BOTTOM LINE

Farmland prices. Everyone's interested. For most, the value of farmland probably comprises the majority of your net worth. After the recent price explosion in most areas of the country, people normally feel excited about the land they own, and upset that they don't own more. It's almost like trading commodities: In a bull market you never have enough and in a bear market you always have too much.

Why the big move up? Frankly, commodity prices have not been the driver of this bull market. One exception — extremely profitable cattle prices (prior to Dec. 23) boosted land values in cattle feedlot areas such as western Nebraska, Kansas and Oklahoma.

But in the Midwest, the land price boom has been driven primarily by one thing — low interest rates. It's been a domino effect, for the most part, and works like this:

Because of low interest rates, a young couple living in a metropolitan area can now buy a $150,000-200,000 home. Their payments will be approximately the same or less than what they are currently paying in rent. As a result of these new buyers, real estate developers are able to buy farmland at extremely high prices and develop entry-level to middle-income homes.

The farmer selling his property for exorbitant prices, which in large metro areas can range from $20,000 to $60,000/acre and in some cases even more, then looks for another farm to buy farther from the city. If he sells a farm for $30,000/acre, he doesn't really care what the next one is going to cost. He's merely looking for a 1031 (tax-free) exchange to be able to roll the profits into another farm.

Another group of buyers includes investors who have been watching farmland values go up and have concluded that ag land is a good investment.

The third group of buyers includes farmers sitting on significant equity in land they already own and are willing to add to their current land base at higher prices.

Mix these three groups together and it's like adding gasoline to a fire that's burning out of control.

Farmland has long been a good investment and will continue to be for years to come. Price jumps seem to move in leaps rather than gradual trends. And I think this last leap is close to an end if not already there. This will result in a leveling of values that could last for the next several years. The key issue is not how high land prices can go, but the risk of land values going down — which is slim.

Can The Trend Continue?

In my opinion, the high land-price trend can continue, but certainly not at last year's rate of increase. Some areas close to metro areas have increased 20-50% in value in just the last 12 months. These kinds of increases can't be sustained.

The real clue to the intermediate term direction of farmland values lies in where interest rates are headed. I'd assume that rates are going to be slightly higher, if not modestly higher, in the next 6-12 months. If you add two percentage points to the prime lending rate, breaks will be applied to farmland increases immediately.

But one of the important issues to recognize in farmland values is that the odds of a crash similar to the 1980s is slim to none and slim has already left town. Why? The crash of the 1980s was caused by high debt and high interest rates. And the only way a crash can occur is to have forced liquidation sales. The only way to have forced liquidation sales is excessively high debt where an individual can not make the payments. That is not the case today.

The accompanying chart shows the picture. The horizontal line is the debt repayment capacity in agriculture. In 1973 we had an enormous amount of debt repayment capacity available. But by 1980, because of high debt and high interest rates, that had completely eroded.

In today's environment, much of the land has been bought with cash or very little debt. Consequently, the threshold risk level is nothing close to the level of 1980.

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.