“Land prices are way too high, far beyond productive value.” How many times have you heard people say this or something like it?
As Earl Smith of groPartners Farm and Land Management pointed out in a session at Crop Production Week in Saskatoon, this has always been true. Even when land prices were much lower, the cropping return from a particular piece of land would seldom make the land payment.
Smith used a central Alberta example with a land price of $3,000 an acre. (Top quality land in Saskatchewan is more typically around $2,000 an acre.)
With an interest rate of 5 per cent and a 20-year payment term, the annual payment on $3,000 an acre land comes to $240. With a big crop at the prices available last fall, you might actually be able to pay all your cropping expenses and the land payment. However, you certainly couldn’t do it with an average crop.
And as we all know, grain prices might not stay so high and interest rates might not stay so low into the future. So how can you justify paying so much?
Smith listed the cash rent for the land at $80 an acre, but cash rents for good land are now often reaching $100 an acre or above.
Cash rent is a good proxy for what farmers think they can pay and still make a dollar. There’s a big gap between a $100 per acre cash rent and a $240 loan payment.
But what if you had the money and paid cash for the land. If you have money in an interest bearing investment these days, chances are that it will be earning less than 3 per cent. You could buy land at $3,000 an acre, rent it out for $100 an acre and make just as much.
The difference is that land might continue to increase in value. Like gold, land is an investment. Unlike gold, land also pays an annual dividend.
To take the emotion out of land purchase decisions, Smith advises producers to consider land ownership and the farm business as two separate enterprises. Call land ownership your Land Company and call the farm business your Operating Company.
By itself, is farmland a good investment? Smith actually believes that farmland prices will soon see a downside correction, but he remains bullish about agriculture and land prices over the long term.
No one can see the future, but owning land is much more tangible for many of us than owning stocks, mutual funds or gold. Land hasn’t always increased in value, but over the long term it compares favourably with many other investments. So your Land Company may want to buy more land.
Can your Operating Company pay your Land Company a fair market rent so that it can afford to make payments on additional new acres?
For the Land Company, it may require market rent on two or three quarters so that it can afford to purchase one new quarter.
Alternatively, your Operating Company could rent land from someone else. Returns over and above the rental payment could be invested in something other than additional land.
Viewed this way, land purchase and rental decisions can be more rational.
If buying, Smith cautions producers to keep debt manageable. Make sure you have a good margin of safety in your debt repayment ability and make sure your debt to equity ratio is strong.
Earl Smith’s presentation is posted at www.cropweek.com.