This week’s post is an overview of a two-part series (here and here) posted on AEI Premium the week of Jan. 4, 2021.
The farm economy turnaround since August has sent ripples into the farmland market. Recent data from the Kansas City and Chicago Federal Reserve districts show values were higher in late 2020. The combination of strong commodity prices, record-high direct payments, and low interest rates have largely offset the greatest U.S. recession of our lives. This week’s post reviews key fundamentals and what lies ahead for farmland values in 2021.
The data we most consistently follow and summarize in this post are from Purdue University. Their June estimate of top-quality farmland was a 4.5% increase relative to the previous year. More specifically, the increase pushed values to $8,579 per acre but remains 12% below the 2014 high of $9,765 per acre.
When examining farmland values, we often discuss the economic fundamentals of earnings and interest rates (opportunity costs). When we look at these two measures, one can see some of the reasons for optimism. Cash rents often serve as a proxy for farmland earnings. Figure 1 shows the average cash rent on average quality Indiana farmland from 2010 to 2020. Cash rents in 2020 increased to $217 per acre, their highest level since 2015 and on par with levels seen in 2012. Part of the reason for higher cash rents is the influx of federal farm program payments as well as the recent increases in crop prices. Both factors caught many by surprise. Given the magnitude of the farm economy turnaround, we should probably expect that rents will head even higher in 2021. If this happens, expect it to be very supportive of farmland values.
Figure 1. Average Cash Rent for Average Quality Indiana Farmland, 2010-2020.
Beyond dollars per acre, another way of looking at rent is relative to the bushels of production that one expects from farmland. Rent per bushel has fallen quite significantly from 2015 to the present (Figure 2). This largely occurred as cash rents fell due to lower commodity prices, but the upward trend in expected yield edged this lower. For example, from 2010 to 2020, expected corn yield increased from 155 to 180 bushels per acre. This is to say the per-acre highs cash rents hit in 2013-2015 would not be the same “per bushel” equivalent given 2021 yield expectations.
Given the combination of the higher yields and the current strength in commodity prices, one might expect that farmland rents will increase further in 2021. This is another factor that would be supportive of farmland values in 2021.
Figure 2. Cash Rent Per Expected Bushel for Average Quality Indiana Farmland 1976-2020.
The most common valuation metric that we examine is the rent to value ratio. This is shown in Figure 3, along with the average annual yield on the 10-year constant maturity U.S. Treasury bond. Today, this ratio – most commonly referred to as the capitalization rate – sits at 3%. This is a very slight increase from its 2.9% lows achieved in 2014 and 2016. As one can see, this ratio is very low in the context of farmland’s historical capitalization rates. For instance, prior to 2006, farmland’s capitalization rate had never fallen below 4%.
However, it is also very important to remember that the long decline in capitalization rates has come in conjunction with a long decline in interest rates. For example, the yield on U.S. Treasury bonds has declined steadily since 1988. For most of the period shown, the 10-year bond actually traded at a yield slightly higher or on par with farmland capitalization rates. Since 2008, farmland has actually had a higher yield. Today, its yield is significantly higher than that of the 10-year U.S. Treasury bond. While 2020’s interest rate decline may be somewhat temporary, at present, farmland yields look high relative to interest rates. As such, further pressure upward on farmland prices should be expected from this factor as well.
Figure 3. Cash Rent Divided by Average Indian Farmland Value and Yield on 10-Year U.S. Treasury Bonds, 1976-2020.
Over the next several months, there will likely be a steady stream of reports and headlines noting strong farmland values. For several reasons, this will make it hard for decision-makers to wade through the information and size-up conditions. To help, the following question has been included in the Ag Forecast Network:
“What is the probability of top-quality Indiana farmland values increasing by more than 10% in 2021, per the June 2021 Purdue Survey (versus June 2020 value of $8,579)?”
For background, Figure 4 shows the annual change in the value of top-quality farmland since 1980. While a double-digit increase seems large, values have surged by more than 10% nine times in 41 years (22% of observations). Keep in mind that these are nominal data and are not adjusted for inflation, also making the annual changes seem large as general inflation is included.
Furthermore, top-quality Indiana farmland has increased by more than 15% during four years in recent history; 2007 (+16.9%), 2011 (+22.8%), 2012 (18.1%), 2013 (19.1%). While a stretch, a 15% increase in 2021 would push top-quality farmland values to $9,866, above the 2014 highs.
This is all to say the base rate – a 10% increase in farmland values per the Purdue annual survey – might be more prevalent than most of us initially expected. As always, the primary goal with AFN is challenging our thinking and calibrating our expectations as new information becomes available.
Figure 4. Annual Change in the Value of Top-Quality Indiana Farmland, 1980-2020. Data Source: Purdue University.
Wrapping it Up
The farm economy in 2021 has started on a high note, with the farmland market poised to head higher. This result might be surprising to many outsiders, but there are a variety of good reasons for this.
When we think of the economic fundamentals driving farmland, we consider income and opportunity costs. In 2020, both of these turned in a favorable direction. Farm incomes were higher in 2020, driven first by huge government program payments and secondly by rapidly improving commodity prices. Second, farmland values continue to be supported by very low interest rates. Given the current low interest rate environment, one must wonder whether farmland capitalization rates will also fall further and, in turn, be even more supportive of farmland prices.
In short, the two major factors driving farmland prices – income and interest rates – are both moving favorably. From 2014 to 2020, only interest rates were moving favorably for farmland values. The question most are considering is, “how high will farmland values adjust?” While many unknowns exist, it’s important to avoid getting caught in the hype of what might become a stream of bullish farmland data. While the Indiana farmland data in this post – and the related AFN question – aren’t directly applicable to many readers, the lessons that can be learned are still valuable.
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Questions of the Week: A look at the Ag Forecast Network consensus for Indiana Farmland Values in 2021.