‘The honeymoon is over for buy-to-lease models’  

Detlef Schoen, principal at DS Assets and chairman at Aquila Capital Farms Australia, explains how he looks at the risk-return profile of farmland investing and why institutional investors are sometimes forced to invest at the top of a food commodity cycle.

How do institutional investors end up investing at the wrong point in the cycle?
We are dealing with an inherently cyclical business. The problem is that in large institutions, decision-making and execution take a long time. If a slow-moving investor decided to get into grains or dairy now, by the time they are ready to invest, the next cycle might be near its top. Conversely, if it takes an institution two years from first analysis to deployment, now may be a good time to think about, but not yet invest in, Australian beef.

To what extent is farmland an uncorrelated asset class?
[Looking] at what’s driving farmland values, it’s worth noting that land-use optionality and non-farming demand for land can provide a significant downward buffer and booster.

I farm two hours away from Melbourne, and even [if I have] consecutive years of sub-par cashflows, because this land is productive, [I have optionality] and won’t lose money. I could go into sheep, dairy or horticulture instead of grazing, or subdivide into lifestyle blocks.

In remote regions and on land that locks you into a narrow spectrum of farming systems, values are driven by buyers’ perceptions of net present value based on yield and price expectations for commodities.

In this case, they will be similarly uncorrelated to equities and bonds, but correlated to food commodities, with the benefit of cash returns and inflation protection.

What about buy-to-lease strategies?
Some strategies are inherently problematic, offering returns not commensurate with true or underlying risk. Passive strategies have been very fortunate over many years because farmland has seen strong generic appreciation; leasing farmers were making money, so volatility was low. [Now], based on elevated asset values, many farmers cannot afford their leases.
The honeymoon is over for those models and reality has sunk back in; passive returns are what’s left over after the operator has made an acceptable return, so look at the total combined profitability between operating company and property company.

How do you make your money work in the current environment?
Institutional or corporate investors can hire a manager and do what the previous owner would have done had he had money, boosting returns and, over time, farm values.

The risk profile becomes better by co-investing alongside the best operators that increase efficiency or scale up.

The reason well-educated and successful farmers are willing to speak to private capital [at the moment], is that the family farm has been bled dry of equity through generation changes. Combine that with today’s banking environment and the result is unbankable farmers.

What are the risks and opportunities in Australia?
Australia is like Brazil but without the political risk. It can learn from Brazil in large-scale cropping or integrated beef value-chains. Brazil is dominating the red meat space worldwide because of its cost base. Australia could produce as cheaply as and in some cases does. However, there seems to be widespread complacency. Any quality premium should be added upside and not be taken as an excuse not to be a global least-cost producer. There is an enormous potential to [invest more to] double stocking rates. What you need is capital – which the family farming sector in general doesn’t have.