Progressive Farmer – The Down Side

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Lower commodity prices and higher interest rates are reining in emotional buying as the market settles toward a new reality.

Farmland prices the giddy swore were forever—and the contrarians described as a bubble on the verge of popping—are finally at a shifting point.

This is not some real estate bubble set to explode and send agriculture into a downward spiral like that of the 1980s. It’s more like a balloon with a small leak drifting lower bit by bit, with occasional bobs of opportunity.

John Kurtz expresses it best: “It used to be you could take $5 million and buy any row-crop land, and you’d look pretty smart. Maybe you’d buy it at $5,000, and now it’s $8,000 an acre. It isn’t that easy anymore.” Kurtz is head of Kurtz Auction and Realty, based in Evansville, Ind., a state that reported a 14.5% increase in cropland values during the last 12 months.

That pales in comparison to the numbers coming out of South Dakota. Cropland prices there are reportedly up more than 30%, with accounts of some cropland selling for as much as $12,000 an acre.

John Horter isn’t jumping into the frenzy. This young farmer and rancher has been out of the land market since 2011, when he bought his last quarter section outside of Bristol. He says current prices are so high that he can’t justify buying land right now.

“Commodity prices should be what land values are based on,” he stresses. “Unless corn goes back to $7 and soybeans to $15, I think you’re going to see things taper off.”

Horter, who owns 320 acres on what is called the Prairie Coteau, says he’s tried to take advantage of higher corn prices, breaking up pastures to plant more corn. He averages 125 to 130 bushels on corn and about 30 bushels on soybeans.

Taking out pasture ground led to cuts in his Angus and Charolais cow herd, now at around 225 head. He says it’s more economical to raise them in the feedlot than on grass. The producer adds to his income with a custom-harvest and planting business that spans some 2,500 acres.

Horter is a fifth-generation farmer, and his son, Dane Steven, almost three years old now, marks the sixth. While he says he would love to expand his land base for Dane and any siblings that come along, now is not the time.

Delta DEVINER. Take a trip down to the iconic Mississippi Delta, and you’ll find a Midwestern girl who wholeheartedly shares Horter’s view of today’s land market.

Considered one of the top farmland investors in the country, Shonda Warner heads up Chess Ag Full Harvest Partners. Warner buys land for her private equity firm’s fund and rents it back to farmers. She has an eclectic background, including being raised on a Nebraska farm and working as a Goldman Sachs trader.

“To me, farming is no different than any other business. At the end of the day, economics have to apply. It’s been hard to stomach paying the prices being traded in the Midwest. I can’t financially understand or make the numbers work, especially with $4 corn,” she says.

Warner had been investing in the Mississippi Delta but now feels it’s time to look for opportunities elsewhere—the location of which she prefers to keep to herself. She feels emotion has been a tsunami-like force in this land market. Warner is especially concerned with where operational leverage stands and the way many farm families continue to make decisions about land acquisitions with more emotion than economic calculation.

In addition, she has concerns some operations have gotten too big too fast, and she’s not sure due diligence has been done prior to lending some operators money for expansion.

“There are some farming operations that in the last five to 10 years have gotten huge,” Warner explains. “These people are not leveraging land purchases with land but with their operations. I’m concerned we’re going to see operations fail, and that the operational problems will lead to a sell-off of land.”

Warner has a history of not always saying what people want to hear. Six years ago, a room full of Mississippi farmers booed her as she told them they would all be planting corn in the years to come.

“I was told in no uncertain terms that they had always grown cotton in the Mississippi Delta, and that this wasn’t going to change,” she recalls. “But when it came down to it, they did what was the most economically efficient. That meant corn, and we’re seeing yields averaging 150 bushels or more an acre.”

ACREAGE SHIFTS. Geographic commodity shifts have gone beyond corn in the Delta. What were once considered fringe areas for corn and soybeans are now better able to grow these crops economically because of new and improved varieties. This shift has been behind the large price spikes in cropland in North Dakota and South Dakota during the last year.

The USDA’s most recent “Land Values” report showed a 41.5% rise in cropland prices in North Dakota, and the aforementioned 30. 2% increase in South Dakota. That increase spans the reporting period from June 2011 through June 2012, so many in the market feel the numbers are on the low side.

These higher land prices may sound positive, but they have meant lower returns. Larry Janssen, professor of ag economics at South Dakota State University, says the big run-up in land prices means what was once a 7% average cash return on land here is now a 3 to 4% return.

“Over the last 12 years, cash rents have risen at half the rate of land values,” he says. “As corn prices go down, I can’t see how that won’t impact cash rents for 2014. It will create at least a leveling effect, maybe more. Land values will follow cash rents. Cash rents will reflect income capacity.”

Janssen adds during the last year, farmers have used land they already owned to serve as equity for purchases. “There’s been a lot of emotion with these decisions, I think, especially in cases where buyers are trying to get into farming or expand operations.”

