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One of our favorite qualities about farmland investing is the advantage proper farm valuation can allow.
Unlike public stocks, there are few data points and metrics which define a clear and comparable valuation of any given farm. Very few farms trade within a small geographical area, and even fewer that are similar in quality to a given farm in that same area.
This can make farm valuation challenging, but it can also present opportunities for those who understand the asset.
In this first article of two on valuing agricultural land, we describe the factors that determine the value of a farm and the indicators AcreTrader uses to understand that value.
You can also read more about AcreTrader's valuation process for farmland in part two of this series.
Determining Factors of Farmland Values
Most investments are valued based on their ability to provide returns to the investor and/or the likelihood of being worth more at a later date. As we frequently point out, farmland has historically provided both (in a very stable manner ) for investors.
So what actually creates the underlying value? Is it the rent and other profits from the land annually, or is it the appreciating value of the land?
Ultimately, the land’s ability to produce more income today than it did 5 years ago is the base source of value appreciation. However, that appreciation cannot be realized if there are not buyers in the local land market to provide the ability to exit an investment.
Income produced on the property is the most important factor for a farm investment. After all, why own an investment unless you think it will pay you a return at some point?
Not only must that farm produce a strong return on the capital invested, but that farm must also produce a return consistently over time. A field that makes 220 bushels of corn one year but 90 the next would be less preferable than one that would produce 180 bushels in every year.
In most cases, consistency is based upon how much crop a field can grow, how consistent the yields of that crop are, and how much and how easily can that crop be sold in the local area.
With consistency, both the farmer and the landowner have a better ability to plan while understanding what typical returns should be.
The size of the land market often determines the value of farmland. Even if the income on an asset is good, it will be hard for a farm to sell at a premium price if there are few buyers in a region.
Strong land markets often have many sales and many buyers. High buyer demand generally drives up the price of the land in a given area.
Lots of sales provide context for any individual property. These sales will allow buyers to compare different properties to one another and better gauge what a reasonable price would be for a property with similar qualities in the same area.
Other Assets and Income
Other assets and non-farming sources of income may also affect the value of the farm.
For instance, revenues from hunting leases are not always consistent, but could supplement the income on a property and therefore add to its value. Other physical assets like grain storage, rental houses, shops, drainage tile, irrigation equipment, and wells can also add to the value of a farm.
Useful Indicators for Proving Farmland Values
So if the sources of value are based upon assets, income, and the local land market, what are the indicators of these qualities?
Consistent income for a farm can be judged by historical performance, the physical qualities of a farm, and the quality of the farmer on the farm.
Below, we have included a few questions you can ask to find indications of farm quality.
Historical Rent - What kind of rent has been paid on the farm in the past?
Historical Yields - What are the yields from the last 5 years on this farm? Would this justify higher rent?
Soil Quality - What kind of yields can be grown on soil of this type? How do other farms with this soil type in the area perform?
Field Quality - Is the field shape rectangular or irregular? How many different types of soils does it have? Is it flat or hilly?
Water Quality - Are there water rights issues? How much water does the well pump? Will there be a lack of water in this location in the future? Are there salinity issues?
Tenant Quality - How many tenants are in the area? Are they producing yields above the state average or below? Are they willing and able to pay good rents?
Commodity Distribution - How easy is it to get crops to market? How many options are there for farmers to deliver grain?
A good land market can be judged by the number of recent sales in the area, comparing those recent sales with the farm for potential investment, and researching the types of owners in the region.
Here are a few questions you can ask to find indications of land market quality:
Number of recent sales - How many sales have occurred in the last 12-24 months? What size were they? Who were the buyers and sellers?
Comparable sales - How many sales were similar to the property being considered? Similar size? Similar quality? Similar tillable acreage?
Land ownership - How many investment funds are in the region? How many individual investors are in the region? How many farmers own large tracts of land in the region?
Other Assets and Income
Other assets and income can be good or bad.
There are times when a house on a property is unlikely to be rented because of its poor condition or bad location. Grain storage may not be useful if everyone in the area has newer storage and lots of capacity.
On the other hand, a property may have fantastic hunting and the hunting lease may drastically increase the income on a property.
Here are a few questions you can ask when considering non-core assets and income:
Irrigation - How old is the irrigation equipment? Are the diesel engines powering the well(s) in good condition?
Shops - How old are the shops? Are they in good condition? Can they fit a full sized tractor inside? Are they heated?
Houses - How close are they to a town? How old are they and what condition are they in? Are they difficult to access or close to a shop or grain storage on the property?
Other facilities - Could the grain storage be leased to another farm? Are there hog, poultry or dairy facilities that could be leased or sold?
Hunting leases - Is the hunting lease at market rate? Is the hunting lease short term or long term? Is the property near a big city with people willing to pay more for hunting rights?
While the source of a farm’s value can derive from many factors, understanding the underlying features of the asset can make it easier to understand.
Being able to break down the important factors and make sure proper qualities are present to allow upside potential is very important. It is one of the reasons AcreTrader is able to disqualify so many potential investments for our investors.
Our screening makes investment much easier for our investors by providing fewer, but more qualified options.
Please note: this article is meant to be a topical overview and, as such, does not include specific financial advice. Every situation is unique, and you should consult with a licensed attorney, accountant, and/or financial advisor prior to entering any written contract or verbal agreement.