Flexible cash rent leases helped Iowa grower Curt Hansen ride out the farm crisis of the 1980s. Today, flexible leases are helping him manage risk.
Volatile crop prices and high input costs are making it hard to set a fair fixed cash rent, says Steven Johnson, Iowa State University Extension. So a growing number of landowners and farmers are turning to flexible cash rent leases, which adjust automatically as yields and prices fluctuate.
There are many types of “flex” leases, but most provide for a minimum or base rent payment, plus a bonus payment if gross revenues exceed a specified level. This arrangement allows the owner and renter to share risks and rewards, Johnson says.
In the current economic climate, “a flexible cash farm lease will likely be fairer to both the landowner and the tenant,” Johnson says. If prices or yields are below normal, the tenant pays less rent. If yields or prices are higher than expected, the landowner shares the additional income.
However, setting the base rent and agreeing on revenue calculations and bonuses can be quite a challenge, says Kevin Dhuyvetter, Kansas State University Extension. Still, says Hansen, who is a landlord as well as a renter, “I believe the concept is very good, especially in volatile times like we're going through now.”
Hansen and his son raise corn and soybeans on 2,700 acres near Baxter, in central Iowa. Hansen also owns the 160-acre farm he grew up on in north-central Iowa. This year, he and the farm operator, a close family friend, decided to try a flexible cash rent lease.
“We established a base rent that we thought was reasonable,” Hansen says. “It's a bit lower than the going cash rent.” Hansen will receive 35% of any gross revenues over $800/acre for corn and 40% of revenues over $600/ acre for soybeans.
To calculate gross revenues, Hansen and his tenant use the USDA average county yields for Franklin County, multiplied by the Farm Service Agency (FSA) average posted county price from Oct. 15 to Dec. 15. “We picked that time frame because it's usually the lowest price of the year” and does not reflect crop storage costs, Hansen says. He spent a lot of time trying out different combinations of price, yield and input costs, and concluded that the flex lease “is fair to both parties.”
Joe Hutchinson, a retired banker and farmland investor from West Des Moines, IA, has had a similar arrangement with his renter for the last two seasons. “I think it's the way to go,” says Hutchinson, who doesn't object to taking on more risk in exchange for upside potential.
The lease on his 300-acre farm calls for a guaranteed base rent, due in two installments on April 15 and Dec. 15. Hutchinson receives 35% of any gross revenue over $600/acre. The $600 bonus trigger point reflects average production costs, including the base rent expense, he says.
Farm revenue is calculated using the USDA average county yields and posted county prices. Hutchinson likes using public data because it avoids potential disputes over farm-level yield numbers. And on his highly productive land, which typically outperforms the county average, the lease is “very fair,” he says.
Flexible cash rent leases require farmers and owners to agree in advance on how yields and prices will be determined, says Kent Thiesse, vice-president of MinnStar Bank in Lake Crystal, MN.
Like Hutchinson and Hansen, you can use average county yields, although those numbers aren't available until the following spring, which delays the final rent settlement, Thiesse says. And individual farms may vary a lot from the countywide average.
As an alternative, you could use actual farm-level crop yields. These can be determined through combine yield monitors or weigh wagons, elevator scale tickets or storage bin capacity. Yield numbers should be corrected to a specified moisture level, he notes. The certified yield and acreage data required for farms enrolled in the new ACRE program could do double duty for gross revenue calculations, Johnson says.
To establish a crop price, Thiesse suggests using your local elevator price on one or more set dates, or the average of several harvest delivery bids at one or more local markets. Spell out the dates and locations in the lease, he says.
Your local FSA posted county price is another good way to set the crop value, Thiesse says. “It's easy to get, consistent and based on hard data.” Another plus: the prices are adjusted monthly, “so there's less variability. That gives the numbers a lot of credibility,” he says.
The thorniest aspect of flexible cash rental agreements is setting the base rent and the amount of revenue needed to trigger a bonus payment, says Jim Jensen, Iowa State University Extension farm management field specialist.
In theory, flexible cash rent should adjust both up and down, but in practice, the base rent is usually the minimum rent paid, he says. So, “the base should be set so risk is truly shared. As production costs go up, you need to lower the base rent so the landlord is sharing the risk.”
Likewise, the closer the base rent is to the going rate for fixed cash rent, the more revenue is needed to trigger a bonus payment, Kansas' Dhuyvetter says.
Last December, Joe Hutchinson and his tenant renegotiated the base rent for their 2009 flex lease after crop prices fell and fuel and fertilizer costs shot up. “The original guaranteed base rent was too high,” Hutchinson says. “It wouldn't cash flow, so we lowered it.”
Thiesse suggests using current crop-production budgets and five-year historical average yields as the starting point for base rent and bonus negotiations. Crop insurance parameters could be another starting point, Dhuyvetter says.
Dhuyvetter encourages farmers to consider a flexible cash rent lease. But he warns that the devil is in the details.
“It's more complicated than doing a fixed rent contract or a traditional one-third/two-thirds share rent contract.” In fact, most people he talks to end up sticking with a traditional lease.
“I do think we're going to see more flexible cash leases, but they don't fit every situation. Landlords are different and their needs are different, so this is not for everybody,” he says.
Risks and rewards are shared by tenant and landowner.
Rent adjusts when yields or prices fluctuate.
Landowner does not have to be involved in production or marketing decisions.
Farm program payments don't have to be shared with landowner.
Because the rent adjusts automatically to changing conditions, multi-year leases are feasible — an advantage to the grower when making fertilizer, tillage and machinery decisions.
Works well with the ACRE program in providing FSA data for the annual planted acres and certified farm yield.
Next Page: FSA RULE CHANGE SPURS INTEREST IN FLEXIBLE LEASES
Flexible cash rent leases are still uncommon, but a USDA rule change is likely to encourage wider use.
In Iowa, flexible leases make up only about 12% of all cash farm leases, says Ann Johanns, Iowa State University Extension program specialist. But interest in flex leases is up sharply, she says, and farm management experts are fielding more questions about them. That's partly because of a recent change in FSA rules, says Kent Thiesse, vice-president of MinnStar Bank in Lake Crystal, MN. Rental agreements that provide for a guaranteed base plus a bonus are now considered cash rent leases, rather than crop-share leases.
This means USDA farm program payments no longer have to be shared between the farmer and the landlord — a provision that had stifled innovation, Thiesse says. The rule change “has opened the door to creative flexible lease agreements.”
Flexible cash rent leases that adjust the rent based on yield alone or price alone can increase the farm operator's risk in some years, cautions Jim Jensen, Iowa State University Extension farm management field specialist.
This could happen with leases that flex for price only, in years when prices are high but yields are low; or with leases that flex for yield only, when yields are high but prices are low, he says. Growers with these types of flex leases should use additional risk-management tools, such as crop revenue insurance, Jensen says.
Baxter, IA, farmers Curt and Brock Hansen have a flexible lease with one of their eight landlords. This lease, which Curt first negotiated during the 1980s farm crisis, flexes for crop prices only. The landowner receives a payment based on a fixed number of bushels per acre. The bushel value is set by averaging crop prices for six pre-set dates over a six-month period.
The rent isn't due until December — a cash flow advantage for the Hansens and evidence of their long, trusting relationship with the landowner. The terms set a minimum and maximum rent, which “protects us both” by keeping rent within a desirable range, Curt Hansen says.
As with a fixed cash rent lease, though, the Hansens bear all the yield risk. To offset that risk, Curt says, “I hedge with crop insurance and I forward market.”