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Investing Fundamentals

December 20, 2018

Mitigating Risk in Farmland Investments

Net cash farm incomes (take-home money for farm operators) have fallen over the last 5 years, but the price of farmland has remained relatively stable despite the downturn. Despite the stability, investors must think about protection during weak farm economies.

Thankfully, many of the risks that can come with owning farmland during turbulent times can be resolved for investors with the right structures.

Methods for Decreasing Farmland Investment Risk

Method #1: Cash Rent

Rental contracts for farmland vary widely between different regions. However, there are generally two most common types of rent contracts: revenue share and cash rent.

Revenue share pays the landowner a percentage of the crop produced on his or her farm at the end of the year. While crop share arrangements can add some additional upside to the returns, it also adds risk to the investment by giving the landowner:

  1. exposure to the operational successes and failures of the farmer (including weather risk), and
  2. more direct exposure to commodity markets, since the land owner's crop will have to be sold.

Cash rent is a lease paid to the landowner annually. Importantly, the rent is a fixed dollar amount per acre agreed upon in each lease (leases are typically 1-5 years).

Cash rent is the number most often discussed in farming circles and researched by the USDA; there is good data about state and county average rents, which allows investors to understand an individual farm compared to others around it.

For AcreTrader farmland investors, cash rent provides stability without an immediate link to commodities markets or weather risk. This allows investors to have regular, stable rental returns while allowing the land itself to appreciate over time. Net_farm_income_and_net_farm_cash_income.png

Method #2: Diversification

Another source of stability is diversification of farm property. The more varied properties an investor can own, the more likely the income stream will be stable. In any given year a property may be in an area where there is a drought or other weather related problems affecting production.

As discussed above, this will generally not affect any given year’s rental income since the rent is negotiated at the beginning of the season. However, a series of problems in an area could reduce the frequency in which it is appropriate to raise rent alongside a farm’s typical productivity increases and economic inflation. In other cases, rent could even decrease.

Any property owner needs to work with farmers to make sure rent is fair to all parties. However, owning multiple properties reduces the risk that the entire portfolio could have these problems at the same time. AcreTrader provides a flow of different investment options to allow investors to build their own portfolios of land and decrease their own concentration risk.

Method #3: No Debt

Leverage creates a different problem for farmland owners. The fixed cost of a farmland payment can cause issues with the variable revenues farms often generate. For instance, if a farmland investor purchases land and cannot make his debt payments, then he risks losing his investment to the bank.

For this reason debt ratios have been low since the 1980’s when many landowners held too much debt on their land. farm_sector_solvency_ratios.png The most stable investors and funds do not typically use debt to invest in farmland. Land can be purchased outright and should generate income from the investment in the first year with no risk of debt default.

For this reason, AcreTrader typically fully funds all of its deals at closing and places no debt on the subject property.

Also, AcreTrader provides an alternative to debt for farmers: a farmer can bring a property to the platform that she would like to farm, but cannot purchase on their own.

The farmer can then purchase a portion of the land (depending on what they can afford), sell the rest to investors, and lease the land to farm. This way, they can increase the size of operations, but without taking on the huge expense of land, while still gaining value from land appreciation.

Method #4: Long holding periods

One of the prime advantages of farmland is its ability to store value and appreciate over time. Unlike stocks which depend upon the underlying business’s ability to perform, farmland’s value depends upon the demand for food and the amount of land available to grow that food. As the world’s population increases and the amount of arable land decreases, land assets should grow in value. arable_land_use_per_person.png

While there may be fluctuations in the price of farmland during small periods of time, over long periods of time the value has increased greatly. AcreTrader purposefully offers assets with longer holding periods to take advantage of this feature of farmland.

Method #5: Liquidity

That said, AcreTrader does understand that investors need the ability to get money out of an investment. This can be complicated in the case of volatile farmland prices. If the greater farmland market is doing well, but in one area there are no buyers, a landowner could have to wait a long time to find liquidity. Further, selling a farm can be tedious and complicated when owning farmland outright.

AcreTrader can potentially provide two solutions to this problem. First, we can provide investors for those wanting to sell land without buyers. Second, for investors needing liquidity, AcreTrader is exploring the ability to sell shares in farms to other investors on the AcreTrader platform. This could help allow for liquidity in an efficient and cost effective manner for all involved.

Conclusion

Many factors can contribute to risk during a farm recession; however if investments are made with the factors above in mind, investors can help protect themselves during hard times. While prices can fluctuate in the near term, the AcreTrader platform provides structures and incentives that can help investors attain even more stability in an already highly-attractive asset class.

To see our current offerings, please click here.

Note: The information above is not intended as investment advice. Data referenced herein USDA and World Bank, 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.