For the past several years, we have seen double-digit land price increases in many states. Will this keep up?
I don't think so. I know I may be swimming against the current with most people's thinking, but I will share with you some of my thoughts that support my rationale that prices may not keep going up at the past rates — and may even go down.
An analysis of our client base of cash grain farms in central Iowa indicates that in 2004 the average projected profit per acre was $55.50 and the actual profit per acre was $74.69.
Our data, compared to average, suggests that we have the top farmers in our database and they seem to be those who are buying the land.
From a broad perspective, look at the Standard & Poor's 500 stock index. Its current value is at 20 times earnings. Assume the $74.69/acre earnings times 17 would give one a value of $1,493/acre — far below current sale prices. This may not be a realistic comparison because there is appreciation in farmland that is the result of other factors besides cash return earnings. If one adds a 50- or 100-year trend line appreciation in Iowa farmland from 1950 through 2000 or 1900 through 2000 it is 4.38% and 3.83% respectively.
There are many ways to analyze investments. Emotion enters into many of them, but one has to look at the bottom line, and at this point I believe there are better investment alternatives in production agriculture that can return double-digit returns. Plus it gives you the diversification advantages I wrote about in last month's column.
On the other hand I still find cases where I recommend a purchase of land if it fits into other long-range plans. The bottom line is every decision requires a lot of analysis.
Additional pressure on farmland prices may come from reduced profit potential due to increased fertilizer, fuel and other operating costs. Another wild card is what will happen to the 2007 farm program and what will those changes do to future profitability.
In looking at our clients' 2006 cash flow projections, it's obvious costs are going up at a very rapid pace and additional emphasis will need to be placed on increasing revenue with better marketing and best management practices.
Having experienced the farmland price drop of 1982 to 1987, I know it can happen. However, that price drop started in farmland and then moved to other sectors of the economy. (Agriculture has such a multiplier effect in economic expansion or decline.) My sense is this slow down or decline will not start with farmland, but with residential housing, then move to commercial real estate and finally to farmland. (See sidebar.)
I often tell clients to look at additional investments on a risk-to-reward teeter-totter. The potential reward has to be greater than the potential risk or you shouldn't do it, as it puts at risk too much of what you have spent a lifetime putting together. Don't make an investment that will tip the risk to reward scale against you.
The Housing Bubble
I am more concerned about residential real estate values than farmland values based on some of the following data.
As stated in the July 25 issue of Barron's, the following data is surprising:
Real estate has accounted for 70% of the rise in household net worth since 2001.
More than 40% of the private sector jobs created since 2001 have been housing related.
Sub-prime market loans have accounted for 28% share of new mortgage funding in the past six months (vs. 5% five years ago).
An estimated 42% of first-time homebuyers made no down payment on their home purchase last year.
More than 60% of new mortgages loans in California this year have been in interest-only loans or option ARMs.
This real estate boom is unprecedented in terms of both the number of countries involved and the record size of house-price gains.
“Measured by the increase in asset values of the past five years, the global housing boom is the biggest financial bubble in history,” according to the June 18 issue of The Economist. “The bigger the boom, the bigger the bust.”
Moe Russell is president of Russell Consulting Group, Panora, IA. Russell provides risk management advice to clients in 20 states. For more risk management tips, check his Web site (www.russellconsultinggroup.net) or call toll-free 877-333-6135.