Road Warrior

Criteria for Enduring the Commodity Super Cycle and Land Value Correction

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Working with the agricultural lending industry, I have sensed anxiety concerning a possible land value correction when the current commodity super cycle abates, suppressing cash flow and profits. The current super cycle has persisted 2.5 times the duration of previous cycles over the past century. There is no doubt that the current super cycle is bringing complacency in management to some and a bulletproof approach to growth to others.

When a correction occurs, the timeline is usually six years. Whether it is stocks, suburban and urban real estate or farm real estate, the behavioral and emotional impact typically results in six years of economic white waters, during which even the best of businesses struggle. Real estate values usually reset to a level seen 10-15 years prior to the correction. The key is not having to sell assets at the bottom of the cycle, and enduring through the dip so you can hit the ground running after the economic storm has passed.

As a case in point, many producers purchased inflated land in the late 1970s. Those who were able to weather the economic storms of the 1980s and continued to own land found that the land value after a 30-40% correction returned approximately to the value 15 years earlier. Those that did not have their financial house in order were required to sell, taking a huge loss on land.

Let’s start the discussion on some of the criteria needed to build your financial fortress to withstand the demise of the super cycle or a land value correction.

 

Profits, profits, profits!

If a farm is profitable and the profits are allocated properly, all financial criteria on the farm and ranch business will improve. In recent years with the extensive appreciation of land values, some have ignored profitability, or it has become a secondary priority. This is particularly true with the “millionaires on paper” as a result of inflation that have never earned a dollar of profit.

A disturbing trend being observed concerning profits is that there is a widening gap of profitability and performance. Ranked by profitability, the top 20% of producers on many of the university and commercial databases earned 10% or greater return on assets (ROA) over the past 20 years, while the bottom 20% earned 1% or negative ROA.

To endure a downturn, ROA prior to the downturn needs to be above 7%. Profits that are turned to cash flow - as opposed to appreciated or devalued assets - are used to pay bills, service debt, and fuel your growth strategies.

 

Calculating Return on Assets

Net farm income

$100,000

Interest paid

+$50,000

Subtotal

$150,000

Management fee or living withdrawal

- $75,000

Subtotal

 $75,000

Subtotal / Total assets

 

 

$75,000 / $1,000,000 = 7.5% Return on Assets

 

Next time we will cover additional strategies for weathering a downturn.

 

Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at sullylab@vt.edu.

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What's Road Warrior?

Dave Kohl is an ag economist specializing in business management and ag finance. He can be reached at sullylab@vt.edu.

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