April 01, 2020
Is Farmland A Good Investment Opportunity?
The AcreTrader team has written previously about farmland investing in bear markets, and given the recent volatility in global markets, we wanted to take a moment to revisit the topic in today’s context.
One of the aspects that makes farmland investing so attractive is the historical performance of the asset class, which includes competitive returns in the form of annual cash flow as well as asset appreciation with relatively low volatility.
Below are a few considerations regarding farmland investing during rocky times.
Why Farmland As An Investment?
Investing in farmland is similar to other forms of real estate, such as residential or commercial properties, in the sense that there are two different forms of income - cash flow and appreciation.
According to NCREIF, these two income streams have generated annual returns of 11-12% over the last 25+ years for farmland investors (a topic we explore further in our investing whitepaper).
But there’s more to farmland than attractive passive income potential - farmland has also experienced less volatility than many other popular asset classes, including gold, bonds, and stocks.
In an unpredictable market environment, it is critical to understand the underlying volatility of your investments.
When considered in this context, farmland has demonstrated a superior risk/return ratio relative to other similar assets.
The Risk Adjusted Return of Land
We can further explore the risk adjusted return of farmland by considering the widely-used Sharpe ratio.
The Sharpe ratio is simply a way to numerically evaluate the excess returns generated above the risk free rate while taking into account its volatility (price swings).
Using the Sharpe ratio allows professional investors to understand whether they are exposed to excessive risk in the pursuit of higher returns.
In general, a higher Sharpe ratio is viewed as better because it implies the asset is generating higher returns with lower risk.
Here again, farmland has had an advantage over other investments with a Sharpe ratio over the last 40 years of 0.86 according to Hancock Agricultural Investment Group.
With recent major sell-offs in financial markets, it is worth considering how much exposure farmland investments may have to movements in the broader stock market, as many popular investment classes are heavily correlated in price to the stock market.
Importantly, farmland values have little to no correlation with price movements within the stock market, as one recent analysis by TIAA Nuveen demonstrated.
For investors, this means that including farmland in a portfolio can provide an important diversification element that increases non-correlated returns while reducing overall volatility.
It’s no surprise then, that larger institutional investors have been increasingly turning to farmland as a growing piece of their overall investment strategy.
It is important to note that the diversification benefits from investing in farmland primarily apply to direct farmland investing (like on the AcreTrader platform) rather than to investing in a publicly traded REIT.
In fact, where the NCREIF farmland index has had a -0.03 correlation with the S&P 500 over the last three decades, the two major publicly traded farmland REITs have had a 0.66 and 0.78 correlation with the market - impairing one of the most attractive elements of including farmland in a portfolio.
How Interest Rates Affect Land Values
The final benefit we’ll discuss is the role of interest rates in farmland investing.
During recessionary periods, the Federal Reserve will frequently work to reduce interest rates to stimulate and encourage economic activity.
The value of real assets, like farmland, will normally move in an inverse fashion to interest rates meaning that when a recession does occur, lower rates could actually increase the value of farmland in a portfolio.
For farmland investors, the benefits of low interest rates are twofold.
Low interest rates have a well documented negative correlation with commodity prices. Higher commodity prices increase the gross return per acre for the farmer, which in turn drives higher cash rent prices for land owners.
As one paper from Purdue University succinctly notes, “as the opportunity cost of capital declines, land values will rise.” Farmland is thus a useful tool to an investor seeking to allocate capital in an environment of low interest rates.
Is Farmland A Good Investment Opportunity?
Economic recessions provide unique challenges to investors seeking to hedge against downside risk and find stable investment opportunities.
Farmland, with its low volatility, lack of correlation to broader market indices, and strong performance in low interest environments, offers a competitive and appealing opportunity for investors in difficult economic times.
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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