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Lease Longer, Lease Stronger

Canadian farmers know how to rent land. In fact, in 2006, they rented close to 65 million acres, and paid an estimated $2.6 billion for the privilege. Now, however, the buzz is all about long-term leases — which can make the standard one-year rental agreement look like child’s play.

Long-term leases can have lots of benefits, but they’ve got lots of potential complications too. How do you set fair prices? How do you handle government programs? What happens if something goes wrong at home and you have to break the lease?

The good news is, lots of bright people have already done lots of hard thinking about these issues. The tough news is, there’s still a lot of thinking that you need to do yourself.

But there’s another piece of good news too. Landlords are more receptive than ever. In past, says Ralph Howes, production economist with Saskatchewan Agriculture, a long lease was a sign that a farmer and the landlord had worked together for years and had gained each other’s trust. Now, a long-term lease can mean that circumstances have changed.

As more landowners become seniors and live off-farm — and often out of province — long-term trust relationships become crucial, which means more landowners recognize there’s a benefit for them to think long term.

Additionally, in some provinces land investment companies are becoming big players, and most prefer longer leases. For example, Assiniboia Capital Corporation now manages the largest farmland fund in Canada, with over 110,000 acres owned and under management. “Our leases tend to be from three to five years, depending on the circumstances,” confirms Brad Farquhar, vice-president of Assiniboia.

Setting rates

Typically, land rents are either carved in stone, such as a cash payment of a predetermined amount, or they are more flexible, such as a flexible cash rent agreement that adjusts the rent based on yields and commodity prices, or a crop share lease which is based on a predetermined division of the crop.

With the traditional cash rent, the tenant pays no matter what happens. The farmer tenant assumes all the risk, does all the marketing and supplies all the inputs and work. “Landlords who want cash rent don’t want to participate in the risk of farming,” says Howes.

Often, this is a handshake annual deal based on what the local market is paying. The difficulty is trying to get good market data, since it’s private information, negotiated between two parties.

Saskatchewan Agriculture used to publish a survey from over 1,000 cash agreements. The last time the province did this was in the spring of 2007, when it found the average arm’s length cash rental rate was $23.54 per acre, with individual rents ranging from $5 to $52.50.

The problem with surveys by cropping district is that there are huge variations in productivity within a district. And sometimes the information gets thrown around the coffee shop one too many times. For instance, rumours swirled about $250 per acre in southwestern Ontario this winter, and $75 per dryland acre in southern Saskatchewan.

If that’s what you’ve heard, you maybe haven’t heard the whole story, says Howes.

Compounding the rumour problem is that some landlords read the headlines about high crop prices and food shortages and don’t necessarily understand how the commodity markets work, or the current costs and risks. “What they see in the paper isn’t realized price, it’s a futures price without freight included,” says Howes.

Commodity prices do directly affect the cost of rent. In Saskatchewan, for instance, wheat still tends to guide rental rates as it willll come into play at least once in a four year rotation.

In 2008 the leases that were rewritten generally increased by $5 to $10 acre, says Howes. The next two years the renegotiated agreements went sideways. “2011 is an interesting mixture,” Howes says.” We’ve got optimism because of the commodity prices and pessimism because of the wet conditions.”

Howes recommends farmers calculate rental rates based on their cost of production and estimated earnmanagement ings per acre, not on the rumour mill. This is especially important for longer-term leases. Some farmers look at average net revenues per acre over many years to set cash rent amounts. Others add a premium for longer terms.

“Know what you can afford to pay,” Howes says. “Comparing a beginning farmer with a more established farmer is quite a different situation.”

Many of the provincial extension websites have spreadsheets for valuing costs for both the landlord and tenant based on a farmer’s actual costs. Ontario’s land leasing tools at www.omafra.gov.on.ca/english/busdev/facts/01-065.htm include a variable rent, crop share calculator and flexible cash rent chart.

Another option for calculating cash rent is to base it on an estimated return on investment for farm land in the area. “Typically in Alberta that’s three to 3.5 per cent,” says Mark Muchka, business development specialist with Alberta Agriculture and Rural Development (AARD). “This is in 90 per cent of the province, except in urban areas.”

Flex options

Ironically, market volatility is not only one of the reasons why farmers want longer terms, but also a factor that pushes up the risk of committing to such rents.

Flexible cash leases and crop-sharing agreements may help. They often have longer terms than cash rent since they can be extended without renegotiating the rental amount.

They aren’t the only options, however. Adding flexibility to a long-term cash lease can be done several ways. Here are a few.

A simple way is to write in a price review with longer-term leases. “Maybe it’s a five-year lease, with two-year price review,” says Howes.

To help cover the risk of extreme weather conditions, some farmers are adding a clause to their agreements so they pay only for seeded versus cultivated acres. However, inequities can arise in situations like last year when government support income was on flooded fields, both seeded or unseeded. To avoid this problem, lease agreements can include how to deal with government pay-outs.

Timing cash flow with when rent is due is another way to limit cash-flow risks. In a cash lease, the rental payment may be paid in full at the beginning or end of the season, or it may be divided into spring and fall payments.

Other agreements calculate a fixed rent base and add on a flexible component for average yield and prices. Merle Good, business specialist with Alberta Agriculture, has estimated a good base price is 20 to 25 per cent of seeded crop insurance value at 80 per cent coverage. From that number, a factor is added to reflect what’s happening in the market and yields.

