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Making a smarter deal for farmland

If farmers are so sharp at land buying, who do so many pay too much?

Acquiring more land has the potential to boost your farm business, but like anything in life, there are no guarantees.

On most farms, it’s among the big decisions of an entire lifetime. Do you buy that farm down the road and take on all that risk? Or do you watch someone else farm it and mutter, every time you drive, “That could have been mine”?

Either way, it’s harder than anyone outside of agriculture might think to make it a coldly rational decision. Emotion can so easily get in the way.

But that’s only other farmers, right? You wouldn’t let that happen to you. Or would you?

Additional land can bolster your farm business, but its acquisition isn’t a guaranteed boon, especially if emotion governs your expansion decisions.

“Farmland and buying situations will invoke emotions,” says Saskatchewan agricultural realtor Tim Hammond. “Producers are human and, as such, subject to emotions.”

Even the most accepted strategies can be based as much or more on emotion than on shrewd strategy.

For instance, Farm Credit Canada vice-president and chief agricultural economist J.P. Gervais says location can stir up emotions and colour your assumptions.

“There is still the feeling that when something becomes available that’s located near where you are, that that’s an opportunity,” Gervais says. “Farm operators feel that if they’re not at least considering it, then that piece of land’s not going back in the market for another 40 years or so.”

Maybe this is one slice of the land market that technology is taking care of, though. While location remains a significant factor, farmer and accountant Lance Stockbrugger says it’s not as much of a driver as it was years ago. Producers are more willing to move to different areas in part because equipment, thanks to higher speeds, has becomes more mobile.

But other factors still matter, including the size of the farm on offer, Stockbrugger says. There’s greater attraction to, say, 2,000 acres than two quarters.

The scaling argument

Also stirring emotions is when farmland that’s been leased goes up for sale.

“You farm that land; you know that land better than anybody else. Maybe it’s not worth what they’re asking for, maybe you should let it go, but typically guys will just pay the price, as long as they can,” Stockbrugger says.

After all, the argument goes, no one’s making more land.

There’s also a business scaling argument to consider, Stockbrugger says. Can you afford to lose those acres after equipping yourself for that size in terms of machinery and manpower? If you don’t end up buying it, how do you replace those lost acres?

It’s important to acknowledge and be aware of your emotions to reconcile them with the business case, says Hammond.

“It is okay to pay a premium to secure certain farmland if you understand it is a premium and it is worth it to you,” Hammond says. “Sometimes the risk of paying a little too much is better than the risk of losing the opportunity to farm that land.”

“I have seen a a quarter sell for twice its market value at auction,” says realtor Tim Hammond. For buyers, though, there are risks in sealed bids too. photo: Getty Images

Open auction or sealed bid

The farmland market is a combination of rational decisions, emotional discounts and motivated premiums, Hammond says. And that’s not just on the buyer’s side. He’s seen sellers take discounts for reasons that are more emotional than business rational.

In one instance, a seller had no family member to take over the farm, but still retained a strong desire to leave a farm legacy.

“The seller would rather help out the young neighbour who they really like by giving him a break on the price than achieve a premium from the non-local farmer already farming 50,000 acres,” Hammond says. “The seller is happier knowing the young buyer is going to pick up where he leaves off and that they helped him do that.”

He’s also seen sellers experience a significant emotional event in their life — such as divorce, death, foreclosure proceedings — and, as a result, take a discount for a straightforward, immediate, low-profile sale.

Emotion can also get the better of people in a bidding situation, leading to overpayment.

“Under the right circumstances, that can happen at a public auction,” Hammond says. “I have seen a quarter sell for twice its market value at auction.”

Both buyers bidding on the parcel had an emotional connection to it and, as such, they were both prepared to pay a premium for it.

“In this case, it resulted in a huge premium,” Hammond says.

Another example where big premiums can occur is in a closed (sealed) tender process.

