October 20, 2020
Comparing Farm Investments: Permanent Crops Versus Row Crops
We generally split the world of farm investments into two categories: row crops and permanent crops. While this oversimplification doesn’t take into account other land uses like pasture or timber, it encompasses just about all land directly used to grow food, fuel, or fiber.
Row crops, or annual crops, are things like corn, soybeans, rice, and cotton. These crops are planted and harvested every year and have historically offered less cash flow but more appreciation.
Inversely, permanent crops like tree nuts and tree fruits have offered more cash flow but less appreciation.
Investing in both crop types may assist in an overall portfolio diversification strategy, and each appear to have some distinct advantages and a few relative disadvantages that we’ll cover below.
But first, a brief overview table of the two:
What Are Row Crops and Permanent Crops?
When thinking of row crops, these could be anything from smaller-looking vegetable plants on the ground all the way to an 8-foot tall corn stalk.
Importantly, these annual crops are planted, grown, and harvested in 6-9 month cycles. This provides the farmer an opportunity to rotate to different crops each year for productivity, nutrient, and/or pricing and profitability reasons.
On the other hand, when thinking about permanent crops, it is easiest to imagine trees or vines that are stationary and are generally harvested every year. Almond trees are often productive for 20+ years, while wine grape vines may be productive to over 100 years!
This means as an investor, you may be “locked in” to a certain crop type for many years to come and may directly endure more ups and downs in commodity pricing.
An example of two recent AcreTrader row crop and permanent crop offerings can be seen below, and it is easy to spot differences in crop types, returns, and geography.
Weather Affects Each Type of Farm Differently
Given row crops are typically planted in the spring and harvested in the fall, a cold winter climate is less impactful vs. many fruit and nut bearing trees that cannot survive a harsh winter.
While row crops do also thrive in fair climates like that of California, it often makes more financial sense to grow higher-value permanent crops in these areas with ideal climate conditions.
As a result, the large majority of permanent crops are grown on the West Coast and in the Southwest U.S. while areas like the Midwest and Mississippi Delta are dominated by row crops.
Permanent Crop Investments: Cash Flows and Appreciation
From a simplistic viewpoint, investment returns in farmland are generated from (1) annual cash flows and (2) annual appreciation, and adding these two can provide an approximation of total annual returns or IRR.
Given the higher amount of investment capital necessary to plant and operate permanent crops, in addition to the time that it takes for the trees to become productive, these often produce higher cash-on-cash returns over the lifecycle of permanent crops vs. row crops, but total annual returns may be similar given lower appreciation potential.
As an example, an almond orchard may take 4-5 years to become fully productive, but these trees can often produce 5%-10% annual cash returns to the investor.
Importantly, the investor’s cash flow is typically based upon actual revenue (crop prices x crop yields) of the farm or, more commonly, on profitability (actual revenue less total expenses).
As a result, there can be larger swings in annual income vs. row crops, due to weather affecting crop production or crop prices fluctuating.
While there may be a 7% average annual return, actual returns in individual years may range from 5%-10% with some years producing outliers above or below this range.
Another consideration in this almond tree example is that, after 20-25 years, the trees begin a production decline and may need to be replanted. Thus, the trees themselves tend to lose value (depreciate) over time.
Assuming an equal investment in land and trees, 6% annual appreciation in the underlying land value each year alongside 3% annual depreciation in the value of the trees would imply 3% total appreciation annually.
Simplistically, this 3% appreciation coupled with the 7% average annual cash returns would imply a total IRR, or annual return, of 10%.
Row Crop Investments: Cash Flows and Appreciation
In contrast to permanent crops, when investing in row crop land, investors do not typically have any of their investment directly in the crops themselves or involved in operations of the farm.
This means that the farmer typically pays the landowner a cash rent to use the land for growing crops and the farmer takes on the operational risk of running the farm and commodity price movements.
The annual cash returns to row crop investors also tend to be far less variable than that of permanent crops because the income is an annual rent paid by the farmer. Most rents are agreed to well before the annual crops are planted, and these rents tend to be stable or growing over time.
Without exposure to depreciation of trees or vines, row crop investors’ financial exposure is limited to the underlying movement in land value.
Thus in the example above, the investors would see 6% appreciation in land value each year without the offsetting asset depreciation.
In a scenario where the farmer’s rent nets a 4% annual cash payment to the investor, and using the same 6% appreciation figure from above, the investor would experience the same 10% IRR as permanent crops albeit with a different balance of income vs. appreciation.
Other Considerations for Buying Land in Permanent or Row Crops
From an investor’s standpoint, row crops are the more straightforward investment relative to permanent crops.
An important part of identifying appropriate row crop investments is a numbers game: locate large numbers of farms for sale or farms potentially for sale and whittle down to the ones with attractive water, soil, and financial profiles.
To help with this process, we employ intensive data collection, processing, analytics and software tools, and are lucky to have among our farm sourcing team both an Accredited Farm Manager and an Accredited Rural Appraiser, licensed by ASFMRA, the gold standard in land investment and management accreditation.
Beyond identifying land for sale, or land that could be for sale, at attractive prices, it is important that the land has appropriate soil and water characteristics (aka quality) for long-term appreciation.
There are many additional idiosyncrasies to consider like farm tenant pool, local sales activity, location relative to distribution points, and topography.
As an example, topography also plays an important role in row crop land for an important reason: water management.
Unlike watering trees that is typically done with “micro” irrigation, row crop watering is typically via “macro” irrigation (via pivot or furrow irrigation systems ) and the “lay of the land” is an important factor for moving the water across the farm.
We outline this sourcing and valuation process further in our Introduction to Valuing Farmland article.
While much of the above is also true for both row crops and permanent crops, when identifying and underwriting permanent crop land to purchase it is also important to have a firm economic understanding of the crop itself as well as a solid farm operating partner.
While we do similar deep diligence on permanent crop land and assets, we also work with leading farmers and conduct substantial macro research on specific crop types that we share with investors.
In underwriting permanent crop investments, we often partner with a local “sponsor” that participates in the business economics and works directly with the local farming team and community.
Given the operational complexity of running an efficient permanent crop operation, we feel it is important to have a partner overseeing each deal that has economic incentives aligned with the investors’ goals.
Some farmland investors feel differently and like to manage permanent crops directly, but we like partnering with almond experts for almond farms and apple experts for apple farms, etc., and we feel that sharing economic upside with these sponsors is an efficient and effective way to have constant oversight and optimization of farming and investment outcomes.
In concert with the above considerations and many more, our dedicated farm sourcing team works relentlessly to maintain our high underwriting standards and adhere to our strict diligence process, an overview of which can be seen below.
Diversifying Farm Investments By Crop Type
Though row crops and permanent crops each exhibit unique investment characteristics, owning both types of farmland can play an important role in a diversified portfolio.
The ability for investors to access these assets has been limited at best, but AcreTrader now makes it easy for investors to not only diversify their overall portfolio easily with land investments, but to also diversify their portfolio across multiple types of farmland in order to gain broader exposure across this important asset class.
Note: The information above is not intended as investment advice. 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.
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