Economists tell us that open markets work when two conditions are met. First, there need to be many buyers and sellers in the market. Second, all parties also have to have good knowledge of the product being marketed.
In many land rental markets, neither of those conditions is met, says Mark Gannon, president of US Farm Lease. Typically there are few parties involved when land comes up for rent. Often too there is limited knowledge of the land itself, and the landlord may not really know how the prospective tenants would farm the land.
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Gannon, who has been active in farm real estate since 1979 and is former land manager for Iowa State University, started US Farm Lease in 2008 as basically an online match making service for landlords and growers.
“US Farm Lease is not just an auction of cash rents,” says Gannon. “Our service treats land leasing more like a job application. The landowner provides very specific details of the land he wishes to rent and prospective tenants respond with not only a bid, but a detailed cropping proposal and references.”
The auction process also ensures proper written leases are developed, whether they are cash, flexible, or crop-share agreements.
When Gannon started US Farm Lease, critics said the site would cater only to large farm operators who have the financial strength to outbid smaller operators. In fact, Gannon has found that smaller farmers often win. Sometimes that’s because large farmers may be unwilling to provide detailed cropping plans or financial information in support of a bid. Other times, a landowner will forgo a higher rent in favour of a bid from a tenant who promises better conservation practices. Sometimes too the owner may want to give a break to a beginning farmer.
“Price is just one factor that needs to be considered when renting farmland,” Gannon says.
North of the border, farmland lease rates continue to be a hot topic of conversation. Many growers and landowners have taken exception to my assertion in a recent COUNTRY GUIDE issue that rental rates should be based on the productivity of the land rather than its market value. Even more farmers and landowners are upset with the statements in the same article by Craig Dobbins of Purdue University suggesting many rents are set by the “greed factor” and that “growers should not be as aggressive in bidding for land.”
I have been told a number of times that rents are not set by greed but by supply and demand, and that it is the free market which determines land rental rates.
Look though at nitrogen prices over the past 18 months, when ammonia prices soared over $1,500 a tonne and the price of potash reached $900. Even though growers were receiving more value from each pound of N and K applied because of the higher grain prices, I have yet to talk to a grower who was happy with sky-high fertilizer prices. As a result of grower resistance, fertilizer demand eased and prices fell.
Yet we are not seeing this same market reaction in land rents. In fact, even though grain prices have fallen dramatically, land rents have actually increased again this year. If the market really sets fair rental rates, why didn’t we see them drop?
One possibility is many landowners simply don’t know what the real agricultural returns to land ownership are. If they don’t know anything about the economics of farming, it may seem fair to landowners to ask for a rental which reflects a four per cent return on thier investment in land. But if crop production only produces a one per cent return, it may be unaffordable.
What was your return to land last year? After deducting your variable crop expenses and fixed
Be wary. Trying to justify poor equipment investments by unprofitable land rents can quickly spiral out of control
costs from gross crop income, how much was left as a return on your investment in land? Did you make the four per cent return on your own land investment that landowners are seeking?
The return to investment in land will differ for every farm operation and the difference can be huge. Gannon tells me that in the corn and soybean areas of Iowa, there can be a difference in net income of $200 per acre between the most and least efficient farm operations. Given this variability, unless you know what your actual returns to land investment are, it is impossible to judge if the market value of rent is actually fair.
Fortunately it is very easy to calculate your returns to land. Simply take your gross crop income, deduct all crop input costs, machinery operating costs, custom work, hired labour, crop insurance, utilities and interest to get the return over variable expenses. Now deduct building repair costs, property taxes, insurance and licenses, machinery investment and depreciation costs, building investment and depreciation costs, and your own labour and management withdrawals.
What’s left is the return to land ownership. Divide this number by acres farmed and you have the return to acre, if all land farmed is owned. If some of the land farmed was rented, by deducting the income and expenses which can be attributed to the rented land you can calculate the returns to owned land.
Compare your returns-to-owned-land with returns-to-land-farmed. Did renting land last year actually make you money? Did you earn the same percentage return on your owned land that you are willingly paying a landlord? Now repeat this exercise with expected returns and costs in 2010.
Many provincial government websites will help you with these calculations. For instance, in Saskatchewan’s 2010 crop guide (which can be found at www.agriculture.gov.sk.ca/crop-planning-guides) land is charged to the operation as a fixed cost at $21.20 per acre. This is based upon a 4.5 per cent return on the average market cost of $471 acre. Given this land cost, and without deducting anything for owner labour or management, wheat, feed barley, and canola all show a positive return for 2010.
However, on this average, black soil, Saskatchewan farm, the calculations show that you would be losing money on every acre of barley and wheat grown if instead of an owned land cost of $21.20 per acre, you are paying $60 per acre in rent, especially if you include your own labour, management and an allowance for risk.
Yet $60 per acre was the price set at a recent Kramer agricultural land lease action at North Battleford. As a result many landlords in this area have been pushing for $60 leases. After all, most growers consider a public auction to be a good indicator of market rates.
There are factors which mitigate high land rental rates. As farm equipment continues to increase in size, capacity and cost, farmers are being forced to farm more acres in order to minimize equipment costs per acre.
Where a farmer has excess equipment capacity for his farm base, it may be more profitable to rent more land, even at an above-cost rental rate, than to try to pay for excessive investment in equipment with owned land.
Be wary, though. Trying to justify poor equipment investments by unprofitable land rents can quickly spiral out of control. CG