A potential buyer is at a great disadvantage there, not knowing the price the seller expects, what competing buyers are prepared to pay, or even if there is another buyer interested.

“They only get one chance to make an offer and they don’t want to lose the opportunity,” says Hammond. “I have seen tenders where a 30 per cent premium is achieved with only one offer submitted.”

Become a better buyer

Farmers are already shrewd. To go the next step and to actually excel, however, the experts say it’s essential to draw up a plan and have it in place before land even comes up for sale.

“Be prepared. Be in a position where you can respond and act quickly on an opportunity should it present itself,” says Hammond.

Gervais agrees, and adds that a good place to start is by making a list of different factors to consider, including why you want more land in the first place.

“You’re tying a good part of your wealth in an asset that is not very liquid,” Gervais points out. “You have to have a plan that matches up to your strategic goals.”

Stockbrugger stresses the value of focusing on cash flow before making any bids, and says farmers often look at a property’s price compared to other pieces of land, as well as historical values. Current low interest rates have made farmers keener on buying as they’ve lowered the cost of payments on land.

But what producers must address is if they can cash flow their purchase over the long-term, say, 25 years, says Stockbrugger.

Prices of commodities and inputs change and so do yields, and you can’t use your cash-flow numbers from three years ago to justify buying today. Also, as you buy more, more of your cash flow will be taken up with making payments.

“On every purchase, you should look at, ‘Can my cash flow sustain the payments?’” Stockbrugger says.

It’s crucial, too, to factor in how much more you might have to spend on equipment and manpower if you buy that ground. Be realistic, Stockbrugger says. It’s too easy for farmers to talk themselves into thinking more acres always means greater efficiency and lower costs.

Sometimes it doesn’t.

Consult your team

To ensure your plan is as thorough as possible, work with professionals who can provide the help and support needed in areas you don’t feel equipped to deal with on your own.

“I see the need to behave as CEOs,” says Gervais. “If you think of any CEO in a company, they usually don’t have all the answers, but they know how to surround themselves with people who do have the answers for them.”

An accountant and a lender are two of the experts to consult first, says Stockbrugger.

Yes, it’s more effort, but there’s a pay-off, says Hammond. Producers who understand the metrics of their capacity can make decisions and act quickly. “That will involve having up-to-date financial statements, and having regular discussions with members of your farm management team, including your accountant and financial institution,” he says, but adds, “Acting quickly will give you an edge over competing buyers who need three weeks to talk to their credit advisor first.”

Farmland advisors and realtors can also assist producers in weighing the cost of the opportunity with their capacity, risk tolerance, and long-term goals, says Hammond.

“I say we have never sold a parcel of farmland; it always sells itself. Our role is to help people make the decision that is right for them,” Hammond says.

If you’ve found you can afford it, then you can work on what the land is really worth, and if it will make your operation more efficient and effective, Stockbrugger says.

There are the obvious productivity considerations. Consult your agronomist to consider the property’s soil profile. What’s the drainage like, the salinity levels, and what’s the history of production and chemical applications?

Other professionals, though, will raise questions you might not have considered. Your lawyer who will then consider important questions related to zoning, possible underground pipelines, easements and if a mortgage is already registered against the property.

Deeper into your buying transaction, your accountant can assist again, determining exactly what you’re paying for, Stockbrugger says. Are you buying raw farmland, or assets as well, such as buildings and grain storage?

It’s important to allocate the purchase price to those different assets at the time of negotiation because you can’t do it after the fact, Stockbrugger says. Whereas the seller wants to put little of the price toward the buildings, it’s in the buyer’s interest to do the opposite in order to take advantage of tax depreciation.

Also, if from a tax perspective the seller prefers to receive the proceeds over a period of time, it could save the buyer in interests costs, but also make the buyer willing to pay a little more, Stockbrugger says. Again, your accountant can serve your interests here as well.

Mistakes to avoid

Numerous pitfalls face potential farmland buyers, and our experts point out a few common ones they’ve seen over the years.

