The average value of prime Iowa farmland punched through the $5,000/acre ceiling early this year.

Top-quality farmland in the bellwether state hit $5,200/acre, according to the latest survey of farm realtors by the Iowa Realtors Land Institute. That's up 21% for the year ending March 1.

It's the same story across the Corn Belt. Farmland values continued to push higher in 2007 and the first half of 2008, driven by record grain prices and strong farm income. But the boom may be losing steam as soaring production costs and softer grain prices dampen farm income prospects.

Nationwide, cropland values rose 10.4% from January 2007 to January 2008, according to the USDA Land Values and Cash Rents Survey, released in August. In the past five years, U.S. farmland has appreciated nearly 80%, the report says.

FARMLAND VALUES continued to climb in the first half of 2008, according to several regional surveys.

In the U.S. heartland, farmland appreciation slowed slightly in the first three months of 2008, then edged up again this spring, according to the Federal Reserve Bank of Chicago, which surveyed lenders in Illinois, Indiana, Iowa, southern Wisconsin and Michigan. High-quality farmland values in the region rose 15% during the 12 months ending July 1, bankers estimated. Illinois led the region with a 17% annual gain in the value of good farmland; Indiana values climbed 16% and Iowa values 15%, according to the Chicago Fed survey.

In the northern Corn Belt, non-irrigated farmland in Wisconsin, Minnesota and the Dakotas posted annual gains of 24% in the first quarter of 2008, then slowed to 22% in the second quarter, according to lender surveys by the Federal Reserve Bank of Minneapolis.

Farmland values in the Plains States of Kansas, Missouri, Nebraska and Oklahoma plateaued during the first half of 2008, according to the Federal Reserve Bank of Kansas City. But values “remain well above year-ago levels,” says Kansas City Fed Economist Jason Henderson. The region's irrigated cropland gained 21.6% for the 12 months ending July 1, and non-irrigated cropland gained 18%. The biggest gains this year were in Nebraska, where values rose 24% for the period, lenders estimate.

“Clearly, the agricultural real estate market has responded to crop commodity prices, which have shot upward to record levels,” says University of Nebraska Extension Economist Bruce Johnson.

“There is a lot of confidence that crop prices and demand will remain strong,” says Mike Duffy, Iowa State University Extension economist. Participants in a recent Purdue University farmland survey, for example, expected corn prices to average $5.06/bu. over the next five years and soybeans to average $10.86/bu.

Flush with profits and positive expectations, active farmers are competing to buy land to expand their businesses, says David Oppedahl, Chicago Federal Reserve Bank business economist.

IN INDIANA, about three-fourths of respondents in Purdue University's 2007 and 2008 farmland surveys say demand from farmers for land is up. Likewise, in Illinois, 60% of land buyers in 2007 were farmers, up from 40% in 2006, according to an annual real estate survey by the University of Illinois. In Nebraska, nearly 75% of land buyers last year were active farmers, compared to 59% four years ago, according to a February market survey by the University of Nebraska.

That's a change from earlier in this decade, when land markets were buoyed primarily by investors looking for diversification and bigger returns on their portfolios, says Duffy, who oversees Iowa State University's annual farmland survey. “A lot of money came out of the stock market into land.”

Housing development and 1031 land exchanges also pushed up ag land prices in the first half of this decade, Fritz says. Capital migrated from financial assets to real assets such as “residential and commercial real estate and ag real estate,” he says. “That prompted purchases of transitional land and triggered 1031 exchanges,” which allow sellers to defer capital gains taxes by buying land elsewhere within 180 days.

Pension and endowment funds are a growing force in land markets, says Fritz, who follows U.S. farmland trends. For example, TIAA-CREF, the New York-based retirement fund manager, invested in Westchester Group's $400 million International Agricultural Investors LP fund, which is buying row-crop land in the U.S. and Australia. George Washington University's endowment fund plans to invest $70 million in farmland in the U.S. and abroad, he says.

Institutional investors are stoking Nebraska's red-hot land market, Fritz says. In that state, which last year ended its ban on corporate ownership of farmland, an investment group recently paid $52 million for 19,202 acres of ag land and buildings in Lincoln County. According to Fritz, the sale set off a series of 1031 exchanges in which buyers paid significantly more than the going rates for ag land.

Demand for farmland is intensified by the limited supply available for sale, says Louwagie, the Iowa broker. In a mid-year survey of members of the Illinois Society of Professional Farm Managers and Rural Appraisers, 63% of respondents said the volume of farmland sold in the first half of 2008 had fallen from a year ago.

“It's a market that is by nature very thin,” Johnson adds, supplied mainly by estate sales and retirements. “The reason for buying land is the very reason for holding it.” Fritz has heard reports of institutional investors “out scouting for land on an unsolicited basis.”

