Throughout most of the U.S. grain-producing states, cash rents are rising along with the overall value of good land. Some look at this trend in dismay, wondering how land prices can keep going up when the prices of corn and soybeans are near 30-year lows.
The answer is fairly simple. Asset values are cash-driven. Who has the cash? How much do they have? What do they want to do with it?
In addition, two other factors, to a large extent, drive this market:
- Farm consolidation.
- Government payments, such as LDPs.
The first factor is by far the most important. The cost of adding an additional 600 acres to a 6,000-acre farm is an altogether different issue from a 600-acre farm doubling in size. Large farms can afford to “overpay” for marginal acres — whether it makes economic sense or not.
In light of this trend, many are concerned about when the potential “train wreck” will occur — such as the one we witnessed from 1982 to 1986 when farmland prices collapsed.
Is such a decline possible again? Until recently, I'd have said “No.” But some issues now make me nervous as we look three to five years down the road.
First, let's recognize that in order for farmland values to drop significantly, you must have forced liquidation sales. In order to have forced liquidation sales, the majority of producers need to be in extremely high debt situations and, most likely, also paying high interest rates. As you'll notice in the chart, that's what happened in the early 1980's. Agriculture exceeded its debt repayment capacity.
Today, farm debt is nowhere near where it was in 1980, but it's increasing at a fairly steady rate. What if we wake up five years from now and the prime lending rate is 14%? I'm not making that prediction, but what if …
Think about it. In the past 18 years, it has not paid to be a long-term borrower, because rates have been trending lower. It's now time to start thinking in the other direction.
What if a producer has expanded rapidly and has all of his money in short term? He's unwilling to shift to long term. Why? Because the current rate is approximately 7.5% on long term while he may be borrowing short term at 6%.
But don't compare today's long-term rates to today's short-term rates. Compare today's long-term rates to where you expect them to be three to five years down the road.
In a declining economy, some say the potential for rates to go higher is slim. I strongly disagree. This economy will turn, as will the demand for money. More importantly, both state and federal governments are running huge deficits. Who was the largest borrower of money in the 1980's? The government. If the demand for money increases appreciably over the next two years, interest rates will follow.
Parting Thoughts
This is a time to be thinking long term, particularly for those who have been expanding operations aggressively the past few years. Pay close attention to getting as much of your financing locked up on long-term rates as you possibly can. Your risk of being wrong is small, and the potential of interest rates going much lower is also small. If rates double from where they are, the farmland value picture will not be as rosy as it is today.
Richard A. Brock is president of Brock Associates, a farm market advisory firm, and publisher of The Brock Report. For a trial subscription and information on Brock services, call 800-558-3431 or visit www.brockreport.com.
