An unexpected result from rising interest rates

Rising interest rates may have another impact on farmland prices that most people don’t consider.

Obviously, higher borrowing costs will have an impact on the ability of some people to cashflow farmland purchases. This is the same relationship cited for people buying homes. Higher interest rates are widely expected to temper and perhaps even reverse the direction of house prices. Whether they cool the red-hot farmland market remains to be seen.

The less widely talked about influence of rising interest rates is that it will probably convince more land owners to put their land up for sale. This isn’t something I’d thought about until I saw a Tweet on the topic from Tim Hammond of Hammond Realty.

Up until recently, money in a fixed interest-bearing investment was earning peanuts. Rising interest rates are also increasing the rates paid on GICs and similar term investments. It isn’t big money, but I’ve seen rates approaching 5.0 per cent and that should continue to increase if the Bank of Canada continues to increase its bank rate.

Let’s look at it from the perspective of a non-farmer that owns land. This could be land that’s long been in the family or it could be land purchased over the last decade or two as an investment.

In Saskatchewan, if you bought land 10 or 15 years ago when it was much cheaper, you could probably earn a 4 or 5 per cent return on investment from the rental income. On top of that, your investment continued to increase in value each year.

As land has increased in value, rental rates have also increased, but not by the same proportion. Land in Saskatchewan that’s worth $3,000 an acre may have a cash rent of $100 which is 3.3 per cent per acre. These days you might actually have better annual earnings from a GIC.

In neighbouring provinces, land of comparable quality typically carries a much higher price, but the cash rent isn’t a whole lot different. That land is paying an annual return of far less than 3.3 per cent.

Land continues to increase in value and while few observers expect that to stop anytime soon, value appreciation isn’t assured. Professional investors may have set a target to double their money and the way the land market has appreciated that target has been reached faster than most would have predicted.

Farmland owners that are not professional investors may be motivated by liquidity. Rising land prices adds to your net worth, but you can’t use it to go on a vacation or fund your kid’s college education.

This is why Tim Hammond expects higher interest rates will encourage more non-farming owners to put farmland up for sale. He also thinks some producers will be encouraged to sell a bit of their land to pay down debt and restructure their business.

Hammond notes a decade ago, there were about 800 farmland packages listed for sale under MLS in Saskatchewan in a typical year. In recent years, that number has declined to about 200. Not all farmland is listed under MLS, but it’s a good indicator of how much land is coming up for sale.

For many producers, there just hasn’t been any nearby land to purchase at any price. Hammond expects a more balanced market in the years ahead. Farmland prices may indeed continue to increase, but there should be more farmland trading hands.