June 10, 2019
How Landowners Earn Income From Farmland
There are several ways landowners can earn income from their farmland investments. Each business model carries different levels of risk and reward.
The best choice for you will depend upon things like your level of capital reserves, your level of experience with farming and production agriculture, and your preference for investing in active or passive income opportunities.
The following is a brief overview of the most common farming arrangements here in the United States.
In this scenario, the landowner and the farmer are one and the same. Getting started as an owner-operator requires capital for land and equipment, business acumen, physical strength, and extensive hands-on experience that is typically earned by working for more experienced farmers.
Most owner-operators have grown up in the business and work for family members, but the complexities of modern farming have led more young farmers to also obtain college-level degrees in agricultural sciences.
Buying a farm in order to become an owner-operator is less like making an investment and more like buying yourself a full-time job. While farming your own land can yield the highest annual returns during years with good harvests, it can also carry the most dramatic swings in profit and loss from year to year.
If you do not have adequate farming experience, millions of dollars available to purchase the land and equipment, or the desire to assume the responsibility of running an agribusiness full-time; becoming an owner-operator will not be a suitable option for you.
With a custom farming operation, you hire farmers to grow crops on your land and pay them a set rate or fixed fee. Hired custom farmers typically provide and maintain their own equipment and tools-of-the-trade necessary to nurture the crop from planting through harvest.
As the landowner you pay 100% of the input expenses including seed, fertilizer, pesticides, etc., and also keep 100% of the profit. This can be especially lucrative in years with great harvests and, when factored over several years, can net average annual returns approaching 9% to 10% of the land value (assuming you own the land outright).
The custom farming model is far less labor-intensive for the landowner than being an owner-operator. However, it is only a good fit if you have some agribusiness experience, ample capital to cover input and labor costs, and the risk tolerance to go through one or more bad harvests or years with low commodity prices.
With a crop sharing arrangement, the landowner partners with a farmer. The landowner provides the land, while the farmer provides the labor and equipment to work the crops. The terms for this partnership often vary based on regional customs.
For instance, a common arrangement in midwestern states is where the landowner and farmer each pay half of the input costs and share equally in the profit of the harvest.
In the delta states, however, a more common arrangement is where the farmer pays all of the input costs and takes 65% to 80% of the revenues, while the landowner receives 20% to 35%.
With a crop share arrangement, the landowner has significantly lower out-of-pocket expenses compared to custom farming. Unlike custom farming, however, the farmer has less obligation and financial incentive to prioritize your land over other parcels he is working, where he may be fully invested and earning 100% of the crop revenues. This could be problematic if the farmer finds themselves overworked and facing a choice of where to invest time and effort.
Averaged over several years, a crop share agreement may earn the landowner 5% to 6% of the land value annually.
Compared to the cash rent model below, however, you assume significantly higher risk with exposure to commodity markets, crop risks, and inclement weather, yet achieve only a slightly higher return.
Cash Rent (Lease)
With a cash rent agreement, the landowner acts only as landlord. A tenant farmer pays you a fixed dollar amount per acre per year for the right to farm your land.
The farmer uses his own equipment, assumes all input expenses, and, for the most part, conducts his business as he sees fit. In turn you collect an annual rent check, usually before planting begins each spring, which is typically 3% to 5% of the land value.
For example, if you have 100 acres of farmland valued at $3,000 per acre, you could reasonably expect to charge a tenant farmer anywhere from $90 to $150 per acre for a total annual cash rent of $9,000 to $15,000.
For all these reasons, AcreTrader investment offerings focus on the cash rent model.
Of all the income options discussed here, cash rents offer the lowest relative risk and require the least amount of activity for the landowner.
Since most cash rent contracts are fully prepaid before planting season, this arrangement prevents landowners from taking on any crop risk from the farmers and prevents farmers from taking on any credit risk from the landowners.
Because cash rent leases require no direct labor or inputs from landowners, they are a good fit for those who lack the experience, ability, capital, time, or desire to actively work the land.
Cash rents are a truly passive income opportunity with relatively little risk. For these reasons, AcreTrader investment offerings focus on this model for investors.
Residual Income Opportunities
Depending on the unique features of your land and your level of creativity, you may also be able to secure residual income beyond your agricultural operations.
Some common arrangements involve hunting leases, mineral rights, or even renewable energy leases for wind turbines or solar panels.
To explore these and other passive income streams in greater detail, check out our article on additional passive income opportunities of farmland.
There are many ways to earn income from farming your land, including several other unique business structures not discussed here.
While cash rent agreements provide an ideal passive income opportunity and serve as a natural choice for those simply seeking diversification from other markets, each investor must decide what best meets his or her needs.
To see our current farm offerings, click here.
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.
Overview of the factors that determine the value of a farm and how AcreTrader uses these indicators in the farm valuation process.
Review this comparative analysis to help you decide between investing in farmland vs gold, two of the world’s oldest and most valuable asset classes.
Learn when you may benefit from having a lawyer to help you sell farmland given your individual circumstances and value of land.