Due diligence on due diligence

A few days ago, an advisor told me that a client with a substantial investment in American farmland was facing the prospect of some “serious” unrealised losses on the value of that land.

The LP, which my contact didn’t want to name, invested in US agriculture through a large private equity firm, and is now trying to figure out how to get out or mitigate the damage.

My contact said the losses were mainly attributable to the client and the fund manager misreading the publicly available information on farmland pricing. “The market isn’t that transparent, even in the US,” I was told. “The published data doesn’t move that quickly.”

Two years ago, there were glowing headlines promoting the profits investors were making from rising American agricultural land values. Forbes wrote about how increases had, on average, beaten the stock market. The magazine used the same data that the United States Department of Agriculture has been publishing for many years: annual averages for farmland values in different states. Available public information also includes land registries. But looking at these is not enough.

My contact added: “They just rushed in there after everyone else a few years ago. They should have taken a much more careful look and realised prices were slowing. Actually, if you know something others don’t and get the information that isn’t widely available for an asset, you can make a lot of money out of it. They paid for due diligence, but they obviously got it from the wrong people as well. You need to do due diligence on your due diligence, and then you’ll get more from your money.”

One dangerous practice, and still a common error, is for investors to follow on the heels of others instead of doing rigorous analysis themselves. Philip Jarvis, managing director of Direct Agriculture, which helps family offices, ultra high net worth individuals and specialist funds acquire farmland in Australia, says investors have to be careful not to blindly follow others.

Jarvis says: “You get someone marching in, [and] following the herd without really understanding what they are acquiring. It was the case in the US, then it was dairy in New Zealand, and now it’s beef in Australia. Every time I have seen something like this it is because the advisor or the acquiring party hasn’t done their job. Lip service is given to due diligence because of the big headline. Look at the headline, but then don’t let it stop you from looking at the actual asset.”

He also argues that going into the market as a big investor with a high profile can in itself put inflationary pressure on valuations, so maintaining a low profile and tapping into local knowledge is essential to getting the best price. “The quiet achievers are so good because they are so thorough and understand their operations. What institutions do is pick up on a thematic. When a [large investor] has to deploy capital and the markets hear about it, that in itself pushes the price up. So institutions often end up arguably paying too much for assets.”

The key to avoiding this particular trap, once again, is getting one’s due diligence right, regardless of whether you’re making a direct investment in a piece of land, or committing capital to a fund manager to pick and price the assets for you. Cutting corners will likely catch you out, and before you know it, a huge investment can end up under water.