For three decades, Hammond has heard producers say, “That farmland won’t pay for itself!”

Yet, somehow, it almost always does, he says.

“Do not wait for farmland values to drop. Look for ways to make it work at the current price. Be flexible,” Hammond says.

When you’re determining the price that you’re willing and able to pay for land, first establish how much cash you have available, if the transaction will allow you to make a profit, and if you can cover losses if they appear, says FCC’s Gervais.

But more important than price is how a property fits into your strategic plan for your operation, he stresses.

“To buy or not to buy just based off of what you expect price trends to be like in the next little while doesn’t look to me like a path to strategic goals in your business,” Gervais says. “If you’re buying just to build wealth, it lacks a strategic plan for where you take your business.”

If it’s only about investing, there might be other wealth-building strategies that are more attractive or make more sense from the point of view of diversification. Nevertheless, “historically, there’s no denying that land’s been a good investment,” Gervais says. “Returns have been good lately and for a long time. And there’s been very little volatility in the land market, which has been good compared to other investments.”

Another mistake to avoid is expanding to a new location and not knowing how farming works in that area, and that practices are going to be different there, says Stockbrugger.

He’s seen people moving into his province to farm from different parts of the country and even abroad.

“Farming is different in every area of the country, even the province,” Stockbrugger says. “Just because you can do it where you were, doesn’t mean you’re going to be able to apply the same practices to where you’re going.”

Productivity is also likely to differ elsewhere. Land’s value typically reflects its productivity and, if it comes cheaply, the reason may well be because it doesn’t produce as well or generate the same profits as the acres you own elsewhere, Stockbrugger says.

Hammond notes that another error that farmers sometimes make is to only make an offer on a seller’s most productive land.

“Typically, when a farmer sells out, they have a combination of more productive and less productive farmland,” he says. “A common approach that buyers have is only offering to purchase the more productive farmland.”

The issue for the seller, though, isn’t finding a buyer for his most productive acres, but disposing of his less productive land too. Hammond says agreeing to purchase both improves a buyer’s odds.

Says Hammond, “All-or-none offers can be powerful negotiating tools if you have the ability.”

Maybe you should just rent

Producers looking to expand also need to determine if it makes more financial sense for them to lease the land than own it.

Around his area of central Saskatchewan near the community of Englefeld, Stockbrugger says renting is much cheaper from a cash-flow standpoint than buying it.

Gervais adds that leasing comes with considerable flexibility in managing financials, and it frees up cash. But having said that, it also exposes producers to risk if they’re unable to negotiate a long-term lease.

“What happens if you lose the land and you’re stuck with extra equipment you intended to use to farm more acres?” Gervais asks.

It’s part of the risk-reward tradeoff in owning versus leasing. Neither exclusively owning every acre you farm, nor leasing it all, is optimal, he says.

But there’s still the prospect of a big long-term win with owning, says Gervais. “Building equity within your operation is still a good strategy.”

Robust demand

Canadian farmland demand remains robust, with values continuing to rise, in spite of the COVID-19 pandemic, as producers continue scooping up acres.

Through the first half of 2020, farmland values in Canada rose 3.7 per cent on average, thanks largely to major gains in Alberta (4.9 per cent) and Saskatchewan (4.2 per cent), according to Farm Credit Canada.

The results are better for the 12 months between July 2019 and June 2020, when the national average increase reached 7.1 per cent, heavily influenced, again, by Alberta (8.5 per cent) and Saskatchewan (7.9 per cent), two provinces that account for 72 per cent of farmland, FCC recently reported.

The federal Crown ag lender tied the demand strength to historically strong returns on farmland, low interest rates, and grains, oilseeds and pulse receipts.

In a release, FCC put it in a nutshell: “The limited supply of farmland available in the market and producers’ confidence in the sector’s long-term outlook are also key drivers of land prices.”

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Richard Kamchen

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