from combine yield monitors can also be used, but is usually not as accurate as direct measurements. Yields should be corrected to a standard moisture level, such as number 2 yellow corn. The lease agreement also should specifically state how the current year’s price is to be determined. The time and place to be used for determining the current year’s price should be agreed upon at the beginning of the agreement. Some agreements use an average of the local cash market prices available on several specified days during harvest. Others include forward contract prices available on certain dates prior to harvest, so as to better reflect the operator’s marketing opportunities. Other possibilities include futures prices (adjusted for basis), FSA posted county prices, or USDA average monthly cash prices.
Assume the same facts as presented in the first discussion of “flexing for crop price only:” base cash rent of $175.00 per acre; base corn price of $3.50 per bushel; and a base yield of 170 bushels per acre. After harvest, the actual corn price turns out to be $3.80 per bushel (average closing price at Anytown Elevator during the period September 15 to November 1). The actual yield is determined to be 200 bushels per acre for the current year.
The formula for the calculation of the cash rent would be as follows:
base rent × (current year’s yield ÷ base yield) × (current year’s price ÷ base price)
$175.00 × (200 ÷ 170) × ($3.80 ÷ $3.50) = $223.53
Stated percentage of the current crop’s value. With this method, the operator and landowner need to agree at the beginning how to determine the current year’s yield and price. Both parties also need to agree on the percentage share of the crop to be used for calculating the actual amount of rent. The formula for determining each year’s cash rent is:
current year’s yield × current year’s price × agreed-on percentage
This method results in a sharing of risk similar to that realized under a crop-share agreement, except the owner does not bear any risk for higher input costs.
The owner and operator should discuss and agree on whether crop insurance indemnity payments will be included in the value used to determine the rent. Under a crop-share lease the landowner can purchase crop insurance on his/her share of the crop. By including any crop insurance payments received by the operator in the gross revenue, the owner can indirectly “insure” the cash rent to be received. If insurance payments are included, however, the premiums paid by the operator should be netted out first, even in the years that no indemnities are received.
Minimum base rent plus a bonus. With this method, the operator and landowner agree upon a minimum base rent for the field or farm, and a base gross revenue value. Base gross revenue should reflect an expected yield and price. These values can be determined in the same manner as for a fixed cash rent. This base rent is typically discounted from the “market” rent due to additional risk being passed on to the operator with the flexible nature of the rent. Both parties will have to agree upon what percentage of the increased value over and above the base revenue would be added to the base rent. Again, these details should be worked out at the beginning of the leasing period and included in the lease agreement.
This method operates as follows: Suppose both parties agree on a base cash rent of $175.00 per acre, assuming a normal yield of 170 bushels per acre and a corn price of $3.50 per bushel. The base gross revenue would equal 170 bu. x $3.50, or $595.00 per acre. They also agree the cash rent will increase by 30 percent of any increase in crop value above $595.00 per acre. To illustrate, if the price of corn increased to $3.80 per bushel and the yield turned out to be 190 bushels per acre, the cash rent would be increased to $213.10 per acre. The cash-rent bonus value is calculated as follows:
$3.80 × 190 = $722.00
$722.00 − $595.00 = $127.00
$127.00 × 30% = $38.10
$175.00 + $38.10 = $213.10
As discussed above, the owner and operator should agree on whether or not to include crop insurance indemnity payments in the gross revenue value.
Flexing Rent on Changes in Cost of Inputs
The cost of variable inputs can change significantly from year to year and cause large swings in profitability. Incorporating a factor that reflects a ratio of the base year’s cost of inputs divided by the current year’s cost of inputs will help stabilize the bottom line for operators. The important inputs to include in this calculation are seed, fertilizer, pesticides (herbicide, fungicide and insecticide), and diesel and drying fuel. These costs should be expressed in dollars per acre rather than price due to the difference in the level of use of the different inputs. Bear in mind that basing rent on input costs will naturally increase the landowner’s interest in how the operator purchases those inputs (for example, he or she may wonder if everything is being done to minimize such costs, such as hedging input prices, buying in quantities sufficient to get discounts, soliciting bids from multiple suppliers to get the best price, etc.). These issues should be discussed by the landowner and operator, and should also be addressed in the written lease.
