Does setting cash-rental rates feel a little like playing roulette? Can you guess the winning number? Surging farmland values and volatile crop and input prices are complicating next year’s cash-rent decisions – and intensifying risk.
Many wonder if future revenue will be high enough to justify escalating rent? Meanwhile, costs for seed, fertilizer, fuel and chemicals are going up. Beyond that, who can predict next year’s weather or yields?
All in all, “It’s very hard to know ahead of time what rent will be fair,” says Purdue University Ag Economist Craig Dobbins.
One way to cut some of the guesswork is with a flexible cash lease. Unlike fixed cash rent, flex rent adjusts automatically as crop yields or prices fluctuate.
“I look at flexible rent as a hedge on risk,” says Arvid Schwartz, who raises corn, soybeans, sweet corn and winter wheat in Sibley County, MN. He has nearly 20 years of experience with flexible leases. “In a good year, you’ll pay more rent – but in a good year you don’t mind paying more rent. In a poor year you’ll pay less rent.” And it’s those poor years “that we worry about.”
Schwartz, who served as chief financial officer and treasurer of Twin Cities-based Group Health Plan (now Health Partners) before going into production agriculture, has farmed for 23 years. He has the financial strength to withstand a drop in farm markets. But, “if I were a young farmer, renting most of my land, I’d want to have flexible cash-rent agreements. You can really appreciate what that would mean in a poor year.”
There are many ways to structure flexible leases, Purdue’s Dobbins says. Rents can adjust for yield, price or total revenue. “I recommend the total revenue approach, which adjusts for both price and yield.”
In the simplest revenue-sharing lease, the landowner receives a portion of the gross crop revenue. In Iowa, for example, rent has historically ranged from 30% to 45% of the crop value, says Jim Jensen, Iowa State University (ISU) farm business management specialist. In the last five years, though, Iowa rents have not risen as fast as crop values, he says.
Dobbins agrees: “In general, revenue from crop production has outpaced rents.”
Another common flexible lease calls for a base or guaranteed minimum rent, plus a potential bonus. If total revenue exceeds a specified threshold, the landowner gets a share of the additional money. If revenue falls short of the bonus threshold, the tenant pays only the base rent, which is usually less than the local going rate.
Flexible leases require landowners and tenants to agree on:
• a base or minimum rent and, if desired, a maximum rent;
• the amount of revenue needed to trigger a bonus rent payment;
• how to calculate yields and crop prices; and
• how to divide up bonus revenue.
Flexible leases are more complex than fixed cash leases and take more time to negotiate, says Loyd Brown, president of Hertz Farm Management, Nevada, IA, which manages 2,000 farms in central Indiana, Illinois, Iowa, Nebraska, southern Minnesota and eastern Colorado. In the last five years, about half of the company’s cash-rental properties have switched to revenue-sharing flexible leases. These agreements are a very fair way to go in today’s volatile farm economy and competitive rental markets, Brown says. “Both owners and operators are interested in long-term relationships and being fair with each other.”