California ag investments – time to relocate assets and capital?

West coast permanent crop specialists Paul Frankel and Jeff Steen, partners at Kachina, consider the most viable options for institutional investors to reduce their California ag exposure.

California agriculture – a reliable and star performer for institutional capital over the past 20 years – is facing a number of significant, acute and persistent challenges due to climate change.

Investors are at risk of more than just lower returns on those assets; there is even potential for capital impairment of their ample and growing farmland portfolios thanks to its impacts. Investors must look with a new lens at the geographies to which they allocate capital and should be actively pursuing more secure acquisitions in places other than the San Joaquin Valley.

There is a growing realization among investors that climate change is not some nebulous looming threat on the horizon but rather a dark cloud directly overhead – a daunting set of unpredictable elemental evolutions, any one of which alone could in the near-term devastate portfolios, farms, livelihoods and communities.

For instance, in California, warmer winters and springs have reduced chill accumulation for crops that require high numbers of chill hours, such as pistachio; this has led to early blooms. Variable weather has caused frost damage in almond and citrus trees. And epic fires and persistent drought have famously been some of the most noticeable climatic changes.

In 2015, the last time California was nearly as parched as it is today, 540,000 farmland acres were fallowed; land that could have grown 54 million tons of grapes or 27 million tons of tomatoes. According to the organization California Farm Water Coalition, as of June 2021, more than 2 million acres, or 25 percent of California’s irrigated farmland, was receiving 5 percent or less of its normal surface water supply. More than half of that received no surface water allocation at all. Other areas had their supplies cut by 25 percent or more.

New risks need new solutions

Any single one of these stressors poses an existential risk to vast swaths of planted acres in California from negative consequences such as decreased yields, increased and novel pests and disease, reduced crop production, and lower quality and utilization. All of which lead to increased operating costs, lower crop prices, or both.

And so, the risk profile of those investments is rapidly changing, not only due to new and unusual weather patterns, but also as a result of the regulatory and economic reactions to “global weirding,” as the founder of the nonprofit Natural Capitalism Solutions, Hunter Lovins, refers to it.

Mitigation is and will be achieved by adaption, such as through the development of new infrastructure, crop switching and novel genetics for resilience, and greater use of agtech, and/or moving and repositioning investments into safer regions. Both are compatible, valid responses with unique trade-offs, but starting to shift now by relocating acres and crops most at risk positions investors for short-term capital preservation, business continuity and long-term advantage.

Adaptation is already well underway as new planting systems and protective structures for heat, cold, sunburn, wind, and insects are installed with increasing frequency. Genetics research and field trials are progressing on new varieties that need fewer chill hours to successfully set an economically viable crop, and on new draught-tolerant germplasm.

In parallel, regenerative and organic farming techniques will help reduce environmental burdens. Specific districts may necessitate switching from water-intensive or permanent crops to annual crops, to other agricultural products, or to alternative land uses altogether.

Capital must be willing to resettle to new geographies by finding crops with similar risk/return attributes in less volatile, proven agricultural settings and/or replanting in new locations crops that are today grown in San Joaquin Valley and surrounding areas.

This capital reallocation should occur quickly to avoid the potential fallout from significant risks posed to current investments, such as environmental regulation. This year will bring, for example, the first mandatory groundwater restrictions in California via the Sustainable Groundwater Management Act. Delays in repositioning capital could result in lower valuations at exit, higher entry prices for new farm purchases in climate-advantaged locations and second-mover opportunity costs.

Advantages of the Pacific Northwest

With the relative advantages of plentiful water, crop optionality, land prices and appreciation rates, the Pacific Northwest and select other geographic niches can provide safe harbor for institutional capital seeking the positive attributes of farmland in their portfolios.

Washington and Oregon offer optionality to plant strong performing local crops such as apples, berries, grapes, cherries, hops, nuts, pears, and stone fruit, for which there exists a large-scale, robust support infrastructure of packing, storage, marketing, services and equipment providers, rivaled only by California.

There is also the potential to plant crops such as almonds or pistachios in novel sites less impacted by climate change than the San Joaquin Valley and other southern California growing regions.

For top quality soils and growing sites, Washington and Oregon irrigated farmland trades at a discount to California, with significantly lower water risk – largely thanks to the Canadian Rockies, the Columbia and Willamette Rivers, and a meteorologically advantaged location – and offers similar per acre profitability of permanent crops. Farmland appreciation in the Pacific Northwest has historically been as impressive as in California.

Favorable temperature and precipitation trends under nearly all future climate scenarios only bolsters the case. Commercially suitable locations for almonds extend into established permanent crop farming regions such as the Willamette Valley and Columbia Basin. Growing conditions improve as climate changes take effect. Current almond crop extent is limited to California, the vast majority in the Central Valley. However, multi-year trials for almonds and organic hazelnuts have been ongoing in Idaho and Washington, respectively. These demonstrate commercial viability and even some horticultural advantages over the current epicenter.

Considering the issues around water availability, crop yields and quality, and the myriad other climate and correlated business challenges forcing change as we speak, institutional investors must re-examine their risk-return profile for farmland in the areas like the San Joaquin Valley. An honest comparison between the valley and the Pacific Northwest, for example, should lead to institutions to begin migrating capital to more climate-secure locations.

Kachina is an asset manager that specializes in permanent crop farmland in western US