Does it pay to own farmland?
What are the average returns from owning farmland over the years? Two Iowa State University Extension economists, William Edwards and Don Hofstrand, recently studied that question, looking back over the years since 1970.
Annual returns are in two forms: cash returns and change in market value. The source of data they used for cash rents and land values is USDA’s data series for whole-farm rents and value, not data from ISU Extension, which refers to rental rates for corn and bean land only.
Cash rental rates are used as estimates of the cash returns to farmland. The rate of cash return (percent) each year is computed by dividing the cash rental rate by the market value of land in the same year. Cash rental rates are a gross return, not a net return, because property taxes and other ownership expenses have not been deducted. These will probably reduce the total return by one to two percentage points. Also, cash returns have not been adjusted for inflation over this period.
• Over the years farmland ownership has yielded a competitive rate of return.
• About half the return comes from a rise in land value, which is unpredictable.
• Land value appreciation doesn’t pay the mortgage or ownership costs.
Another form of return is the annual increase or decrease in market value of farmland. This increase or decrease is computed as a percentage change in value from one year to the next. The estimated cash rent rate and the land value are based on USDA surveys. They differ slightly from ISU surveys.
• Cash return. The rate of gross cash return has been up and down since 1970. The return was only 3.8% in 2008 because land values were rising faster than rental rates. Conversely, the rate was 9.6% in 1987 because land values declined faster than rental rates during the farm financial crisis of the mid-1980s. Average from 1970 to 2009 was 7%.
• Land value change. The return due to changes in land values was much more volatile, ranging from a high of 36.8% in 1977 to a low of minus 28.1% in 1985. Over the period, land values increased by an average of 6.7% per year.
• Total returns. The total return (annual cash return plus change in land value) averaged 13.6% per year and ranged from a low of a minus 19.1% in 1985 to a high of 43.1% in 1977. Rates of return have varied greatly during specific time periods over the past 39 years.
Farm boom vs. farm crisis
For example, during the farmland boom in 1970-81, land values increased rapidly (15% on average) providing a total return of 22.3%. Cash rental rates and land values for the decade before 1970 were very stable. Farmland values and rental rates started their rapid rise in 1973-74, when grain shortages pushed prices to extremely high levels.
During the farm financial crisis years of 1982-87, land values declined rapidly, about 13.6% per year. Cash returns as a percent of land values actually increased during this period because land values dropped faster than rental rates.
However, the land value declines more than offset cash returns and the average total return was a negative 5.6%.
The rapid expansion of the ethanol industry beginning in 2004 has pushed land values and rental rates upward. The value in 2009 was $3,850 for an increase of 75%, or 15% per year. The average gross cash return over the period was 6%. In the past few years, land values have increased faster than cash rents.
Summing up: Over the years, farmland investments have yielded a very competitive rate of return. However, about half of the return comes from appreciation in land value, which can be highly unpredictable. Moreover, appreciation in value does not provide any cash for making mortgage payments or paying other ownership costs. The study is on ISU’s Ag Decision Maker site at www.extension.iastate.edu/agdm/articles/edwards/
Source: ISU Extension
This article published in the September, 2010 edition of WALLACES FARMER.
All rights reserved. Copyright Farm Progress Cos. 2010.