This chart on farmland pricing speaks for itself. The cause of this sharp increase is well known to everyone and focuses on three sources: Chinese demand, ethanol and unprecedented buying by commodity index funds.
While eventually one, if not all three sources, will start to weaken, none are showing any signs of weakness at this point, and thus the reality is that enormous price support for land values continues.
Some would like to compare this to the bull market in the 1970s, which led to the early to mid-1980s collapse. About the only similarity between this bull market and the 1970s was that it lasted for about eight years. The trend took off in 1973 and peaked in 1981. The acceleration of the current trend started in 2000 and here we are in 2008.
But that is about where the similarities stop. As one chart shows, debt repayment capacity in farmland exceeded 100% in the early 1980s because of high debt and high interest rates. The current move is being propelled by “cash” with very low debt and very low interest rates. Asset values can only drop sharply as a result of forced liquidation sales. Without large debt, you will not have forced liquidation sales.
One other interesting comparison of history is, however, that land values have typically peaked once investors and farmers bid the land values to where the return is approximately 3% of the value of the farm. Many areas of the country are not to that level yet, but some are getting close. Cash rents in some areas of Illinois are now exceeding $400/acre.
While you can argue that this trend may slow the increase in values (and it might), keep in mind that this is a gross revenue game. Even if you were to argue that grain prices are nearing a peak, with corn about $5.50/bu. and soybeans trading over $14, the next wave of support may not come from prices, but from yields.
Major seed companies forecast that, within the next two years, we should anticipate at least a 10-bu./acre increase in corn yields. At $5/bu., that adds another $50/acre of revenue. This is a revenue game — not a price-per-bushel game.
There are always those predicting a crash in grain prices and land values. Neither is likely to occur soon. Inevitably there will be a minor train wreck financially from overextended producers paying high rents and selling grain before covering their costs.
The risk in this environment is locking in one leg of the profit equation (revenue vs. cost) before the other leg is locked in, and then betting on the wrong leg first. This should be another incredibly profitable year for the majority of corn and soybean producers, but the decision-making is becoming more difficult than ever.
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.