Draft flex rent that’s fair to both sides
Are flex rents a better way to rent land today? Flex rents are agreements that increase or decrease the actual rent paid up or down depending on yield, price and/or input costs.
• Flex rents might fit current U.S. economic situations.
• Flex rents allow actual rent paid to flex up and down.
• Making flex rents fair to both sides takes some work.
But a good, fair flex rent isn’t as easy to set up as it sounds. The devil is in the details, according to Dwight Aakre, a North Dakota State University Extension farm management specialist. He explains in his answers to the questions below.
Q: What is the biggest mistake you see people making with flex rents?
A: The most serious mistake is designing a method of adjusting the base rent only on movements in the price of the crop produced. Yet the majority of questions I receive from landowners are about how to write a lease that raises the rent solely on the market price of the crops.
The problem with this is that price is just one of the factors in determining revenue, and revenue is just one of the factors that determine profitability. To make it even worse, some landowners want only an upward adjustment when prices rise, but no downward adjustment when prices fall.
Q: How do you make a flex rent fair to both sides?
A: The base yield should reflect the production capacity of the land being rented. The average production history calculated for multiperil crop insurance for that tract of land would be a good source. An APH can be up to a 10-year average, which likely will underestimate current potential due to the latest technology. This can be accounted for by using trend yields. Starting in 2012, multiperil crop insurance policies include a trend-yield option for corn and soybeans in several states, including North Dakota.
The base price can be more difficult. For many years crop prices exhibited little volatility, trading in a relatively narrow range from year to year. The last four to five years have been quite different. Prices have been much more volatile, both daily and from year to year. In addition to increased volatility, overall price levels have been higher in this time period.
It is this increase in price levels that has caught the attention of landowners — but are these higher prices here to stay? If the base price selected reflects the recent higher prices, and future price levels begin to decline to previous price levels, landowners will be disappointed with the agreement that may significantly lower their rent relative to what they could have received with a straight cash-rent agreement.
Likewise for the tenant, the risk is that prices make another substantial move upward, and the adjusted rent becomes much higher than a straight cash-rent agreement would have provided.
This suggests that the base price of a flexible agreement may need to be renegotiated annually even with a multiyear rental contract. Either local cash prices or the futures market prices may be used for determining the base and current-year prices. If futures market prices are used, then the base rent needs to be adjusted to reflect local basis level.
Q: Are there ways to simplify a flex rent?
A: A basic spreadsheet can be designed to do the calculations. However, the difficult part is not the math, but rather determining the base values to compare to current values. Some producers are deciding to negotiate a fixed cash-rent agreement and then adding an additional bonus to the rent in good years. This is a more simple approach, and if done thoughtfully, can be just as effective in maintaining an amicable relationship between landowner and tenant.
This article published in the March, 2012 edition of DAKOTA FARMER.
All rights reserved. Copyright Farm Progress Cos. 2012.