The total cost of seed, fertilizer, pesticides and diesel and drying fuel per acre must be calculated for the current year and the base year. Dividing the current year’s input costs by the base year’s input costs adjusts the base rent up or down depending on the change in these input costs.
If the rent is to be adjusted on yield, price and input costs; the formula for the calculation of cash rent would be as follows:
base rent × (current year’s yield ÷ base yield) × (current year’s price ÷ base price) × (base year’s input costs ÷ current input costs)
For the “base rent plus bonus” approach to setting a flexible cash rent, the base gross revenue can be set equal to the operator’s actual cost of production rather than the expected revenue. In this way the bonus rent becomes a share of the operator’s profits, so the lease is in effect a profit-sharing agreement. A charge for the operator’s labor and management, as well as base rent, should be included in the estimate of production costs. This type of agreement shifts some of the risk of unexpected increases in input costs such as fertilizer or fuel to the landowner. It also requires the operator to accurately determine the production costs for that particular land unit, and communicate them to the owner. This will require sound, verifiable farm production and financial records be kept by the operator. This type of agreement also requires some ability on the part of the landowner to audit and verify this information.
Incorporating Flexible Provisions in Written Lease
If it is decided to use some form of flexible cash rent, the details of how the rent will be determined should be clearly specified in a written lease agreement. Including one or two examples with different prices and yields is helpful, as well. The example lease included in this publication includes a page designed for two of the methods for flexing rent discussed in the preceding sections. If some other method of flexing cash rent is preferred, the method should be described in detail in “Method III” of the agreement. Whatever the method used for flexing cash rent, it should be described in writing and included as section IV-C in the total lease agreement.
Putting the Agreement in Writing
A copy of a cash-rent lease agreement form is included in this publication. Some of the advantages of a written agreement are:
- It encourages a detailed discussion of the agreement that leads to a better understanding by both parties.
- It serves as a reminder of the items originally agreed upon.
- It provides a valuable guide for the heirs if either the operator or landowner dies. By statute of frauds, interest in real estate generally must be in writing.
The agreement should be carefully reviewed each year to ensure the terms of the agreement are still applicable and desirable.
Every lease should include certain items. These are the names of the parties involved, an accurate description of the property being rented, the beginning and ending dates of the agreement, the amount of rent to be paid, a statement of how and when the rent is to be paid, and the signatures of the parties involved.
These minimal provisions alone, however, do not meet all the requirements of a good lease. Additional provisions should provide guidance on how the land is to be used and outline possible problem areas and solutions.
A good lease should clearly identify the property being rented. If the landowner wishes to reserve the use of certain improvements on the land, these reservations should be clearly stated in the lease.
Absent a statutory or constitutional limitation, the duration of the lease can be any length of time agreed upon by the parties. Most leases are for at least one full year. Operators sometimes request leases for more than one year, particularly if they must invest additional capital in equipment or make improvements on the farm being rented. In some states farm leases are automatically renewed on a certain date if neither the owner nor the operator provides a notice of termination to the other. In other states, termination notices must be served a minimum number of days before the lease is to end. Either party should communicate a desire to end or modify a lease agreement far enough in advance for the other party to make needed adjustments, seek other rented land, or seek a new operator. When a lease is terminated, provisions should be made to reimburse the operator for unrecouped investments in improvements, fertilizer applications, tillage or other considerations. Landowners and operators should also consider the cropping systems likely to be used on the property when setting the starting and ending dates of the agreement to avoid the issues that can arise when a lease is terminated with a crop still growing on the property.
In general, most transactions involving real estate require a contract in writing to be enforceable. In most states, though, oral leases for not more than a year are valid. Nevertheless, even if the lease term will be a year or less, landowners and operators alike should strongly consider using a written lease to make sure that the obligations and rights of the parties are clearly defined and understood.