If you want to see emotion, go to a land auction: Neighbor often bids against neighbor for what they see as a once-in-a-lifetime chance to buy a piece of farmland. Has it pushed the limits of sanity on prices?

R. D. Schrader says he still sees this as a market of supply and demand. As long as supplies of farmland relative to that demand are tight, prices will hold. In addition, he points to a lack of good alternative investments.

The president of Schrader Real Estate and Auction Company, in Columbia City, Ind., does, however, sense a slowing in the rate of increase for farmland.

“There is still a lot of cash in this market, and things are very competitive. But we aren’t seeing the 25% annual increases we did for a while. I don’t think anyone expected us to sustain that.”

Schrader has followed the farmland market for more than 30 years and says the majority of buyers continue to be farmers. While the traditional corn states led and accelerated the appreciation in land values, he says that appreciation is shifting more to the Dakotas.

He adds that lower corn prices are no shocker to this land market. People buying land are still, for the most part, looking long term; no one expected $7 corn to last forever.

“We’ve certainly seen some prices paid for farmland that others may have thought out of line. But I can tell you, most buyers we see are conservative people, and often they had the cash,” Schrader explains. “Another generation was coming, and the location was right, so they were willing to put the money in. They are the sort of people who can handle a bump in the road when it comes along.”

SHAKY FOOTING. Purdue University land prognosticator Craig Dobbins says there are two things that would take farmland prices down a notch or two, and one of them has already happened.

“Commodity prices are the big one. Next are interest rates. Declines in some inputs costs like fertilizer will help to soften downward pressure, but I expect to see a lot more caution in this market going forward,” he says.

Dobbins adds many of the elements that created the acceleration in land prices have stabilized or leveled. Ethanol demand, for one, is not expected to rise dramatically in the foreseeable future. And crop insurance, which resets annually, will provide a lower protection level.

The $5 Million Question

As part of The Progressive Farmer’s annual report on farmland values, we asked 10 leading brokers and realtors from across the country one simple question: “If you had $5 million to invest in farmland, where would you spend it?” From all the responses, two common themes emerged. First, the importance of a good water supply cannot be overemphasized. Second, even though you may be enticed by other regions of the country, buy what you know in a market you understand.

Time for Buyers to Beware

Howard Audsley believes “caution” is the watchword for today’s farmland market. This appraiser and realtor, in Columbia, Mo., says he would be very careful about putting money into farmland right now.

Audsley contends he’s seeing what he believes to be “fraudulent” conditions in the farmland market. “One property I know of sold six times last year,” he says, adding that it nearly doubled in price during that 12-month span. Some are putting cash rents on land well above what they should be based on crop share. Out-of-state investors are especially prone to getting caught in the hype.

“The intent is to flip the property,” he says. “This is a game of musical chairs, and you’d better be out when the music stops. We’ve seen some crazy stuff. It was aggressive before; now it’s over the top.”

He adds that anyone intent on investing should do their homework. If the property has changed hands even once in the past year and is now offered with a high-dollar cash rent, that would be a warning sign to apply the brakes. On the other hand, if the buyer knows the seller, knows the history of the property and is comfortable with the price, there’s no reason not to buy. But it’s important that it fit the operation and the buyer is willing to accept the risk.

Quality and the “I” States

Dale Aupperle believes when it comes to the land market, the “trend is your friend.” And that’s why he’d still buy land today.

“From 1972 through 2013, prime Illinois farmland went from $850 to $13,000 an acre. That’s a 6.5%-per-year increase. That’s a 40-year proof of investment,” says the president of Heartland Ag Group, based in Forsyth, Ill.

Aupperle says he’d keep his $5 million in the “I” states: Illinois, Indiana or Iowa. He would focus on the best of the best, looking for prime soils with good drainage. Larger blocks of land would be important, as would a visible location and proximity to a major processing center or river outlet.

Looking for Diversification

Less than half of Dennis Badtke’s $5 million would go into land.

The real estate appraiser for Badgerland Financial, Fond Du Lac, Wis., says he would put about 45% of his money into real property, put 45% into the stock market and bonds, and keep 10% liquid.

On the land portion of his investment, he’d stay in the Midwest, focusing on something that could get a 5% rate of return.

“I’d see irrigated farmland as having less risk than, say, some type of improved property. It’s more likely that the property with a lot of improvements would depreciate,” he says. “Also, I believe commercial property is higher risk. Farmland is still lower risk, so that’s what I’d focus on.”

Water, Crops and Trees

Wally Binns would keep his money in the Southeast. Specifically, he would look at land in south Georgia and central Alabama with water.

Land that can be irrigated with a good, reliable water source is the key to a good investment right now, says the broker with J. Durham and Associates, in Albany, Ga.

In addition to water, he would focus on fiat land with good soils. Row crops, pecan groves and timberland would provide a diversified mix for Binns, who feels timberland is undervalued at the moment and due for a comeback.

