In fall 2010, Sheila Bair, chair of the Federal Deposit Insurance Corporation (FDIC), raised a few eyebrows when she suggested that we could be headed for a “farm land financial bubble” due to the rapid increase in farmland values in recent years. The FDIC oversees the financial health of many of the community banks that are involved in agricultural lending. Since that time, the Kansas City Federal Reserve Bank has also raised similar concerns, which raises the question: Are we headed for a financial bubble in land values?
Average farmland values across the U.S. nearly doubled in actual dollar value in the decade from 2000 to 2010, and increased by approximately 58% on an inflation-adjusted basis. Average land values in Iowa increased by 16% in 2010, compared to a year earlier, and nearly doubled from 2003 to 2008, before showing a slight decline in 2009. More recent land sales data show that Iowa’s average farmland value increased by nearly 20% in a six-month period from September 2010 to March 2011, and they have continued to increase since then. Land values have also been increasing in other Midwestern states, though not quite as dramatic as the land value increases in Iowa. Southern Minnesota land values have also increased considerably in the past few years, with a majority of sales in the past 12 months for high-quality, tillable farm land ranging from $4,500 to $6,000/acre or more, with some recent sales topping $7,000/acre.
Both the FDIC and the Federal Reserve Bank raised concerns that farm land values may have risen too fast, based on the rapid increase in commodity prices in recent years and the very low interest rates to finance real estate. They are concerned that a sudden drop in commodity prices – along with an increase in interest rates – could result in a major downward adjustment in land values. Some have suggested that a significant increase in ag real estate interest rates could cause average land values to drop by as much as one-third, which could result in financial challenges similar to the 1980s for farm operators and agricultural lenders.
Currently, most people associated with agriculture are very bullish about commodity prices, land values and the overall agriculture economy, which is very similar to the late 1970s. Usually, when everyone is thinking one direction is when things change, and sometimes that changes can occur quite rapidly. Even with the very strong agriculture economy that currently exists, one wonders how many farm operators are adequately prepared for a sudden reduction in grain exports, resulting in a rapid drop in grain prices, along with lower farm profits, and potentially higher interest rates.
Here are some yellow caution flags to think about related to land purchases in today’s agriculture economy:
- The cost of production for corn and soybeans for seed, fertilizer, chemicals and fuel increased by 10-20% for 2011, and is about double the cost of production five to six years ago.
- Land rental rates have also risen quite dramatically in many areas, with increases of 30-50% in the past two to three years in some locations, and even higher rental rates expected for 2012.
- The increased cost of production, combined with the higher land rents in most areas, means that for many producers the breakeven price for corn production is now over $4/bu., and near $10/bu. for soybeans.
- What will happen to grain prices if export markets start to soften in the next couple of years, or if there is reduced grain demand for livestock production or renewable fuel production, due to high grain prices, limited grain supplies or changes in government policies?
- Are farm businesses adequately prepared from a risk-management standpoint to withstand a major downturn in commodity prices or the agriculture economy in the next two to three years?
- Are farm operators paying adequate attention to overall farm debt levels, as well as the repayment capacity for term loans that have been added in recent years for purchases of land and other capital assets?
Does the current strong commodity prices and excellent average Net Farm Incomes in recent years, along with the rapid increase in farm land values, automatically mean that we are headed for a repeat of the 1980s farm crisis? Not necessarily, as there are a lot of differences in the financial management of farm operators now, compared to the 1970s and 1980s. Many farm operators are in a much more sound financial position today than they were in the early 1980s, and most ag lenders have taken a much more strategic approach on their lending principles, as compared to a few decades ago.
Here are some key reasons why farm businesses and ag lenders might be in a stronger position today on financing agricultural real estate than they were in the 1980s:
- There is a good chance that ag commodity prices will face volatility over the next few years, and will incur some periods of lower prices; however, prices are not likely to stay extremely low over several years, given the strong world demand that exists for grain.
- The average farm debt-to-asset ratio in the U.S. has declined considerably in recent years, and is now only 10%, which is well below average farm debt levels in the 1980s.
- Much of the farmland today is being purchased by well-established farmers, who are combining this with other owned and rented land, limiting the overall cash flow impact.
- Many farm operators are paying 50% or more down on the land parcels that they purchase, and thus are only financing 50% or less of the purchase price, as compared to financing 75-80% in the 1980s.
- Most ag lenders are limiting how much they will borrow on farm land purchases, both in terms of percent of purchase cost, as well as total dollars per acre, which provides some room for a downward adjustment in land values.
- Most ag lenders are looking at debt repayment capacity and cash flow ability of farm businesses before they finalize loans for farm land purchases, and are factoring in potential downturns in land values and commodity prices.
Prospects look good for 2011 and 2012 from a farm profitability standpoint, especially in the crop sector, as well as for the overall agriculture economy in the U.S., and interest rates will likely remain low for both farm operating loans and longer-term loans. This scenario is likely to result in continued strong demand and prices for Midwest farmland during the next couple of years. However, producers, ag lenders and others connected to the agriculture industry need to heed the warnings issued by FDIC and the Federal Reserve Bank, and be wary of the caution flags that things could be changing regarding farm profitability and loan repayment ability, thus affecting farmland purchase decisions.
Overall, farm businesses and ag lenders may be better positioned today than in the early 1980s to withstand a downturn in the agriculture economy, but there are still many farmers who could be quite vulnerable to sudden changes in farm profitability. Farm operators need to work with their farm management advisors and ag lenders to develop sound risk-management and financial-management strategies to protect the financial stability of their farm businesses when considering land purchases.
Editor’s note: Kent Thiesse is a former University of Minnesota Extension educator and now is Vice President of MinnStar Bank, Lake Crystal, MN. You can contact him at 507-726-2137 or via e-mail at email@example.com.