Sometimes a portion of the rent is fixed cash and a portion is crop-shared. Other leases may incorporate a cost of production formula, where the tenant receives, for example, the first $100 per acre of income. If there’s additional revenue, the landlord receives another set amount and any balance goes to the tenant, or you could split the additional revenues.

With crop share agreements, the landlord and tenant share the revenue from the land, with both parties sharing in the risk of production and price. Ratio of inputs and outputs are set ahead of time, often 1/3 to 2/3 or 50:50. The actual dollars are calculated after the crop is sold, which may reduce cash flow problems. However, administration is more complicated as production needs to be accounted for separately and there can be extra hassle factor. Plus there’s potentially less upside to farming this way. “Crop share leases have gone by the wayside here (Alberta),” says Muchka.

Improvements

Many farmers need to grow higher-value crops in order to pay for land rents that are pushed up due to urban pressure. However, on unimproved land, you can’t always grow higher-end crops, like vegetables.

Also, landowners in this rural-urban zone may not care if the land is improved. In some cases, in fact, they may not want improvements, like spreading manure or cleaning up fencerows.

Usually written lease agreements state that tenants need written permission from the landlord before making major improvements, like tile drainage or fencing.

It should be clearly understood what building or improvements are to be made, who will pay the cost of materials, and how the tenant will be compensated for labour and costs. The farmer should make duplicates and staple them to the copies of the lease agreement.

In Western Canada as the farms get larger, they tend to have one centralized storage. However, the smaller farmers use individual yards’ storage space. “That’s another negotiable item,” says Howes. “If you have to buy storage for the rented land’s production, that’s costly.”

Communicate

Two-way communication is key in finding a mutually beneficial long-term rental relationship. Landlords generally want two things: a “good” price, and assurance the land will be cared for and will be left in proper condition. Farmers want two things too: a “good” price, and long-term access.

Landlords aren’t always only gunning for the most money, says Howes, who happens to be a landlord himself. Conversely, farmers need to honestly talk to the landlords about net earnings per acre.

Sharing cost-of-production spreadsheet information with the landlord can be a wise move, especially if the flex part of cash rent is calculated for average margins and yields over longer time period.

Muchka suggests including in the lease agreement that if there’s a problem, it has to be addressed right away. That lowers the risk of having the landowner wanting out of the agreement after planning and possibly buying for the next year.

If a next generation is involved on your farm, Muchka suggests they talk to the landlord. Similarly, he says communication with the next generation of landowners might be prudent in order to begin building relationships.

Muchka remembers his father taking the landowner for a ride on the combine, spending that time together talking. Sharing information is even more important the further away the land owners are from being a farmer.

Some landowners might like seeing a GPS map of their fields or are reassured by knowing that you’ve taken a manure management course or adhere to an environmental farm plan or a mission statement. It can’t hurt to share this information.

The bottom line is to find out what people want. That means getting to know them, and actually asking them what they’re interested in. Maybe they want to be able to hunt in a certain area, or maybe what would really make a difference for them is to get their driveway cleaned out. Others might want to know about genetically modified seed.

Also be prepared to take the time it takes to form a relationship. The more urban the landlord, Muchka says, the more knowledge you might need to share.CG

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A DIFFERENT IDEA

Hubert Shillings farms near Oshawa, Ont. and chairs a local agricultural committee, and he wants municipalities to restrict the farm tax rate so it can only be used on rented land if that land is committed to long-term leases.

“It’s more sustainable system then. How do you do land improvements with short-term leases?” Shillings says. “You don’t.”

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RIGHTS OF FIRST REFUSAL

If long term is what you’re after, maybe your ultimate goal is ownership. In some cases, the tenant is interested in purchasing the leased land but is either unwilling or unable to do so currently.

In those cases, consider a right of first refusal, which is basically an option to purchase the property by matching the purchase offer the landlord receives from a third party.

Another way to do this is an option to purchase. It is like a right of first refusal, but an option to purchase sets out either a fixed price or a formula or method for determining one, perhaps by using unbiased third parties like real estate agents or a certified agricultural appraiser.

Some landlords don’t mind including this option as it shows a dedication to good management practices. Others want compensation. How much this is worth is totally dependent on the individuals. “Some farmers are willing to pay extra for first to purchase clause,” says Howes.

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WRITE IT DOWN

A verbal rental agreement is fine, until something goes wrong. At that point, it’s difficult to prove what the terms were, which means the credibility of the parties may become the deciding factor.

“One thing I get questions about is from farmers regarding lease agreements,” says Jennifer Stevenson, business specialist with Ontario Ministry of Agriculture, Food &Rural Affairs. “All of them resulted from disagreements in what the lease obligations entailed, and all of them involved verbal contracts.”

Most of the provinces’ extension websites have sample cash-lease and crop-share agreements with alternative clauses that can be used to customize your lease agreement. The more time you spend drafting a lease, the less time it takes your lawyer to prepare the final copy.

“Make sure you cover off everything you discuss with the landlord in a written lease,” says Howes. “Things can change, and suddenly you’re dealing with a spouse or an heir.”

On a basic level, lease agreements should contain the amount of rent, how it’s calculated and when it’s to be paid. They should state when the lease starts and how long it lasts and, although not a basic requirement of a lease, this section should address the renewal of the lease if the parties wish to maintain the lease agreement for a period of years. The lease should also state when and how such a renewal will take place, and what will happen if the lease is to be terminated or the property is to be sold.

“You can write in what you want,” says Howes. “You make the rules.” Don’t forget to have your lawyer review the document. You may also have to register longer-term leases.

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Senior Business Editor

Maggie Van Camp

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