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Farming Fundamentals

February 08, 2019

Limited Farmland Supply and the 2050 Problem

By 2050, we will need to grow global crop production by 70% to feed a larger population with increasing food demands. At this rate, farmers will need to produce more food than they have in the last 250 years combined to keep up with global demand.

In order to think about the problem, let’s first review the different pieces of demand and then think about how much arable land the world has available to grow the necessary crops. cerealcropandmeatproductionincreases2050.png

Increasing meat production equals higher grain production

Cereal crops, aka grain crops, make up more than 50% of the global daily caloric intake, and therefore, they make up one of the largest commodity markets in the world. Cereal plants are things like corn, rice, wheat, and soybeans, all of which produce an edible grain for both humans and livestock.

As you can imagine, a rather large portion of the projected crop production increase will be for direct consumption. However, the majority will be used for feed as the global demand for more protein and higher quality food sources is expected to rise by over 130%. feedrequiredperpoundofmeat.png

Rising income levels lead to higher demand for protein

Historically, we have seen that as a country grows their GDP and income levels rise, so does the demand for proteins such as chicken, pork and beef. While this market is mostly saturated in developed countries, the majority of future income growth per capita and population increase is expected to come from developing countries. As you can see, it takes a considerable amount of grain to produce one pound of meat. A 6 to 1 ratio in the case of beef!

The impact of increased demand for cereal crops has already been felt via long-term rising commodity prices, but global demand for these commodities and the land on which they are produced will become increasingly important. arable_land_use_per_person-1.png

The amount of arable land has been decreasing

In the US, like most other countries, the amount of arable land has actually decreased. Basic economics would suggest that, as the supply of land decreases and the demand for food increases, the value of the land will increase in price. After all, they’re not making any more land!

Beyond the obviously favorable supply/demand characteristics for investors, we must also be highly conscious of how we are using the land we have. For these reasons, progressive farmers and agtech companies are constantly innovating with new technologies that help them maintain soil quality, improve planting efficiency and increase their overall yields in a sustainable manner.

The world will need all of this and more to produce all the food that we need by 2050.At the center of all new investments in agriculture is one central question:

Will we continue to be able to feed our growing population with limited natural resources?

Two of the most important keys to success will be protecting arable land against some unnecessary types of sprawling real estate development and innovating in order to increase crop yields on the ground we have remaining.

Today farmland owners have opportunities to partner with progressive farmers and profit from helping to solve a global-scale problem. Individuals can preserve farmland by investing in it and keeping it in production. Further, farmers and agriculture companies are finding new and innovative ways to meet future demand every day. The opportunity for partnership in innovation should be both life-changing and lucrative for those making a difference in the right places.

We believe the future of agriculture looks bright.

Note: The information above is not intended as investment advice. Data in the charts above is sourced from the FAO and NCBI. 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 & Disclosures here.

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The AcreTrader Relative Risk Score (ARRS) is a score we designed internally to judge the relative (not absolute!) risk of various offerings reviewed for listing on our site. While we share this score with our users regarding specific offerings, please note the ARRS is not to be relied upon as a single determinant of risk. Additionally, note the information below is not intended as investment advice. Please see disclosure of additional risks here.

What is Relative Risk?

Put simply, standard investment risk and return usually share a somewhat inverse correlation; the lower the risk of a given investment, the lower the expected return, and vice versa. Government bonds for example, are often seen as low risk, but they offer low returns. Inversely, speculating on currencies in developing countries or typical equity crowdfunding may offer high potential returns, but often come alongside high risks.

Agricultural farmland has historically shown what we view as impressive returns alongside relatively low risk (check out our white paper for more info). However, not all farm investing or general crowdfunding opportunities are created equal. Thus, we created 3 basic questions to help us determine our AcreTrader Relative Risk Score (ARRS):

  • Is there existing or planned debt on the subject investment property?
  • Are there necessary or planned improvements for the property?
  • Are there additional business risks (non-core to farming)?

Examples of the AcreTrader Relative Risk Score

Based on the simple yes or no answer to the above questions, we then describe the project's relative risk as one of four categories:

  • A Low ARRS means a "no" answer to all of the above questions. While these properties will typically have a lower IRR, this comes with a low risk relative to other properties we have reviewed.
    • An example might be an existing corn farm with no debt, no external businesses and no planned improvements.
  • A Moderate ARRS means a "yes" answer to one of the above questions. This type of farm may offer a slightly higher IRR.
    • An example of a moderate relative risk farm would be an existing farm where there is a planned investment in improving the grade of the land, but the project is funded with cash raised up front.
  • A High ARRS means a "yes" answer to two of the three questions.
    • An example might be the same farm above with planned investments, but the project is funded with debt in order to increase returns. While the IRR may be increased via debt (as opposed to using up-front cash from investors), the risk profile is potentially higher as well.
  • A Speculative ARRS means a "yes" answer to all three of the questions. These properties will typically offer the highest IRR but come with the highest risk relative to other properties.
    • An example might be a farm with an attached dairy operation, where debt is issued to improve the property and the dairy business output. Most of the real estate crowdfunding deals we see on the major crowdfunding sites would fall into this "Speculative" category given often high levels of leverage, complex organization, "value-add" necessity, and/or other potential business risks.

