SAFT ON WEALTH-After go-go decade, farmland faces threats

Thu Dec 26, 2013 3:32pm EST

(James Saft is a Reuters columnist. The opinions expressed are his own.)

By Jim Saft

Dec 26 (Reuters) - The rise and rise of farmland values faces two tough challenges: falling crop prices and rising interest rates.

Because farmland is not a widely-held investment, with the exception of large institutions, its remarkable rise gets comparatively little attention.

Illinois average farmland prices more than doubled, to $7,900 per acre in the six years to 2013, according to one Department of Agriculture measure.

A separate survey of Iowa farmland, by Iowa State University, found a 5.1 percent gain in the last year alone to $8,716, taking prices up by 168 percent in the past decade in inflation adjusted terms. ( here )

Much of this rise has had a fundamental basis. The trend over the medium term in agricultural commodity prices has been higher, with strong demand from emerging markets, better management techniques and falling prices for inputs like fertilizer.

Some of the demand for farmland, though is driven by new investors, eager to diversify into so-called real assets and dissatisfied with low-yields and volatile returns in more traditional areas.

At least some of this was driven by investors who reasoned that the Federal Reserve's easy money policy, or "quantitative easing", would create a destructive inflation, and that a real asset like farmland producing a salable commodity would tend to outperform.

While opinions about the outlook over the medium term for agricultural products vary widely, several changes in the investing atmosphere argue that farmland values may find the going tough in the coming year.

First, if not most importantly, the Federal Reserve is beginning to withdraw from quantitative easing, but is doing so without any evidence at all to support the thesis that "QE" will devalue the U.S. dollar.

That is bad for farmland in two ways. A tightening of financing conditions will raise the cost of borrowing to fund purchases, and will create possibly more attractive investments elsewhere, as bond yields rise. That which was helped by QE's advent should be hurt by QE's death, and farmland fits the bill. And while investors are sitting on gains in farmland, the lack of inflation does undermine a part of the argument for real assets.

FALLING CROP VALUES

More fundamentally, crop prices are falling, driven in part by a run of good harvests. Iowa corn prices dropped by 33 percent in the year to October, during which soybean prices fell 11 percent.

Using Department of Agriculture estimates for lower prices yet next year, economists at the University of Illinois cooked up some estimates for farm profitability. The results are sobering.

Highly productive farmland planted in a mix of corn and soybeans might turn a $333 dollar profit per acre next year. ( here )

Compare that to the $7900 per acre average value and you have a yield a bit above 4.0 percent. With longer term fixed rate loans ranging up to 6.0 percent, you have an asset with negative carry even with 25 percent down. And that's before what is almost certainly going to be a rise in interest rates as QE winds down.

That is the kind of things investors see as sustainable when capital values and prices are going the right way, but just a bit of momentum the wrong way and you could see a bit of a correction in farmland prices.

To be sure, it doesn't have to work out this way. Agricultural prices might recover, economic growth might take off. Added to this is the fact that most of the new entrants aren't exactly hot money. They tend to have taken a reasonably long-term view of the sector. Indeed, it might be owner-operators rather than investors who are more vulnerable to a downturn in capital values.

On the positive side debts held by the farm sector are low by recent historical standards. Debts within the farm sector are now barely above 10 percent of assets, compared to 15 percent through much of the 1990s and a peak of more than 20 percent in the mid-1980s. That implies a bit of a cushion should income drop and capital values recede.

Banking data also shows quite low write-offs and delinquencies in agricultural lending, as you would expect after a strong rise in prices.

Of course, U.S. farmland is not the only one to have risen during the age of QE. Farmland in Britain has tripled in value over a decade.

The unwinding of QE is going to be the biggest investment story of the coming year, perhaps the coming two or three years. Plans made for a world of QE won't make sense anymore, and assets bought when liquidity was ample and risk-taking the order of the day will suffer.

Farmland, like housing and like junk bonds, is just one more example. A bit puffed up and a bit vulnerable.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Jim Saft)

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