Risk and opportunity: Flexible cash pasture leases

One of the greatest challenges to cash-renting pasture and rangeland is uncertainty in production of the commodity. Typically, summer pasture leases are established in the springtime with an established cash payment, either on a per-acre basis or on a per-animal-unit basis.

Tim Lemmons

What we don’t know at the time of lease establishment is what the season will bring: Will rainfall and plant growth be sufficient to support the animal? What will happen to calf and feeder prices? Will there be sufficient ranch revenues?

We can insert any number of unknown risk factors into the “what if” question. When pasture prices are established in the spring, and calf prices go up or cattle weights increase due to advantageous rainfall, landowners complain cash rates are too low and they are losing money.

If calf prices go down or weights suffer due to poor rainfall and pasture performance, producers complain they paid too much. The challenge is to find a tool that adapts pasture rental rates for those unpredictable risks. The answer: flexible cash pasture provisions.

What is it?

These tools are not new to crop production and cropland leases; however, there have been issues with applying provisions to the unique characteristics of cattle production. Flexible leases and the application of flexible pasture provisions have been gaining in popularity with increasing uncertainty in weather patterns, commodity prices and ranch revenues.

Overall, the flexible pasture lease is designed to increase cash rental rates when land, animal or revenue performance is better than expected and reduce cash rental rates when land, animal or revenue fails to meet expectations.

The first step in the process is to determine an equitable cash pasture rental rate. Why not a “fair” rate? Who knows what fair really means? What seems fair to some might be viewed as unfair to others. Instead, I use the term equitable, meaning it is based on terms that are just, reasonable and agreeable to both parties involved.

The second step is to determine how the cash lease will flex. Will you flex up or down based on commodity prices? Up or down based on animal performance? Up or down based on pasture performance? Up or down based on overall pasture revenue performance … or all three? The number of flexible provisions included in a lease is entirely up to the producer and landowner.

The third step in the process is to determine your floors and ceilings. This is a critical component to flex provisions and must be included to protect both parties from unlimited risk potential. The ceiling and floor should represent the minimum and maximum payment rates expected.

For example, you might establish a cash rental rate of $50 per animal unit month (AUM) with a flexible provision on expected feeder calf prices; however, the ceiling states the cash rent will never exceed $60 per AUM, and the floor states the rate will never fall below $40 per AUM.

The range between the floor and ceiling are completely up to the landowner and the tenant. Those who are risk-averse might choose a narrow range, while those welcoming of risk might choose a wider range.

Once the flex variable is determined, the fourth step is to get the lease in writing. Never rely on a verbal lease to cover all the elements needed to manage even a basic pasture lease, let alone one that includes flex provisions.

Written leases are designed to protect the business and personal relationship of the parties involved by clearly stating what is expected.

The fifth step is to determine when rent is to be paid. The nature of flex leases is to provide rent potential to landowners with favorable performance and rent reductions with unfavorable performance.

It will be up to the landowner and tenant to decide when payments are due; however, you might decide the minimum payment (or the floor) will be paid before animals enter the pasture with any final payment (determined at the end of the season based on performance) due when the animals come off pasture.

The sixth and final step is to maintain communication. While these types of contracts are written and self-performing in nature, it is always a good idea to keep good lines of communication between both parties.

Never assume that because you had a contract one year it will be automatically renewed the next. Discuss the various provision options, the performance of the pasture and the animals, changes in production costs and any other challenges during the growing season. Good communication is the keystone to a healthy business relationship.

Need an example?

There are an infinite number of ways a flex provision might be written for a pasture, and coverage of all possible options is beyond the scope of this article. The following demonstrates just one of many possible applications of a flex lease provision.

Let’s start with a pasture located in northeast Nebraska with an annual rainfall average of 17 inches from May to October for the last 10 years. The landowner and tenant have agreed to a cash rental rate of $50 per AUM with a total of 30 AUMs (pairs) entering pasture on May 1.

Both parties agree to establish a flexible lease that adjusts the rent based on an expected rainfall during the established five-month grazing season of 17 inches.

Furthermore, they decide to establish a rent floor at $48 per AUM and a ceiling at $52 per AUM. The tenant also agrees to pay the landowner the minimum of $48 per AUM on May 15 with a final payment due by the end of October of the same year.

At the end of the grazing season, it is determined that 19 inches of rain fell on the pasture. The written provision states the rent will adjust based on the percentage of change between expected rain and actual rain. A 2-inch increase in rain represents an 11.8 percent increase, so the rent is adjusted upward 11.8 percent; $50 per AUM x 1.118 = $55.90 per AUM.

This new rental rate is above the established cash rent ceiling of $52 per AUM, so the final rent becomes the ceiling. The tenant makes a final payment of $4 per AUM ($52 - $48) to the landowner on Oct. 31 (Table 1).

Example of a flex pasture rent

The previous example is just one of any number of possible flex lease provisions that might be applied to the cash contract. It is important those using these tools seek educational opportunities to expand their understanding of different methods for flexing a cash lease.

Finally, when starting with these provisions, begin small (smaller parcels, narrow floor/ceiling ranges) and grow as your experience and comfort with the tools, methods and principles grows. For additional assistance with flex pasture leases, contact your local land-grant extension educator or office.