“Owning a farm can be difficult and risky. Just finding a farm to purchase can carry both a financial and time burden when making due diligence trips to rural areas to see potential purchases,” Andrew Smith, co-founder and chief product strategist at OWLshares, writes in a recent report.
“Farmland values and income in the US are insured, and therefore it is often viewed as a very low risk investment,” Smith said. “However there are many political analysts who believe within the next few decades, the Farm Bill will not be renewed and that government insurance and subsidy programs for crops and livestock will cease to exist.”
Economic factors such as inflation or deflation could hurt the returns of farmland or lead to investment losses for the owners, Smith said in the report. “New food regulations, new technology in food processing, loosening of food import regulations, slowing development of emerging and frontier markets, as well as other global macroeconomic factors could lead to lower income, lower value appreciation or even value depreciation in farmland.”
His advice for investors coming into this field? “Buy-and-lease is a better strategy,” he told Agri Investor. “Once you have the lease the value is locked in and it’s much safer.”
Brad Case, senior vice president of Research & Industry Information at the National Association of Real Estate Investment Trusts (NAREIT), doesn’t quite agree.
“The biggest problem with investing in farmland has always been that investors need to make sure that farmers are putting in the work that they are supposed to and making the land as productive as possible,” Case said to Agri Investor in an interview.
He said sometimes farmers aren’t keeping up with improving the land quality and making it more productive. “It’s simply obvious that leasing land is not better, and on top of that, if you own the land and lease it out and you are getting a steady stream of income, this works the same as investing through a REIT but it’s not as safe,” Case said, “because the farmer can just decide not to turn in their rent check.”
Luca Fabbri of the New York Stock Exchange-listed REIT Farmland Partners, which operates a buy-and-lease strategy, said that based on his experience, the risk of farmers not paying rent is “a fairly non-existent risk and there are strategies to mitigate that”.
Fabbri is chief financial officer at Farmland Partners and he previously served as the chief operating officer at America Agriculture Corp, the holding company of a number of farming and livestock businesses. This gives him a solid grounding in the pros and cons of different agri investments.
“When you look at farmland investment, you have to separate farmland ownership business and farming business, they are very different from each other,” he told Agri Investor.
“When you look at farmland as an investment, it’s typically a very safe and stable investment and it’s largely insulated in the short term from the volatility of crop prices. Especially with a cash rent leasing strategy, it’s really the farm operators that absorb the volatility in their business model,” Fabbri said. “The historical land appreciation rate has been hovering around 5 percent on average year-on-year for a long period of the time,” he added, “ and the current cash return from leasing row crop farmland is anywhere from low 3 percent to low 5 percent. When combining these two, the buy-and-lease-kind investors, based on historical averages, should expect an 8 to 10 percent return from farmland investment, for primary crops.” This is low, he admitted, but it’s “like a AAA-rated bond”.
Owning and operating land can yield much higher returns, but there is much higher volatility due to crop price volatility, and investors have to invest in equipment and working capital, said Fabbri. Even the cost of debt is higher for operating loans compared to real estate-backed loans.
“It’s a completely different game,” Fabbri said. “It’s very volatile and it requires a high degree of operational involvement.” In some cases, he said, an operating model can be implemented so that it allows investors to scale the farming operations effectively. “That’s why we see some large operators in specialty crops like berries or vegetables, with integrated farming, packing and marketing businesses.” This type of crop is also less land-intensive but it’s rare to see a truly large operation in row crops because the operations often hit dis-economies of scale and the virtually universal model is that of the family farm, he added.
Matthew Sheldon of the international land team at Savills, who’s based in the UK, agrees with Fabbri’s points and told Agri Investor that investors who own-and-operate might experience an “inability to truly understand production as outsourced management may not have full capabilities” and there is also “human capital risk in operations”. The advantage of buy-and-operate is it gives investors “full oversight and understanding of the asset and production and it has a high level of agility in managing assets”, he added.
It is hard to compare the risk/return profile of different models and structures, however, argued NAREIT’s Case. “But in other types of real estate investment, [investments] through publicly traded REITs in general outperform the private investments,” he said. This could strengthen the argument for farmland REITs, he added.
“If you are risk-adverse and you want a safe investment, you definitely want to focus on the buy-and-lease strategy and you should look at historic average total returns of roughly 8 to 10 percent per year,” Fabbri noted. “For the own-and-operate model, investors should expect a possibly higher return, like 15 percent, but with much higher volatility in the farming business, so when [these kind of investors are] looking at the returns they have to think about how much risk they are taking.”