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Investing Fundamentals

January 09, 2019

Can Farmland Protect You From Stock Market Volatility?

There are no guarantees in life, especially when it comes to investing. Recent surges in market volatility for stocks and bonds serves as a fresh reminder that asset prices don’t always go up. Can farmland save us?

In short: there are no guarantees in investing, and past performance is not a guarantee of future results. With that being said...

Farmland prices historically have no relationship with stock market returns and have offered a highly attractive way for investors to diversify their portfolios.

Farmland Prices and Stock Prices Move Independently

Look at the chart below showing the relative movement between United States farmland (the green line) and the S&P 500, a primary equities index (red line). What do you notice about the correlation between the two? pasted image.png

To be statistically precise, the correlation between these two asset classes is -0.03. Said differently, there is zero statistical evidence that stock market prices influence farmland prices and vice versa.

The lack of correlation alone suggests that farmland is a great portfolio diversification tool. In a world where most other asset classes increasingly move together, farmland helps mitigate the risk of financial loss in all assets at once. Additionally, the relative movement in the chart above demonstrates two other very important points.

  1. Stocks are volatile. Yes, this is known, but it is fascinating to see the annual gyrations between positive and negative annual returns from the stock market. Swinging between 30% returns and 40% losses isn’t for the faint of heart.
  2. Farmland is a much more stable asset class. Note that the volatility in the green line is just how much is made each year in farmland. Said differently, the returns of a farmland investment over time have oscillated between making small returns and large ones, not between huge profits and massive losses like the stock market saw in the early 2000’s or the great financial crisis. To learn more about the historical investment performance of farmland, please see the for investors section of our website. To learn more about our current offerings, please click here.

Note: The information above is not intended as investment advice. Data in the charts above is sourced from Bloomberg and NCREIF. 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.

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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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While the value AcreTrader provides to investors is clear, we are often asked “what do you do for the farmers?” The answer is: a lot! Our management team has historically been involved with farming before founding and working at AcreTrader, and we understand many of the challenges today’s farmers face. While we don’t have a magic wand to solve every farm problem, we do help farmers in a variety of ways.

Ability to Expand Operations

Perhaps most obvious is AcreTrader’s ability to offer farmers access to capital. For example, there are times when a farmer wants to expand his farming operations onto a neighboring parcel of farmland but doesn’t have the funds to purchase it. This farmer can present the land to AcreTrader’s investors. The investors would then purchase the land and rent it back to the farmer, providing him something he might not otherwise have gotten - economies of scale. He can now use his existing farm equipment and labor on the newly-leased neighboring farm, helping him to grow his business and his bottom line. Another avenue for expansion would be for a farmer to sell a portion of their ownership in some land in order to purchase additional land. Where traditionally farmers would go to a bank and get debt (backed by their owned-land), they could instead just sell some portion of that parcel on AcreTrader and use the funds for expansion. AcreTrader can provide another tool for farmers who hope to grow their businesses.It’s one of the qualities of our business about which we are most excited. With more financing options, farmers can choose a solution that helps them reach both their financial and personal goals.

Quick Access To Capital For Improvements

Almost 40% of U.S. farmland is owned by absentee owners that rent the land to farmers. In many of these relationships, the farmer pays a cash rent that is typically up-front before planting season. While some owners will reserve cash for potential capital improvements, others do not or are unable to. This can result in serious problems. For example, the farmer may have the water pump on an electric well break in the middle of the hot summer. If the owner is unavailable, or does not have cash on hand, this can put the farmer in a very difficult situation. The farmer will either have to pay for the well himself (if he has the cash at hand) or risk his crop dying in the field from lack of water. When working with AcreTrader and its management partners, our farmers have support when improvements are needed. Making enhancements and maintaining a farm’s drainage, ditches, and roads not only helps the farmer, it improves the resale value of the farm. In addition to having capital available for on-farm improvements, we move fast. We are always here to answer the call and take action in partnership with our farmers.

Independent Valuation and Information

We work with farms of all sizes and many types of complex situations. From small conservation-focused farms to mega farms, wholly owned parcels to complex family dynamics and ownership structures, we have seen it all. Importantly, we help farm owners and farmers understand their land value and the options available to them as sellers. While we don’t always engage in a commercial relationship with these farmers and owners, we are happy to share our thoughts regarding the value a farm and work through the potential opportunities and options. Understanding the value of a farm and the process of selling can be complicated and stressful; having someone walk you through it can be an invaluable source of both relief and information.

Respectful Farming and Technology Expertise

Farmers know their own business and their land, and we don’t pretend to know better than they do. However, having operational experience over tens-of-thousands of acres has provided us the opportunity to see a lot of problems and solutions. For example, all the new technology offerings from planters and seed solutions to financial software and satellite mapping can, at times, be overwhelming. We have evaluated a myriad of products, and we have seen a lot that are a waste of time and money - the proverbial “solution in search of a problem.” However, we have also seen some true technological advances and products that can immediately help farmers with their business. Here’s an example recent conversation:

Farmer: “Have you guys seen XYZ’s new software for planting season?”
AcreTrader Farming Operations Team: “Yes, but we noticed they were unable to complete their fundraising round, and they have recently gone through layoffs. It’s likely their product functionality and support will suffer. Have you considered solution ABC instead?”

A farmer's localized history and knowledge of the land is irreplaceable. We help our farm partners through our nation-wide knowledge of the agtech industry as well as the nuances of the legal, land improvement, and farm valuation pieces of the business. In short, we let farmers do what they do best and support them wherever we can.

National Presence and Brokerage

As mentioned above, we work with farms of all types and sizes. Farmers usually know their local market dynamics better than anyone around, but our national footprint and years of cumulative regulatory, valuation, and brokerage work help us present additional thoughts and assistance that might otherwise not be available. In addition, we maintain an incredibly unique and large set of relationships with individual and institutional farmland investors alongside a nationwide footprint of partners.

Conclusion

The above are just a few of the ways we work with farmers to make their lives easier and their businesses more profitable. However, every farm is unique, and so are the solutions for its situational improvements. If you are a farmer or farm owner, or someone interested in learning more about investing in farmland, please don’t hesitate to contact us anytime.

Five Ways AcreTrader Helps Farmers

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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