With commodity prices pressuring cropland values lower in most parts of the country, rental rates will need to follow suit for crop production to remain economically viable, according to a new report from Rabobank.
The Rabobank Food & Agribusiness Research and Advisory group report, “The Land Value Wave Dips: Land Values Set to Decline Further, Despite Sticky Rental Prices,” explores the impact of low commodity prices on land values and rental rates.
Rabobank has argued against the concept of a “credit bubble” existing in agricultural land values. However, while the probability of a bubble remains low, land values and rental rates must decline to meet production costs and financing standards, noted report author and Rabobank senior analyst Sterling Liddell.
The relationship between rental values and mortgage payments is a key indicator of the relationship between land values and fundamental drivers. Large spreads in mortgage payments and return values, as seen in the 1980s, indicate a disconnect between the economic value of land and the financed value of land.
The run-up in values
Significant increases in commodity prices between 2006 and 2013 pulled more land into row crop production. Commodity price increases also outpaced production input costs, resulting in strong demand and steep increases in ag land values and rental rates.
With most commodities now in oversupply, both domestically and globally, prices are below breakeven costs. Farmers are already facing the probability of deeper losses than previously expected in 2016. The ability of land to generate an economic return is reduced, cutting into available investment capital.
Read: Commodity prices take a toll on Heartland’s land values
Despite declining land values, rental rates have remained stubbornly high, according to the Rabobank analysis.
“After two years of economic losses at the farm level – which resulted largely from the significant drop in commodity prices – the cost of renting land remains sticky and unsustainably high,” said Liddell.
“If rental costs remain sticky at unsustainable levels through the 2017-2018 growing period, individual land assets face the threat of much deeper devaluation, as nutrient and crop protection programs are cut and abandonment (usage changes) increases,” Liddell said.
The land-value decline was partially slowed due to high levels of ample working capital following the 2006-2013 surge in profit margins. Farm business liquidity, farmers’ desire to control land long term and landowners’ reluctance to accept reduced income continued to support land rental rates above breakeven levels.
Beginning of 2014, the cost of renting an acre of land became detached from the returns generated from producing crops. Higher rental rates have now reduced the availability of working capital below credit standards (less than 20 percent of the cost of production), according to Rabobank.
Cutting production costs includes land
To balance commodity supply and demand at sustainable breakeven levels, Rabobank estimates 3 million to 5 million acres will be forced out of corn, soybean and wheat production over the next three years, putting further downward pressure on land values and rental rates.
The key now is whether land costs adjust enough over the next two years to allow for financing at sustainable levels. If rental rates remain above breakeven levels, producers may cut inputs, including fertilizer and crop protection applications, degrading the production value of the land for multiple years.
The need to control costs may include renegotiation of rental agreements, many of which are short-term (one to three years). Alternative rental agreements that share risk, such as cost- and crop-sharing agreements, could also help avoid long-term negative margin conditions, Liddell explained.
USDA’s National Agricultural Statistics Service also updated 2016 average rates of cash rents paid for cropland (total, irrigated and nonirrigated) and pastureland. The data is searchable by state on USDA’s “Quick Stats” website. County-level rental rate reports are expected in September.
Other factors loom
Factors that can change the outlook for land include volatile weather patterns and global/domestic macroeconomic changes, affecting commodity supply and demand.
Substantial interest rate increases would drive mortgage rates higher and require values to decline more to remain in balance with farming economics.
An aging farmer demographic can also impact land values. As more farmers reach retirement age, the prospect of declining net worth and decreased annual income from rental payments is expected to be an incentive to sell land. More land for sale could have a negative impact on values.
Current government programs, such as the Agriculture Risk Coverage (ARC) and Price Loss Coverage (PLC) programs, have supported margins to some degree over the past three years, but lower program payments, if any, are expected going forward. Consequently, those programs are not expected to provide the same rental price support, Liddell said. PD
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