Conclusion

To summarize, there is no "one-size-fits-all" in investing, and this holds true with farmland as well. While many farms are lower relative risk, this comes with a lower potential IRR. We don't view agriculture and farmland as a get-rich-quick scheme, but rather as a conservative way to earn attractive risk-adjusted returns.


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 disclosures.

A Brief Explanation of the AcreTrader Relative Risk Score (ARRS)

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We have watched with excitement and awe as the online commercial and residential real estate crowdfunding market has grown from practically nothing 5 years ago to a multibillion dollar industry today. As a whole, we view the real estate crowdfunding market as an exciting alternative asset for accredited investors, and we note that most platforms and offerings look great at first glance. However, buyer beware; those 13% IRR figures don't come without significant risks. Below we note several risks that may or may not be obvious when it comes to online real estate crowdfunding.

Leverage

As we note in our post "Leverage: A Dangerous Amplifier," debt is a great tool of modern finance that is not without risk. Most real estate crowdfunding sites offer properties with Loan-To-Value (LTV) rates of 75% to 80%, though some of them are even more levered. In an investment with an LTV of 80%, the owners' equity portion is only 20% of deal value, while the debt accounts for the remaining 80%.

While this leverage can amplify your returns, it also amplifies the downside. An economic recession, poor site selection, poor management, increases in local competition, government regulations, or even just a negative cycle in commercial real estate can drive down the value of the property by 20% or more pretty easily. If the value is down just 20%, this means that the investors' portion of the deal is worth ZERO.

Deal Terms

While often overlooked, the articles of organization and subscription documents can hold important information. Sometimes, the grizzliest of these limitations are buried in legalese that is hard to decipher. While most real estate industry terms are standard, look out for predatory terms or unfavorable treatment in the case of default.

Unknown Sponsors

Many of the well-known crowdfunding sites work with established multi-deal sponsors on their sites. However, that isn't always the case, as we have witnessed well-funded deals that relied upon sponsors that had little or no experience. Even in the case of well-experienced deal sponsors, local real estate knowledge is important, and we have seen examples of seemingly well-intentioned sponsors putting together dangerous looking deals in unfamiliar territory.

Due Diligence Limitations

For an example of the above, we recently came across a hotel recap and remodel offering from one of the industry-leading crowdfunding sites in a southern state. The sponsor had experience in neighboring Texas, but none in the target state where they were (successfully) raising millions of dollars to do a heavily-levered hotel deal. Unfortunately for the investors, and likely even the locally-inexperienced sponsors, there is a mostly-unannounced $100 million development being planned across the street that includes two hotels. At the time of capital raise, it is possible that only local developers knew the massive development was going to break ground soon. While the investors' pitch on fixing up an old hotel looked great on paper, a flood of hotel room supply across the street may end up destroying a lot of value... all because the developer was speculating in a new market.

Heavy Cyclicality

As multi-billion dollar commercial real estate lender Bank of the Ozarks said during its July 2018 conference call, competitors that are getting more aggressive with credit structures and pricing may "set of concerns across the banking industry." It is no secret that commercial real estate is a very cyclical industry. In fact, it is not uncommon to see the real estate industry go through 10%, 20%, or greater corrections (see chart below). For this reason, as well as the reasons listed above, we remain cautious about real estate crowdfunding online. Screen Shot 2018-07-21 at 3.34.09 PM.png

Note: The information above is not intended as investment advice. Data referenced herein and in the chart above is through year end 2017 and is sourced from Bloomberg and NCREIF, 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 disclosures.

The 5 Big Dangers of Online Real Estate Crowdfunding

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This post is our second of a four-part series where we discuss the process of selling a farm. If you haven't yet read the introductory post, you should do so first.

This article also provides good information for those who might be interested in purchasing a farm, either by understanding how AcreTrader’s process works or by doing their own research. However, this is not by any means the only resource one should use. It is a thorough introduction meant to help guide one’s own research and understanding.

A Seller’s Guide to Farmland: Price

As we mentioned in our first post on selling farmland, price is the first component that most consider when selling an investment. Many factors will play a role in determining price. The next posts in this series will dig deeper into the conditions that might raise or lower a price. However, for this piece, we will look at how investors and farmers tend to find the starting value of a property.

Land investors value land two primary ways - comparable sales and capitalization rate. While these two valuation methods can be done independently, they often affect one another.

Comparable Sales

Comparable sales, also known as "comps," are core to understanding the value of a property. Unlike the stock market, land does not sell on a daily basis much less a second-by-second basis. Further, every piece of farmland is unique and not exactly like any other. Therefore, it can be more difficult to determine what the price of any particular property should be.

The best way to compare a farm is to look at nearby sales and adjust their prices by the value of the different qualities each might have. For instance, consider a non-irrigated property which might have sold for $3,500 per acre nearby an example irrigated, top-tier property of similar quality.

