By Brent Gloy and David Widmar

The farmland market turned red-hot in 2021. While there have been numerous reports and surveys, three have caught our attention in recent months. In November 2021, the Kansas City Fed reported farmland values in the district were 15% higher. In December, Iowa State reported a 29% increase across the state. And the trend continues. Earlier this month, the Chicago Federal Reserve reported values were 22% higher.

With all eyes on farmland values in 2022, this week’s post reviews the trends in cash rental rates and capitalization rates.

Background – Farmland Values Data

Throughout this article, we consider Indiana farmland data released each summer by Purdue University. In 2021, average quality farmland values were reported at $8,144 per acre, a 12.5% annual increase. This was the highest valuation reported from the survey, passing the previous nominal high of $7,969 per acre in 2014.

However – it should be noted that if one adjusts for inflation, which is important to do over several years of data, the inflation-adjusted value of farmland in 2014 was $8,966 per acre (2021=100). This is to say that while nominal values are at all-time highs, inflation-adjust dollars show the all-time highs are still a ways off.

Cash Rental Rates

The earnings that an asset generates are important when considering valuations. Figure 1 shows the average cash rent on average-quality Indiana farmland from 2010 to 2021. In 2021, cash rents were $227 per acre, an increase of $10 per acre or 4.6% from 2020. Overall, cash rents didn’t increase very much in 2021 as rents also increased by $10 per acre from 2020.

Looking ahead, cash rents could face significant upward pressure heading into 2022 from a couple of factors. First, the returns for corn and soybean production in Indiana – and across the Corn Belt – were phenomenal. This, along with a cautiously optimistic outlook for 2022, will be front of mind as cash rents are negotiated this winter.

Second, cash rent on a per-acre basis overlooks the upward trend in yields over time. In other words, rent compared to the expected bushels of production matters. Per-bushel rents have fallen quite a bit since 2015 (Figure 2) due to the combination of lower per-acre but also higher yields over time. For example, the expected corn yield increased from 155 to 182 bushels per acre since 2010. This is to say the per-acre highs cash rents hit in 2013-2015 would not be the same “per bushel” equivalent given 2022 yield expectations.

While nearly every input is more expensive headed into 2022, some expenses – generally fixed expenses like cash rent, machinery, and family living – can be very difficult to forecast. It will be several months before data are available on how much cash rents have increased, but the combination of strong profits and higher yields over time could push per-acre rents considerably higher.

Figure 1. Average Cash Rent for Average Quality Indiana Farmland, 2010-2021.

Figure 2. Cash Rent Per Expected Bushel for Average Quality Indiana Farmland 1976-2021.

Capitalization Rates

The capitalization rate is perhaps the most commonly discussed measure of farmland valuation. It is a measure of income generation relative to value and is similar to the inverse of the price to earnings ratio for stocks. The simple capitalization rate is calculated by dividing the cash rental rate by the price of farmland. This provides a percentage rate, with lower values signifying higher prices relative to income generation. Shown in Figure 3 is the capitalization for average quality Indiana farmland and the yield on 10-year U.S. Treasury Bonds since the late 1970s.

Farmland capitalization rates fell steadily from 1986 to roughly 2014. Since then, they have remained relatively flat at just under 3%, but 2021’s reading – 2.79% – is the lowest ever recorded in the series. Based on this data, it appears that buyers are reluctant to push capitalization rates much below current levels.

The rate on the 10-year Treasury bond is shown for comparison purposes. For many of the years shown in this chart, the rate on the 10-year Treasury bond exceeded the capitalization rate on farmland. However, since 2008 capitalization rates on farmland have been higher than the yield on the 10-year Treasury.

Admittedly, the comparison between farmland capitalization rates and the rate on the 10-Year U.S. Treasury bond is imperfect. The 10-year Treasury bond clearly has different risk and return characteristics than farmland. For the bond, there is little risk of the return of principal, and interest payments are fixed and nearly certain to be paid. For farmland, there is much greater risk with regard to the amount of the annual rental payment as well as the valuation of the asset at the end of 10 years. While there are clear differences between the assets, there is a clear relationship between the 10-year yield and farmland capitalization rates, with both showing long downward trends.

Figure 3. Cash Rent Divided by Average Indian Farmland Value and Yield on 10-Year U.S. Treasury Bonds, 1976-2021.

Ag Forecast Network

Given all the news and attention on farmland markets, it can be difficult for decision-makers to sort through all the information and quantify their expectation. Specific to farmland values, the following Ag Forecast Network (AFN) question is open:

“What is the probability of top-quality Indiana farmland values increasing by more than 15% in 2022, per the June 2022 Purdue Survey?”

This question is admittedly challenging for a couple of reasons. First, a 15% annual increase in any asset is a large increase. Second, Indiana farmland values were already up significantly in 2021, specifically 14.1% for top-quality land.

Figure 4 shows the annual changes in top-quality farmland going back to the 1980s. Annual changes greater than 15% have occurred four times in the four decades. The period of 2011 to 2013 is a high watermark. The largest annual increase was 22.8% in 2011, which was subsequently followed by two years of +15% increases. In total, farmland values jump from $5,310 per acre in 2010 to $9,177 by 2013, a 73% increase.

This is all to say the base rate – a 15% increase in farmland values per the Purdue annual survey – might be more likely than expected. As always, the goal with AFN is challenging our thinking and calibrating our expectations as new information becomes available. We encourage you to spend a few minutes considering your expectations or forecast.

Figure 4. Annual Change in the Value of Top-Quality Indiana Farmland, 1980-2021.

Wrapping It Up

Farmland values in 2021 were buoyed by strong profitability and continued low interest rates. Looking ahead, one has to wonder how cash rents and capitalization rates have trended this winter and will ultimately affect valuations throughout 2022.

A few months ago, Brent and David exchanged emails in an attempt to make sense of the latest farmland data. We’ll conclude with a summary of that exchange:

Brent: “…. Had a sale here today. Very strong prices. Made me think a lot about why it’s happening and if I’m missing something….”

David: “The thing that I thought of when I read this is we often think the person that outbids us – either renting or buying – must be somehow better; better financial position, better farmer/yields, etc. In most cases, however, the “winner” is the one that’s willing to accept the lowest rate of return. And you should never underestimate how low of a return some are willing to accept… especially at this point in time. That said, folks could also have wildly different expectations about the future…” (full article here)

We’ve also written about farmland values in several AEI Premium articles in recent months. For those still curious, you can read more below. (If you’re not already a subscriber, you can take advantage of the hassle-free 14-day trial):

• Farmland Capitalization Rates Hit All-Time Low
• WWATA: Low Interest Rates and Asset Values
• WWATA: The Pendulum Swing
• WWATA: Record Farmland Prices – What’s Driving It? Is it Sustainable?
• 5 Maps: Farmland Values and Rental Rates
• WWATA: Death, Farmland, and Taxes
• Always Learning: Indiana Farmland Values up 14.1%