Recent data by the Federal Reserve banks indicate that Corn Belt farmland values had risen between 22% and 25% during the past year. That rate of increase had not been seen since the mid-1970s. USDA Wednesday released 30-year data that does not come close to indicating such rapid ascents in land values, but does raise a question whether there is a bubble within land values. Such a possibility will raise concerns among policy makers who are considering a new farm bill. How will that affect their thinking?

USDA’s land value study looks at a longer-term trend in farm real estate values. The economists report, “Recent sharp increases in farmland values raise questions about whether farmland prices have reached levels that cannot be sustainably supported by expected agricultural returns.” They say the recently established prices are not occurring under the same conditions that contributed to the financial crisis of the 1980s. And they add that while income and land values were linked in the first half of the last century, that fact has become less so, and recently there is little correlation on a national level.

In relation to rental rates, farmland values have increased faster than rental rates, but that has been a 45-year trend. Based on cash rents, it would only take 14 years in 1951 for farmland to pay for itself, but that had risen to 33 years by 2007. “Studies have found that farmland prices are more volatile than rents. Rising incomes in the nonfarm rural economy in recent years may also have contributed to increases in farmland values, with a more limited impact on rents.” While some farmland is sold to capture the capital gain benefits, other farmland is rarely sold because of nonfinancial ownership issues. Only ½% of farmland is sold annually.

The current period of low interest rates has two positive effects on farm real estate values, according to University of Illinois Economist Gary Schnitkey. His research is cited by the USDA economists, who say, “First, for those who have to purchase land with debt capital, it lowers the total cost of purchasing land. Second, interest rates represent returns on competing fixed investments, and when they are low, farmland looks more attractive as an investment alternative.”

The USDA report says farmland values were supported by earnings in 2009 and 2010. “When farm real estate values divided by the capitalized value (price-to-value ratio) exceed 1, farmland values are not supported by the stream of cash flows the farmland could earn. During 2004-2008, farmland values were not justified based on farm earnings alone. Subsequently, market signals indicate that farmland was somewhat undervalued at current interest rates, so it is not surprising that farmland values increased in 2009-2010.” They also report, “In 2010, the price-to value ratio was about 0.9 based on current rates. If interest rates were to jump to the long-term average, the price-to-value ratio would sharply increase to over 1.5, signaling that land values would not be supported by the stream of rents the land could earn at historical interest rates.” In the 1980s interest rates did rise rapidly, causing land values to fall sharply.

Current increases in land values can be attributed to the demand for crops as both food and energy sources, which have kept stocks tight. There has also been a strong export demand fostered by the weak dollar. But USDA economists warn that “the size of the U.S. trade deficit increases the risk of investing in farmland. If other countries become less willing to cover the U.S. deficit, interest rates could climb and debt-financed real estate values could fall.”