“It’s true, timberland is a longer term investment. But I think the old saying of ‘buy low and sell high’ applies here. As the housing market picks up, timber prices follow. So I’d like to have that in my mix,” Binns says.

Recreational Land Investor

Jerry Brown believes recreational land can be a good investment today, under the right conditions.

Brown, broker and president of Brown Realty Company, in Rayville, La., follows both the recreational and the farmland markets. He says in his region, there’s still strong demand for recreational land. In fact, he says he’s seen this type of property increase in value nearly every year, right along with farmland.

In addition to recreational property, he’d look to invest in farmland in the southern Delta region states (Arkansas, Mississippi, Louisiana). He’d put an emphasis on water supply.

Brown adds he does feel these states are a little pricey now, and he says some better prices might be found in Kansas if you can find land with water.

Buy What You Know

Keith Carlson debated with himself at length before settling on Nebraska as the most likely place he’d invest $5 million today.

“The last three years, land values have doubled here, which is just unheard of. And the return on investment is about half of where it was. So why would an investor consider Nebraska? For me, it’s about what I know,” says Carlson, who heads up United Farm and Ranch Management, in Lincoln, Neb.

The appraiser and broker admits he likes the panhandle of Texas as an investment area, finding it tempting in today’s market. But at the end of the day, he knows Nebraska.

“That’s what I understand, so I think that’s where I’d invest. I’d go in knowing it might not make the most financial sense right now. But key to me is that I’d know the water is there.”

Carlson would look for property with excellent water and good-quality soils. He believes the water may increase in value even if the land doesn’t.

“In the High Plains of Texas, in 10 to 20 years with possibly more water restrictions, farmers may be back to dryland farming,” Carlson says.

“Who knows what water will be worth by the time this land is passed down to my grandchildren? It’s possible it could be as valuable as oil.”

Measure the Returns

Clift Land Brokers has a big footprint when it comes to farm and ranch land, leaving George Clift with a broad perspective.

The broker says there are two regions he’d look to invest in today: the High Plains of Texas or the eastern areas of North Carolina, Georgia and Alabama.

In the High Plains, he’d focus on grain-deficit areas, where the commodity brings a premium over the Midwest. He says land here is a consistent producer, drawing from underground aquifers.

“Returns of farms in the High Plains will exceed that of other regions, but you have to understand it. Here it’s all about water and the regulation of water.”

Land prices in the High Plains can range from $750 to $6,000 an acre, depending on the water situation, he explains. But irrigated cropping means you control the variables. A typical irrigated corn crop will take 24 inches of water, and yields will consistently average 220 to 240 bushels per acre.

Looking east, Clift would want to buy land where you could take out trees and convert to row crops.

He expects yields on his investment would be 5 to 6% in the High Plains versus 3% in the Midwest, 4 to 5% in the Delta and 4 to 5% in the eastern states.

Invest in Only the Best

Pat Karst complains $5 million wouldn’t buy much these days, but that said, he’d definitely put it into farmland.

He says farmland has always done well in times of inflation, and since he expects to see inflation in the not-sodistant future, he thinks farmland prices will go even higher. The key, he says, is to focus on the best of the best.

“I’d be diversifying, buying something in the Midwest and something in a Delta state like Arkansas,” says the vice president of Halderman Real Estate, based in Wabash, Ind.

Karst likes diversity in his investment: geographic, crop and water. In the Delta region, he’d check on water quality and availability. He feels this is not as critical in the Midwest. Soil productivity would be his No. 1 criteria there.

“The way I look at it is that if land prices go down, the highest quality land will go down slower and rebound sooner and stronger. So buy the best—that’s my philosophy.”

Location Really Matters

For John Kurtz, a good land investment is all about location. The president of Kurtz Auction and Realty, in Owensburg, Ky., says he’d definitely focus on soil types and fertility when land shopping.

“Today a 1 to 2% change in anything is a large raw dollar figure, whether it’s inputs or yields,” he says. “So you’d want a property that would take out some of the variables.”

He’d look for “pockets of value” where he could get a 6% return. He’d probably focus in the less traditional grain-belt areas, places like Arkansas, Tennessee, Kentucky and Missouri. He’d consider looking in Indiana and Illinois to try to find a bargain.

Kurtz believes there are some good buys in recreational land now, as well as in wetlands. He stresses today’s market requires the buyer to thoroughly research and understand the area in which he plans to invest, understanding that everything is not necessarily going to increase dramatically from one year to the next.

A History of Success

Kevin Pifer would only consider buying farmland in today’s market if the purchase price were what he calls “reasonable.” He’d focus on southeastern North Dakota.

He would want acreage with a history of success. That means proven soils and a strong cropping history of aboveaverage yields for both corn and soybeans.

Pifer is a former North Dakota deputy commissioner of agriculture and has worked extensively in the finance industry. His company, Pifer’s Auction and Realty, has offices in Moorehead, Minn.