Flexible Leases Offer Alternative

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The continued strength in corn and soybean commodity prices in the past few months, and the resulting projected increase in crop income per acre, has caused many landlords to consider significant increases in cash rental rates on rented farm land for 2012. This comes after substantial increases in many rental rates from 2008 to 2011. Many crop producers are concerned that the favorable crop prices may not last long term and that the gross income per acre in future years may not be high enough to justify the higher cash rental rates that are being proposed for the 2012, or potential future rental rate increases.

In addition, crop input costs for seed, fertilizer, chemicals, fuel and crop drying are likely to be higher in 2012, as compared to the 2011 crop year. An alternative to the proposed high cash rental rates for 2012, or potentially even higher rental rates in the future, may be for producers and landlords to consider a flexible cash leaserental agreement, which allows the final cash rental rate to vary as crop yields and market prices vary, or as gross revenue per acre exceeds established targets.

The use of a flexible cash rental lease is potentially fairer to both the landlord and the farm operator, depending on the situation and how the flexible lease is set up. A true flexible cash lease allows for the landlord to receive additional land rental payments for a crop year above a base land rental rate, if the actual crop yields and market prices, or the gross revenue per acre, exceed established base figures. A true flexible cash lease would also allow for the base rent to be adjusted downward if actual crop yields and prices – or revenue per acre – fall below the established base figures. However, many flexible leases have been modified, and only flex upward with added rental payment to the landlords if the base revenue per acre is exceeded. The modified cash lease approach is probably acceptable if the base cash rental rates are within a reasonable range.

Flexible leases also work well for newer or younger farm operators who may not be able to afford the higher cash rental rates for farmland. Most ag lenders are quite supportive of the use of flexible leases by farm operators as a risk management tool. A flexible lease, with a fair base rental rate, allows landlords the security of a solid base rental rate while having the opportunity to share in added profits when yields and crop prices exceed expectations. Flexible leases are a nice alternative for landlords who want to continue to work with long-standing farm operators with cash rental arrangements, without setting cash rental rates too high to keep the current tenants.

The biggest challenge with flexible cash rental leases is determining the base rent per acre, the maximum (and possible minimum) cash rent per acre and the method to determine the flexible rent payments. The best way to establish the base rental rate is to have a rental rate per acre that is agreeable to both the landlord and farm operator. Most land grant universities, and some farm-management associations, publish annual average land rental rates on a yearly basis, which could be used as a resource for arriving at an equitable base rental rate. It is important for producers to have a maximum cash rental amount, in order to assist them with crop budgeting, grain marketing strategies and crop insurance decisions. Typically maximum rental rates are $50-100 above the base rate.

The base yield for a crop can be determined by either using the proven yield (APH) for federal crop insurance, which is updated annually, or some other acceptable method of yield determination. Actual yield calculation on the farm can be determined by warehouse receipts, settlement sheets, scale tickets, bin measurements, grain cart weigh wagons, yield monitors or any other method that is acceptable to both the landlord and farm operator. Many times, yield determination requires a certain degree of trust between the landlord and the farm operator.

In many cases, the base price for a crop is the new-crop price at the local grain elevator for that crop on a specified date (ex., April 1 for corn and soybeans), and the final price is the price for that crop at the same local elevator on a specified date in the Fall (ex., Oct. 15). In some cases a weekly or monthly average price at the local grain elevator from planting to harvest is used to determine the final price. Another alternative that is easy to follow, is the use the revenue protection (RP) crop insurance base price for a crop as the base price for the flexible lease, and the RP harvest price as the final price, which are based on Chicago Board of Trade (CBOT) futures prices. Whatever method is used to determine both the base and final prices should be consistent, using either local cash prices or RP prices from the CBOT. The details for determining prices and yields should be spelled out in a written land rental agreement that is signed by all parties.

With the occurrence of much higher crop input costs in recent years, some flexible cash leases have been modified, and are now based on gross revenue triggers that exceed the cost of production, rather than on crop yield and price triggers. In this type of lease the landlord only receives additional cash rental payments beyond the base rent when the final gross revenue per acre (yield x price) exceeds the established cost of production for the year. Typically, the added flex rent payment to the landlord would be a set percentage of the added gross revenue per acre above the established cost of production per acre, which is typically about 30% for corn, and about 40% for soybeans, with a maximum rental rate per acre. Just as with crop yields and prices, determining the established cost of production for a crop for the year can be a challenge. Some possibilities would be to use cash flow statements for the year prepared by a farm management advisor, ag lender or the producer themselves. Again many universities and farm-management associations have average cost-of-production data available. There also probably needs to be allowances in a flexible lease to allow for added costs or expenses due to weather or emergencies.

Using flexible cash leases agreements between farm operators and landlords appears to be a good management strategy as an alternative to extremely high straight cash rental rates. Landlords who are eligible for social security also need to pay attention as to what effect certain types of flexible payments, such as receiving a percentage of the grain that they must market, may have on the status of their future social security benefits. It is extremely important that all aspects of a flexible land rental lease agreement be spelled out in detail in a written rental contract, which is signed by all parties. Successful flexible cash lease agreements have always involved cooperation, trust and good communication between the farm operator and the landlord.

 

Flexible Lease Resources

Iowa State University has some very good resources on flexible cash leases and written cash rental lease contracts, including sample cash rental contracts, which are available on their Ag Decision Maker website. For additional information on flexible land rental leases, send an e-mail to kent.thiesse@minnstarbank.com

 

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 kent.thiesse@minnstarbank.com.

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