May 20, 2020
How To Diversify Your Farmland Portfolio
While we have often spoken about how farmland can be a great portfolio diversification tool for investors, many investors ask about how to diversify farmland holdings. This is a great question, and, in fact, one of the reasons AcreTrader was founded.
Diversification allows investors to spread risk. In a portfolio, if stocks perform poorly, then one’s bonds or real estate may perform better. Even within an asset class it can be a good strategy to diversify. For instance, one is often counselled to own a wide variety of stocks.
Diversification in land ownership
In farmland, diversification makes sense as well.
Different farms have different qualities that provide benefits and drawbacks from season to season. By owning multiple farms, an investor can spread their risk across geography, commodity, and tenants.
Among the primary risks in farming are weather patterns.
These can often vary even within a county, with different farms on different ends of a county receiving different amounts of rainfall.
Sometimes, this can allow a farmer to plant or harvest at a more advantageous time or give growing crops much needed water at a key period in the growing season.
Crops can also add to diversification.
Any given year may have better weather for growing corn, rice, wheat, cotton or soybeans. Therefore, owning fields which grow different types of crops can add to the likelihood of having a good year in one crop.
Importantly, both weather and crop risk are further mitigated for an investor in a cash-rent scenario, where a landowner is simply renting the land to the local farmer.
Climate, the typical set of temperature and weather patterns for a region, can provide its own set of variables.
In more tropical climates, the growing season is longer and has more growing degree days, which can provide an opportunity for multiple growing seasons in a year.
However, more tropical climates also experience greater numbers of weeds and insects that may hinder a crop’s growth.
Farmers and farm tenants may vary widely by region as well.
In the midwest, farms were originally divided into much smaller tracts than in the Mississippi River Delta. Therefore, farmers have a harder time aggregating large tracts of land to farm and tend to operate smaller farms with smaller teams of people.
In the Mississippi River Delta, there are often larger farmers with larger teams of people who will farm more acreage.
Even within a given region, there may be counties in which farmers prefer different rent structures to farmers in neighboring counties.
Achieving Meaningful Diversification
Given all of these variables through which one may diversify a farmland portfolio, what are the best ways to manage the risk in each? How much diversification should one have?
Unfortunately, this is a difficult question to answer specifically, but there are several general conclusions we may draw about the role of diversification in mitigating farmland investing risk.
Just as index funds have allowed investors to ‘own the market’ through a varied portfolio that works to defray risk, farmland investors may also see similar benefits by owning multiple farms with different qualities.
One benefit of this strategy would be to provide diversification in the weather patterns and events to which a farm owner may be exposed.
Owning farms in a few different regions should allow enough variety in cropping methods, weather tendencies, seed varieties (which are often different in different regions), crops, and other variables to reduce risk across a farmland portfolio.
Farmers and tenant risk can be reduced in the same county. However, that must be balanced with having good relationships with farmers and creating operationally efficient structures for their businesses.
Ultimately, portfolio diversification is a balance an investor figures out over time.
The variables above may be managed to produce effective results. We would also suggest consulting a financial professional while building a farmland portfolio.
Misleading Diversification Factors
There are ways that diversification can be misleading as well. Sometimes while seeking different variables, investors may be increasing risk unintentionally.
For instance, the crops grown on a property may be a way to diversify, but often too much emphasis is put on this point.
In many cases, one crop may have a drastically different risk profile than another and may look like a different type of investment instead of a way of diversifying - somewhat like comparing owning a small business to owning a stock.
We often are asked about crop diversity and would like to spend a little more time on that topic.
The primary crops grown in the U.S. are corn and soybeans. Those two crops make up 35% and 30% of all cropland in the country, respectively.
When you include wheat, the third largest (at 18%), 83% of all farmland grows only three crops. That means that the vast majority of investable farmland will grow one of these three crops over the lifetime of the investment.
Effectively, saying one wants to diversify out of these crops is similar to saying one wants to diversify out of apartment buildings when investing in multifamily real estate - there are alternatives, but they are the exception, not the rule.
What is also important to know is that the drivers for those crops is demand. More people want to eat meat, and corn and soybeans are most often an input for animal feed.
As the world continues to adopt meat as a staple food, corn and soybeans will continue to dominate the farm landscape.
There are other good methods of diversification which can be misunderstood. For example, while we have already discussed the benefits of owning farms in different locations, one can go too far with that idea.
As you can see from the chart below agriculture production is concentrated in certain states.
A farm in Nevada [44th State in the US by revenue] may actually have additional risks from lack of farm tenants in the area or it may not have much farmland in general.
Any good idea can be taken too far.
Optionality In Land Investments
An idea that is often discussed around the AcreTrader office is the idea of optionality. Flexibility gives an investor protection against potential risk.
Ultimately, land itself has a great deal of optionality. Unlike a hospital, which is built for one primary purpose, a farm can grow a number of different crops.
Owning farmland allows an investor to gain exposure to any crops which can be grown in the region and climate with capable tenants in the area.
If a scientist found a way to turn squash into a carbon-neutral, cheap fuel that could power the grid, many acres would switch from soybeans to gourds.
Another example is this study done by the WWF on how the MS River Delta could become the new California.
The potential (and, thus, optionality) in raw land provides an underlying diversification that appeals to all of us here at AcreTrader.
Farmland Diversification Through AcreTrader
AcreTrader has a unique advantage in being able to provide a cost effective way for investors to diversify their farmland holdings.
Most of us have been involved in farming and farm investing for most of our lives. We think about diversification and mitigating risk in every single investment.
Further, the farm team here is constantly seeking to mitigate risk by providing a variety of investment options.
We encourage investors to contact us and discuss the different variables in listings on the platform as they build their own portfolio of farmland.
Note: The information above is not intended as investment advice. Data referenced herein Cornell University, 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.
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