Favorable interest rates and ever-rising agricultural productivity are also propelling cropland values higher, says Oppedahl, the Chicago Fed economist. “We can produce so much more on an acre of land, and that contributes to land becoming more valuable.”

BUT SOME SEE trouble looming over Midwest land markets.

Some analysts think that grain prices have peaked, and input costs are up sharply. Midwestern economists are predicting that non-land corn production costs in 2009 could rise $120-140/acre. Growers are shouldering more financial risk than ever if crop yields should fall or grain prices drop, Oppedahl says, and “farmers will likely face a squeeze in their cash flows next spring.” Red ink flowing from the livestock sector is another concern, he says.

Unprofitable ethanol production, changes in ethanol policies, a worldwide recession, or a big bump in world grain supplies could also weigh on crop prices and farm income, stalling land appreciation, Duffy adds.

Participants in Purdue University's June survey predicted slower increases in Indiana farmland values over the next five years, from 2% to 3%/year. Likewise, over half of Illinois farmland managers and appraisers expected prices to rise 1-5% in the next year, according to the annual University of Illinois Mid-year Land Values Survey.

Still, inflation-adjusted land values in the U.S. have not yet hit the peaks of the late 1970s, Oppedahl points out. Despite uncertainties, “fundamentals favor further increases in farmland values,” he says. Just 2% of Seventh District lenders responding to the Chicago Federal Reserve Bank's second quarter ag credit survey expected district farmland values to decline this fall, Oppedahl says, which suggests that “the recent increases in land values are unlikely to be over.”

Land markets, like all markets, have a history of business cycles, Fritz says. “There's an exceptional amount of enthusiasm now. And the long-term fundamentals do look positive,” he says. “But there are increasing signs of volatility. People need to be cautious about extending themselves and leveraging their balance sheets in this period of optimism.”

RENTS HAVEN'T RISEN AS MUCH AS LAND VALUES

Cash rents - which have lagged behind farmland appreciation - posted record increases in many parts of the Midwest in 2008.

Historically, lease rates have tracked at about 30% of gross revenue/acre for corn, says Michael Fritz, editor of Farmland Investor Letter. However, “cash rents have lagged the income-generating capacity of farmland for some time, and that gap has widened with the run-up in grain prices.”

Since 2004, Corn Belt cropland values have shot up over 70%, the USDA says, while cash rents rose 23% over the same five years.

In Iowa, rates jumped 18% to an average of $165/acre - a $25/acre increase from 2007, according to the USDA 2008 Land Values and Cash Rents Survey. Rental rates rose between $18 and $32/acre, and exceeded $200/acre in many Iowa counties, according to Iowa State University's (ISU) annual rental rates survey.

Nearly every Midwest state saw double-digit cash rent increases this year. Growers paid an average of $160/acre to rent cropland in Illinois, and $135/acre in Indiana, both up 13% from last year.

Cash rents for top-quality Indiana land broke the $200/acre mark for the first time, according to a June Purdue University survey. Rents rose 16% in Minnesota, 18% in Wisconsin and 14% in South Dakota, the USDA reports.

In Nebraska, 2008 cropland cash rents jumped 17-23%, according to the University of Nebraska's 2008 Farm Real Estate Market Survey.

The Federal Reserve Bank of Chicago reported that cash rents in the Seventh District, which includes Illinois, Indiana, Iowa, southern Wisconsin and Michigan, climbed 21% from 2007 to 2008 - the biggest jump since the Chicago Fed began collecting cash rent data in 1981.

Nationally, cropland cash rents rose 13% for 2008, up $11 to $96/acre, the USDA reports. That's nearly double the previous yearly increase of 7%, and it follows a decade of annual increases of 5% or less.

Some large landowners are turning to public rent auctions to test the market, Fritz says. The University of Illinois, for example, held a rent auction for 5,900 acres of cropland, which drew nearly 100 bidders and generated rental contracts 40-100% higher than previous lease rates, he says.

Next year? It's hard to forecast what will happen to lease rates in the future, because the ag land rental market is “notoriously opaque,” Fritz says. An August survey by the Illinois Society of Professional Farm Managers and Rural Appraisers predicts that average cash rents for Illinois farmland will rise about 18% next year. “Cash rents can vary dramatically based on the productivity of the land,” says Bob Swires, of Swires Land & Management Company, Danville, IL.

Purdue's survey found that Indiana cash rent as a percentage of farmland value ranged from 3.7% to 3.9% this year - about the same as last year and well below historical averages. “Over the 34-year history of the survey, rent as a percentage of farmland value has averaged about 6%,” says Purdue University Agricultural Economist Craig Dobbins.