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Investing Fundamentals

November 07, 2019

Commercial Real Estate Crowdfunding or Farmland?

Until recently, investing directly in farmland and commercial real estate has been mainly reserved for institutional investors and family offices with large portfolios. To invest, you needed access to large amounts of capital, the ability to manage ongoing operations, and access to deal flow, propositions which are restrictive for most.

Today, online real estate crowdfunding marketplaces are opening these investment opportunities to more investors than ever before. Whether you are looking to save more for retirement, diversify your investment holdings, or looking for potential passive income ideas, there are many reasons to consider adding real estate assets to your portfolio.

Direct investments in farmland and commercial real estate (CRE) are sought after for many of the same reasons, namely; diversification away from stock market volatility, stable cash flows, and inflation hedging. To compare these two assets, let’s take a look at which has performed better by each of these standards.

Infographic comparing commercial real estate and farmland investment characteristics

Protection From Stock Volatility

One of the main drivers for investment in both of these asset classes is that their values have little or no correlation to the stock market. Said differently, when there is a drop in stock markets, the value of your investment will not necessarily be impacted.

Both asset classes are reasonably non-correlated to stock market returns. Specifically, on a scale from 0 to 1, farmland and commercial real estate have had correlations of .03 and .17 to the S&P 500 respectively. This shows that farmland returns have shared almost no relationship with stock market returns.

As a point of reference, gold has a correlation of .14 to the S&P 500 and is typically viewed as one of the primary safe havens for investors in times of uncertainty in the stock market.

In addition, there is an abundance of research that shows that investments in illiquid assets (ex. assets that you can’t buy and sell on the same day) can actually generate higher returns by avoiding short-term price fluctuations or the “liquidity discount” common in more liquid investments like stocks, bonds, and REITs where reactive selling can result in losses and missed opportunities.

Compared to commercial real estate, farmland typically has little to no vacancy, which helps to smooth returns and provide stability during market downturns. While commercial real estate investments can provide great rewards throughout bull markets, 2008 taught us that market downturns can put stable cash flows and asset values for CRE in question quickly. Note in the chart below how commercial real estate values (yellow line) saw a large correction in price during the 2008/2009 downturn while farmland investor returns continued to grow.

real_estate_returns_chart_20_years

Potential for Stable Cash Flows

Both farmland and commercial real estate crowdfunding investments can offer investors a source of passive income from tenants leasing their property, but are differentiated in several important ways. For example, commercial properties have historically offered higher annual distributions of 4-9% of the purchase value, while farmland has typically offered a 3-5% annual distribution.

However, a more holistic analysis of total returns that includes both rental income and growth in value (appreciation) reveals that farmland returns have averaged almost 12% since 1990 while commercial properties have realized a ~6% total return. This reflects a higher degree of volatility that exists within commercial real estate investing, as compared to farmland investing.

Additionally, quality farmland has a near-zero vacancy rate, as well as relatively lower maintenance and management expenditures. Absentee farmland owners often have long-term leases in place with farmers and receive cash rent typically paid partially upfront before planting season and in full during harvest season. This allows farmland to provide a more stable source of income throughout both good and bad economic times.

Compare this to commercial real estate properties with vacancy rates averaging around 10%, higher management fees, and the potential for more frequent property damage due to public usage and you can understand why CRE may see more volatility in investment returns.

During market downturns, higher vacancy rates due to lower demand for office space and housing can be compounded by poor economic activity. Also, since commercial real estate projects are typically levered with debt, annual cash flows can be squeezed or turn negative as fewer tenants are paying rent.

Overall, commercial real estate does have the potential for higher annual distributions. However, when you consider the total returns for each asset class, farmland has offered higher total returns annually with lower volatility.

Which is the better inflation hedge?

Both farmland and commercial real estate investments provide a natural hedge against inflation as rising prices normally lead to higher rents and property values. However, no other major asset class has tracked with the Consumer Price Index (one of the primary measures of inflation) as closely as farmland with a correlation of .70, outcompeting commercial real estate and even gold as a store of wealth that effectively hedges against inflation.

This is because commodity food prices are highly sensitive to inflation. When inflation rises, food prices and commodity futures do as well, which can lead to an increase the cash rent rates that farmers are able and willing to pay landowners. The increasing of cash rents across an area will typically lead to a corresponding increase in land values as well.

While private commercial property investments can also be a valuable inflation hedge, showing a correlation of .40 with the CPI, the increasing property values and rent rates are more dependent on market stability. If inflation is on the rise and markets are underperforming, you could still end up with higher vacancy rates, and therefore downward pressure on lease rates your tenants are able to afford.

Conclusion

The rise of commercial real estate crowdsourcing platforms have made it easier than ever for investors to gain access to these real estate investment opportunities previously reserved for the largest portfolios.

Both farmland and commercial real estate crowdfunding can offer unique diversification benefits for your portfolio, and you should vet any opportunity thoroughly with your investment advisor before investing. However, when comparing the diversification benefits typically sought after in these alternative investment assets, farmland has historically been a clear winner.

Note: The information above is not intended as investment advice. Data referenced herein TIAA, Yahoo Finance, and Principal.com, with additional calculations and analysis performed by AcreTrader. Past performance is no guarantee of future results. For additional risk disclosures regarding farmland investing and the risks of investing on AcreTrader, please see individual farm offering pages as well as our terms and conditions.