How far is the land market from its real value?
Michael Swanson, Ph.D., Wells Fargo Chief Agricultural Economist
The single most important asset in agriculture is land, and the single most vexing question in agriculture is what land is worth. For agricultural producers, land values incorporate many things that fall outside the cold-hearted economist’s model. Any particular tract of land can have a wide range of values at any time due to intangible factors. However, in aggregate, land’s value comes down to the same driver of every other economic asset. The real question is how much income does it produce? If you trade hard-earned cash for a future stream of income, there are some inescapable things to consider.
Land is an indispensable factor of production in the economic lingo, but land without inputs, machinery, and labor holds no value for crop production. Using microdata from the last 22 years in Minnesota, cash rent in corn production claimed 24% of the total revenues (including government and crop insurance payments), and cash rent in soybeans claimed 32% of the total revenues. Whether producers rent from third parties or rent from themselves, these ratios would apply to the land’s share of the revenue. Setting aside the question of property taxes, which aren’t a trivial expense, the drop in crop revenues will directly translate into lower income for landowners. This will make agricultural land less valuable in aggregate.
One factor that doesn’t get highlighted often enough is the change in the value of alternative investments. Using 15-year fixed rate mortgages as a proxy for the price of money, 2015 is near the absolute bottom for the value of current cash. Year to date, 15-year fixed rate mortgages have averaged 2.99%. The recent bottom of the market was 2012, when rates averaged 2.92% for the entire year. The dilemma for most investors is what to do with cash on hand? If you have to make an investment today, you will find every asset class inflated by the low cost of borrowing, and agricultural land is no exception to this rule. My personal outlook is that inflation will return to higher rates due to the monetary and regulatory policies that are in place, but economist outlooks don’t really matter. The deal gets done in the environment in which you find yourself at the moment.
Using a net present value model, corn and soybean land has 10 times the value it had in the early 2000s. This astonishing calculation (which is overly simplistic) rests on the fact that crop revenues have jumped by fivefold, and the cost of money has dropped from 7% in the early 2000s to 3% in 2015. The higher revenue/income stream leveraged by ultra-cheap money has sent the value of agricultural land into the stratosphere. Financial models seem to imply that land values have adjusted to lower corn and soybean prices relatively well.
However, a different model with different assumptions gives a much grimmer and much more alarming answer. Using land prices per acre, corn prices per bushel, and yields per acre since 1930, I have a model of years of production traded for current corn.
How can you compare 2015 dollars to 1930 dollars? There are simply too many changes in the real economy to make a dollar-based comparison. Instead, I bring the comparison back to how many years of future yield are you trading away for the land?
The 85-year average for trading corn production for corn ground in Southwest Minnesota is 4.4 years. This means that farmers were willing to give the seller the next 4.4 years of expected production in corn prices for that year. Interestingly, this equates to a 23% share of the expected yield going forward, which aligns with the 24% of cash rent since 1994.
The concerning number is that the 2014 land value of $7,400 per acre, a corn price of $3.97 per bushel, and average yield of 160 bushels per acre works out to trading away 11.5 years’ worth of future production. This is the worst trade for the buyers since the Great Depression era. I would assign most of the discrepancy between the “Pollyannaish” net present value (NPV) and the grim Corn Trade Model to the unsustainably low interest rate. An increase of 100 to 200 basis points in the borrowing cost of money without a huge jump in crop revenues would crush the NPV. All models are wrong, but some models are useful. In this case, buyers and sellers of agricultural ground should sit and ponder the two contrasting signals.