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Factors Affecting Farmland Markets

Factors Affecting Farmland Markets. The Changing Landscape of Ag Banking in Illinois IBA Ag Banking Conference Sept. 7-8, 2006 – Springfield Illinois. Bruce J. Sherrick University of Illinois. visit us at: http://www.farmdoc.uiuc.edu/. Outline:. Background, Ag B/S and Lender Shares

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Factors Affecting Farmland Markets

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  1. Factors Affecting Farmland Markets The Changing Landscape of Ag Banking in IllinoisIBA Ag Banking ConferenceSept. 7-8, 2006 – Springfield Illinois Bruce J. Sherrick University of Illinois visit us at:http://www.farmdoc.uiuc.edu/

  2. Outline: • Background, Ag B/S and Lender Shares • Valuation and Income info – how linked? • Investment performance of farmland • Illinois land market updated survey information: who, why, what and how… • Contemporary issues for farmland markets

  3. U.S. Ag Sector Balance Sheet summary US Totals, source USDA

  4. Ag Sector Balance Sheet - keys • Farmland represents 83.5% of farm assets and about 56% of farm debt (8/2006) • Low aggregate leverage relative to other sectors (currently approx. 13.1% ag. D/A and shrinking slowly) • Some shifting among debt providers, little shift between debt and equity • Active equity market absence

  5. Debt shares by Lender through time

  6. Debt shares by Lender through time

  7. History repeated… again “We have two great sources of profit in farming: first, rise in the value of the land; and second, profit on the production of farm crops. The first has been the chief source.” “Illinois farmland will only experience about 4-5% average appreciation in 2005” -Bruce Sherrick, 2004 - George Morrow, 1886 “I was wrong. Again.” -Bruce Sherrick, 2004, 2005, 2006, etc.

  8. Illinois Farmland Markets… cont. compounded increase of 5.7% per year 1970-2006

  9. Capital Gains Rates and Values

  10. Components of return to Farmland

  11. Factors affecting farmland values • Thin Markets – highly inelastic local demand • Performance relative to other investments • Composition of returns changing (farming, vs. recreation, development and 1031 influence) • Recent income levels, interest rates • Changing lease markets, absentee ownership

  12. Farmland Turnover -- Illinois • Thin – average of under 1% annual sales, arm’s length, available competitively, actual farmland intended usage • limited option to expand with contiguous/proximate land through purchase • increases importance of lease markets in value determination • “lumpy” land sales relative to leasing …leads to some exceptional localized events and difficulty in assessing “average” value

  13. History of Farmland Returns as Investment • Long progression of capital gains, one period of losses – data period important when assessing performance • Capital Gains Rates (annual geometric): • 1950-2000: 5.6% • 1970-2000: 5.7% • 1980-2000: 2.0% • 1970-2006 Q2: 5.7% (est.) • 2004-2005 Illinois average increase 28% (USDA) • 2005-2006 Illinois forecast increase 15% (USDA) • Plus: current income in 3-5% range from rent/operations

  14. Farmland as an investment • Academic research shows: • Low systematic risk – behaves much like a fixed income financial asset • High or adequate returns given risk counter to premise of many debates on “low returns” • Role as inflation hedge (positive correlation) • Market friction caveats, explanations • Portfolio models favor inclusion of farmland in investment portfolios – to greater degree than observed in reality

  15. Correlation with other financial assets’ returns

  16. Returns and volatility, 1970-2005

  17. Relatively smooth returns series

  18. … and fairly attractive levels

  19. So what drives the Farmland market? • Within Illinois, considerable risk differences, esp. North to South • Risk-adjustment within class? • cash rent series by county (FBFM) • cash gross returns by county (farmdoc) • test fraction of expected return paid in form of cash rent • Strong evidence of within-class response

  20. Farmland as an investment • Traditional Capitalization arguments: considerable difference in rent and productivity lead to…..

  21. Farmland as an investment • Nothing much in aggregate….Swamped by other effects • So, U of I Study of factors influencing farmland values finds following significant items (Huang, Sherrick, Miller, Gomez, 2006) • Size of tract (-) • SPR (+++) • Distance to Chicago (++) • Distance to metro location (++) • Ruralness indicators (--) • CPI (++) • Population (+) • Income (+) • Livestock activities (+/-)

  22. Land Market Information – ISPFMRA annual survey

  23. ISPFMRA 2005-2006 Land Value Trends

  24. ISPFMRA 2006 -- Survey says…

  25. ISPFMRA 2006 -- Survey says…

  26. ISPFMRA 2006 -- Survey says…

  27. Estate sales prevail ..

  28. Estate settlement leads motivations..

  29. Investors remain main buyers..

  30. Attributes of buyers include … • 56% of buyers used 1031 exchange funds - 2005 • up from 48% year prior, down first half of 2006. • 62% of buyers did not use debt capital • increase of 10% from year prior

  31. §1031 Buyers driving market up..

  32. Chicago impacts dominate..

  33. Price Increase Expected in 2006

  34. Stable Trend expected for 2007

  35. Cash rent and custom farming returns thought to be higher..

  36. Cash Rent variability by quality..

  37. Cash rent leases still most prevalent

  38. Growth expected in fraction of cash rent leases..

  39. Contemporary Issues: • Role of government (payments average 24% of income, 32% pre-, regulation, and changing program design and emphasis) • Energy Bill or Farm Bill? Food v. Farm programs? • Property Tax Updates • Term Structure impacts • What’s on the “Horizon” with competition • Basel II and other badly kept secrets

  40. Questions/Comments? Thanks! visit farmdoc on the web at:http://www.farmdoc.uiuc.edu/

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