The ongoing narrowing of the gap between income and appreciation returns seen in recent NCREIF readings suggests the possibility US farmland values might be levelling-off, according to a managing director at Hamilton Lane.
Speaking to Agri Investor following the publication of its 2019 Real Assets Market Overview, Brent Burnett said that given net farm income peaked in 2013 and farmers’ expenses have since increased, the continued rise in farmland appreciation through 2015 had raised alarm bells within the Pennsylvania-based asset manager.
“We felt at the time, and we continue to feel, that there were certain risks that were not being priced in to some of those returns,” Burnett said, adding that ag is best understood as an asset class suited to producing annual returns of between 6 and 7 percent.
“We think the returns that we’ve seen in the last year or two are certainly more reflective of what we would expect on a go-forward basis than the 10 years prior.”
Given that overall farmland returns should ultimately be comprised of equal parts appreciation and income, Burnett said, the decoupling of farmland values from income seen this decade was not sustainable and has only started to correct.
In its farmland market report released last month, the National Council of Real Estate Investment Fiduciaries reported a total return of 0.70 percent for the first quarter of 2019, comprised of 0.54 percent income and 0.16 percent appreciation.
For the trailing year, the report showed total US farmland markets had produced a return of 6.08 percent that reflected 1.54 percent appreciation and 4.50 percent income.
Because the firm ultimately expects the relationship between income and appreciation to stabilize over the long-term, Burnett said, Hamilton Lane does see risk to the current farmland values. “We think there are some real risks to income right now. We are cautious about where values are and certainly the rate of appreciation has to normalize.”
In addition to rising input costs and debt levels, Burnett added, government policy is new among the risks to be monitored by farmland investors.
Whereas previously policy risks associated with ag investment were relatively narrow and predictable, Burnett said the sector’s role in ongoing trade tensions between China and the United States were not among issues fund managers had been preparing for.
“The trade wars and tariffs policy was very unpredictable and highlights the fact that these are assets that are subject to risks that were not being priced in to how institutions were looking at them,” said Burnett.
To mitigate farmland valuation risk, Hamilton Lane suggests ag investors pursue vertical integration and patient deployment in permanent crops like apples and almonds. Burnett said investors should expect to add between 150 and 200 basis points of return for each stage of agricultural value chain they enter.
“You are still talking about a return profile that is 10, 11 or 12 percent. We think that is very competitive with what we would expect in other areas of real assets as well,” Burnett said.
He added that increasing availability of data – especially readings provided by NCREIF – has been a key factor in bringing more institutions into agriculture, which has happened amid a broader move into private markets and real assets examined in Hamilton Lane’s report.
Though NCREIF’s statistics are not perfect, Burnett said, they do offer a data series that institutional investors can use to illuminate how assets, and the growing ranks of managers, have performed through market cycles.
“You may be a little bit disappointed if you are a recent investor in ag, but if you are a long-term institution, the fundamentals for investing in that sector still hold true,” he said.