Landowners, as well as operators, should enter into long-term leases only after very careful consideration. Remember that the lease is a contract — a contract that “marries” the parties to favorable and unfavorable terms alike. Long-term leases commit both parties to each other for the length of the lease. Long-term leases specifying a fixed cash rent are particularly risky because of unpredictable commodity prices and uncertain costs of operation. Landowners and operators should consider adjusting rental rates from time to time when economic conditions change by adding language to their lease that specifies what conditions will justify an adjustment, and how that adjustment will be calculated.
Cash renting gives the operator a comparatively free hand to decide what crops to grow and the number of acres of each crop. Even so, the landowner and operator should have an understanding about which acres can be used for row crops, small grains, and forages. This is particularly important if the land is subject to wind or water erosion. Both parties also should have a specific understanding of issues such as how much silage may be grown, the maximum number of cattle or other livestock that may be grazed on existing pasture, or how much crop residue can be removed.
Generally, it is desirable to set the dates for paying the cash rent to coincide with sales of crops or livestock. Paying more than one installment also may be desirable. For example, one-half the lease payment may be due at the time the lease agreement is signed and the other one-half payment at the time crops are sold. Several smaller payments can help the operator from a cash-flow standpoint while better meeting the needs of the landowner who may be dependent on the farm rental income for family living expenses.
The sample lease contained in this publication contains provisions for most concerns of both the operator and landowner. The parties can cross out or omit unwanted provisions. Be sure both parties initial these lease changes. But, before provisions are eliminated, the landowner and operator should remember that one of the functions of a written lease is to anticipate possible developments and to state how to handle such problems if they actually do develop.
Cash Farm Rental Agreement Lease Checklist
Parties to Lease and Description
- Date the lease is entered into.
- Names and addresses of the landowner and operator.
- Legal description of the leased property.
- Signatures of the landowner and operator.
- Time period of the lease, including beginning and ending dates.
- Rental amount for cash lease.
- When and how rent will be paid and penalties for late payments.
- Who will carry insurance on the property and the crop.
- Statement that the landowner and operator do not intend to create a partnership by entering into the agreement. Neither party will obligate the other for debts/liabilities or damages.
- Conditions under which the operator may or may not sub-lease the property.
- If the land is enrolled in an agricultural district, providing protection against nuisance suits over farm operations and additional review if land is taken by eminent domain.
- When and how the lease may be terminated and requirements for notice of termination.
- Reimbursement provisions for crop nutrients, lime and/or completed fieldwork upon termination of the lease.
- Acts of the operator that would constitute default of the lease.
- Operator’s rights if the property is transferred or condemned during the lease period.
- Reimbursement provisions for a crop still in the ground when the lease is terminated.
Operation and Maintenance
- Desired or prohibited farming practices, including types of chemicals that may not be used on the property.
- Process of measuring and maintaining soil fertility and pH levels. Which party is responsible for controlling noxious weeds.
- Which party is responsible for maintaining fences.
- Whether the operator has the right to make improvements and be compensated for improvements.
- Whether the operator has the right to utilize improvements made by the landowner.
- Provisions for soil-conservation practices.
- Statement regarding the existing environmental status of the property and responsibility to minimize activities that may cause contamination.
- Use of non-cropland, garden plots, trees, buildings, grain bins, pasture or other areas not rented for cropland.
- Map of the property showing areas authorized for tillage, any areas off-limits to the operator, and any other special features of the property (for example, potentially dangerous areas, areas where hunters may be present, etc.).
Landowner Rights and Government Payment
- Landowner’s right to enter the property for specific purposes.
- Landowner’s right to a security interest in the crops or other provisions for ensuring payment.
- Statement of which party will participate in federal farm programs, including responsibility for eligibility and receipt of payments.
- Nature of landowner participation in management. This may relate to issues regarding income and self-employment, taxes, Social Security payments, and estate planning.
Arbitration of Differences
- Provision that any amendments must be in writing and signed by both parties.
- Procedure for resolving disputes, including the applicable state statutes.
For additional references, see the North Central Farm Management Extension Committee Website at: http://AgLease101.org/
Two outstanding farms in south-central Indiana will host visitors wanting to learn about farm and crop management on July 11th for the Purdue University Farm Management Tour. The Indiana Master Farmer reception and panel discussion will follow.Read More