For a water test case, keep your eye on California

Amid reports that water worries are pushing investors north into the Pacific Northwest, California farmland markets are preparing for a new regulatory regime one manager says will create winners and losers.

Given their intrinsic connection, it’s difficult to say that any particular point in time is especially important for the relationship between agriculture and water. Still, amid indications that farmland-focused fundraising conditions are strengthening, recent feedback reveals a sense that mother nature and regulation could soon conspire to further sharpen LPs’ attention.

At November’s Agri Investor Forum, PGIM Agricultural Investments chief investment officer Jamie Shen immediately highlighted California’s Sustainable Groundwater Management Act (SGMA) when asked about factors likely to be most impactful over the coming 24 months.

For the state’s permanent crop industry, Shen said 2019 will be a critical time to monitor implementation of the bill which gives municipalities until 2020 to plan how they will regulate the use of groundwater from the state’s aquifers for the first time.

Because many of the nut-growing regions of California are groundwater-centric, Shen explained, SGMA will eventually help create a shift in where things are grown in the state. Though litigation and other factors might influence the pace of SGMA implementation Shen predicted “some of it will be very ugly.”

“There’s going to be winners and there’s going to be losers.”

Water availability is, of course, already shaping which farmland markets are of most interest to institutional investors, as Hamilton Lane managing director Brent Burnett told Agri Investor last week, while discussing the most recent farmland markets index report from the National Committee of Real Estate Investment Fiduciaries.

Among the factors that have brought investors long present in California’s farmland markets north into the Pacific Northwest, Burnett said, are growing concerns about water availability and a desire to tap into what are seen as more reliable supplies drawn from the Columbia and Snake Rivers.

While SGMA has provided a framework for producers and farmland managers in California to begin engaging with municipalities and other stakeholders on water issues, the lack of definitive guidance has also created a large degree of uncertainty, Burnett said.

“Groups have been moving to implement on this, I think everyone’s been slow,” Burnett said. “If you are a water manager or an ag manager, you are dealing with all of these different groups and all of these municipalities that may have different plans to approach sustainability with the management of their water assets, there’s no uniformity in that policy necessarily.”

None of this is likely to have been lost on LPs, who have long professed water to be among the most important risk factors considered when weighing an entry into agriculture or picking among competing farmland strategies.

In a memo recommending a $100 million commitment to Homestead Capital’s third farmland fund in late January, the $72.1 billion New Jersey Division of Investment’s deputy director, for example, highlighted that the firm’s ESG policy included scarcity of water among its three key themes.

The dislocations Shen suggests that could stem from SGMA implementation will serve as a good test case on the opportunities and challenges created by shifting demands for water management and related services.

Burnett highlights the uncertainty and near-term obstacles SGMA implementation will no doubt continue to present as an example of those challenges. But Arable Capital’s recent string of irrigation deals and creation of a water and agriculture-focused platform suggest an attempt to seize on long-term opportunities arising from those shifting demands.

Managers have long understood water availability to be among the key factors considered in any farmland investment. What SGMA will no doubt help demonstrate is which are really prepared to capitalize on such dislocations in the future.