If the value of irrigation were estimated at $500 per acre, then an investor would take the value of the non-irrigated comp and add $500 to the per acre price ($3,500+$500=$4,000). This would give the seller an idea of what might be a good price to list the property.

A seller should look at many different comps to understand the prices in a given area. Any single property might have been sold at a higher or lower price due to issues which might not affect the seller’s land. For example, a farm in foreclosure might sell at a lower price because a bank would rather sell the property quickly than hold out for the best price. Or, a large family farm may meaningfully overpay for a long sought-after neighboring parcel. Usually, five to ten comparable properties can give the seller a good idea of what local market value for a property may be. As with any research, the more data points one has the better one’s understanding of the situation.

A high-quality land valuation will consider many different farm qualities by which to adjust comparable sales. These might be irrigation, drainage, soil type, road access, number of tenants in an area, availability of places to deliver the crop after harvest, and many others. Ideally, though, comparable sales will be close in quality to the land that is being sold.

In other words, a potential buyer should be able to understand the property well enough to throw out the comparable properties that are not close enough in quality, while also identifying enough comps of a similar quality to value it against.

Unfortunately, these comparable sales can be difficult to find. This is one advantage of working with an experienced seller or broker like AcreTrader. People who see many sales a year in a given area will be able to quickly estimate what a seller’s property may be worth.

The best investors and brokers will follow up on this intuitive understanding with in-depth research and financial modeling on a farm. They will analyze many sales in the local area and region and derive a fair market comparable value for the property. This will be a starting point for any further discussion of terms a seller might desire (which we will discuss in later posts).

Comps and county average land prices can be found through courthouses, brokers, bankers, land managers, government websites, other farmers, and even some new technology companies like FarmlandFinder or AcreValue. However, throughout the research process, many times a seller may find dated or incorrect information that can be misleading. Keeping a constant eye on the market and having experience with many different sales is an advantage to any seller. There can be limitations to this practice as well. Since comparable sales are backward looking, they only tell you what people have recently paid. Further, this data is often delayed by months or longer.

Comps also do not tell what kind of annual cash return can be expected on a property. There may be a localized buyer who is driving prices up. Paying too much for any property can hurt the long term return, as can buying a “cheap” property with poor rental prices.

Avoiding value traps like this is imperative to making a good purchase. Knowing not only the local market but also the regional and national markets for land provide a material advantage.

Capitalization Rate

Capitalization Rate, also known as “cap rate,” is the expected rent as a percentage of the purchase price of the land (for example, $5 rent on land worth $100 equals a 5% capitalization rate). Most land investors will have a percentage range they hope to hit and will need to adjust either the rent or the purchase price accordingly. Like any equation, a cap rate can be misleading. For example, buying a farm for $1,000,000 per acre and receiving a $50,000 per acre rent will give a 5% cap rate, similar to buying a farm for $10,000 per acre and receiving $500 in rent. However, at $1,000,000 an acre, the buyer would be grossly overpaying based on inflated rents. A seller must have a thorough understanding of what is typical for both sides of the equation to value a farm. Average rent and farm prices can be found in many of the places that comps can be found. The helpful thing about cap rates is that many more sources may be used. Usually land of varying qualities sells for similar cap rates.

Of the two components of cap rates (rent paid and value of the land), true market rent is the more difficult to find. Government surveys will report an average rent paid, but they are dependent on those responding to the survey. There is little data to show the quality of responses and quality of farmer who responds.

For example, while unlikely, what if fifty percent of those who responded to the survey in a given county went out of business in the following year? In that scenario it would be likely that a large number of the respondents were paying too much in rent. Those who rent land themselves, those who rent their land to good farmers, those who sell land frequently, and those who lend to farmers will know the typical rent in a given area. They will likely know the typical farm price and be able to tell you a typical cap rate as well.

The limitations of cap rates can be linked to expectations as well. Many farm investors would love to have rent equal to twenty percent of the purchase price of their land, but this is virtually unheard of under normal circumstances. On the other side of the equation, many sellers would like it if their buyer expected one percent rent on their investment. Understanding a buyer’s motive and expectation for their return can help a buyer price their land.

Most often a seller aims for a buyer’s cap rate range rather than any particular number. The final price will then come down to negotiation and the buyer’s ability to set a rental rate that makes sense for both the buyer and the farmer.

Combining both methods

These two methods are often combined to find the price at which the property is listed. Comps help the seller find typical prices, and a buyer’s return expectations and rents in the area help back into what price could be paid. Most often these numbers are similar. When they are not, a seller must do more research to understand which number is incorrect and adjust one or both to align a price with what the market will pay.

Ultimately this process requires not only market knowledge of rents and prices but also of farmers and farm budgets. This way a seller can understand what a buyer will be able to expect of a tenant in the future. The only way for a property to continue to return rent and gain value in the long term is to have good farmers who are able to make money and take care of the farm. They are the ones who work the land and keep it productive.

To find out more about selling a farm or investing in land, feel free to contact us here. AcreTrader knows farmers, sellers, buyers, and farmland markets. It’s what we do.

How to Sell a Farm Part 2