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This post is the third of a four-part series where we discuss the process of selling a farm. It 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 by no 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: Terms
As we mentioned in our introductory post, deal terms are one of the most under-appreciated parts of any transaction. This can be even more true when selling something like farmland. Most often terms that are important to sellers are those that give them rights to use the land after it is sold. However, other terms could be a lease-back to the original owner after a sale or owner-financing to the buyer by the seller.
Land Rights After Sale
Often, farm sellers want to sell their asset but continue using parts of it. They hope to continue to live in the house they grew up in or hunt the fields and woods in which their fathers and grandfathers spent their winter mornings. Many times this is possible through a carve-out provision, in which parcel lines can be redrawn to exclude things like homesites and hunting woods from the property sale. Alternatively, a hunting lease to the seller can be arranged on favorable terms.
Other land rights which sellers retain can be financially motivated. Mineral rights, water rights, and easements (right to cross the land) could be potentially retained by a seller. These can create an opportunity for the seller to continue to make residual income from the land without owning the rights to the surface of the land.
Thinking through the contract terms and understanding which rights you hope to retain before you sell a property is vital to understanding what kind of price you can expect to receive. Most of the time the fewer terms requested by the seller, the greater the price most buyers will be able to pay.
Lease Rights to Land After Sale
Some farm sellers also hope to have some say in who farms the land after it has been sold. They either want to farm it themselves or help a relative or neighbor do so. In many cases these wishes can be accommodated. A creative buyer can find ways to work with a seller if the property is worth buying. In fact, a sale-leaseback arrangement (where the seller rents the land from the buyer) is fairly common, especially when the buyer is not another farmer.
Sometimes a farmer will want to keep farming the same acreage, so the fixed cost of his machinery remains spread over the same number of acres. This way a farmer can keep his business the same size, but take some money out of land and use the proceeds to diversify his savings or purchase other nearby land.
Thus far, we have discussed leases that are seller-preferrable. There are stipulations to leases that buyers seek as well.
Buyers have lease term preferences that can diverge widely, depending on the type of owner they are. Those who are less active in the farmland market often like longer term leases with trusted parties, since they do not have time to actively manage their investment. They tend to give up some return, since it is difficult to keep up with market rents with longer term leases. More active buyers tend to like the flexibility of shorter leases. It allows them to keep up with market trends in structure and rent, while making sure all parties are content with the terms of the lease every year.
Additionally, many buyers often prefer lease agreements that are written instead of verbal. Especially when a landlord-tenant relationship has been in existence for many years, leases tend to be agreements cemented by a conversation and a handshake. However, when a new buyer does not have the kind of relationship that a previous owner had with his tenant, that same handshake agreement is difficult to maintain. Therefore, setting up a written agreement before selling a property is useful for all involved.
For many sellers timeline is a big issue. There are people who can wait to get the best price, which may take several years of putting a property on the market during peak season and taking it off afterward. There are others who need to sell a property immediately. Since most farms are worth at least hundreds of thousands if not millions of dollars, transactions can take many months to complete.
Usually a property will be listed or shopped to potential buyers for several months before one makes an offer, then the deal will take several more months to close as the potential buyer does due diligence. A seller can request a shorter due diligence period or even a shorter time to close, but many times this affects the price a buyer is willing to pay.
At the same time, most buyers understand the effect of the growing season on a seller. For those sales that are between harvest and planting seasons, most buyers are willing to act quickly to transact before the next crop goes in the ground. For mid-season sales buyers and sellers work together to find reasonable terms. For instance, a buyer and seller may split the profits and expenses for a year based upon the percentage of time each party owned the property during thate year.
A property’s condition is frequently considered. If there was a particularly wet harvest, the fields will likely be in bad condition. This can impact the ability to put down seedplant the crop in a timely manner in the next planting crop season, which can affect the profitability of the farm in the first year of new ownership/tenancy. Other problems might occur with old drainage pipes, wells, or irrigation systems.
Many buyers will discount the price of a farm by the amount they believe they will have to pay to get the farm in working condition. This may mean a few thousand dollars for a culvert or far more if the farm is in particularly bad shape.
There are also times when a buyer may negotiate a higher price from a seller in return for services on the back end. A buyer may pay the price for a fully levelled field with an agreement that the seller will use his equipment to level that field after the transaction closes. There are many agreements like this that can be arranged, if the buyer and seller are willing to work to find common ground.
Most farm transactions involve some form of debt. This can add time to the closing process, as there are more parties and moving pieces involved in the transaction. There are times when transactions may fall through as a result of financing not being approved. As a result all-cash buyers often get preference from sellers, since the likelihood of closing the transaction goes up significantly without a third-party lender involved.
On the other hand, there are times when a seller is willing to finance a buyer’s purchase themselves. For instance, a neighbor may finance a younger farmer who wants to buy her first property. This allows the younger farmer to purchase a property which a bank might not loan enough money for her to purchase otherwise. Often this arrangement is born out of friendship or an interest in selling to someone who is willing to accept terms that others might not. As a general rule, the more simple the payment arrangement the easier and more likely a transaction is to close.
These few categories should give any seller a good start on understanding the different agreements under which a farm might sell. There are more typical agreements; however, different kinds of buyers are willing to be more or less flexible on different characteristics of a sale. We will discuss this in our next post. For now, use these as a baseline for understanding and be sure to work with an experienced real estate lawyer when negotiating any contract.
If you want to know more about how these transactions work, give us a call. We are happy to walk you through the process and help you in any way we can.
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.