Do you want to be in the farming business or the real estate business?
In getting around the country, giving talks, teaching seminars, etc. I frequently find it appropriate to tell listeners, “You can make money ranching.” Invariably hear someone (usually under his breath) say, “Get a rope!”
By using an old “accounting” trick. You simply organize into two (could be more) “enterprises” and keep your books that way–you charge the cattle with an appropriate (the going rate) pasture fee and then charge the rest off to the land.
Actually, I’ve seen folks form two separate corporations, which is also an excellent estate planning tool.
Land costs typically represent more than one-third of a farm’s operational costs. The mix of owned vs. rented land has a significant impact on profitability, risk and the ability to scale. As an operation grows, there can be important differences resulting from expanding through rental or through acquisition of additional land. What are the considerations when deciding to rent vs. buy more land? While not an exhaustive list, a few of the key differences are highlighted below:
1.Return: In a rental situation, returns on ownership (appreciation of the asset) accrue entirely to the owner, while operational returns (farming profits) accrue to the operator, or are shared between owner and operator. In a purchase situation, the operator captures both the ownership and operational returns. And the two types of returns are not necessarily correlated. So one question to ask is: Do you want to be in the farming business or the real estate business?
2.Control: Ownership allows complete control of the land. An owner-operator decides how long to farm the ground, while a renter is always subject to the risk of losing the land if ownership changes or another renter is selected to farm the land. An owner-operator also has the freedom to choose agronomic practices, while a renter may have restrictions from the landowner. Control over the land is particularly important when growing permanent crops, which require significant long-term investment in the ground before achieving profitability.According to the USDA, the average share of farmland that’s rented in the United States is 38 percent; in the Corn Belt and Delta, that share is more than 50 percent, whereas in the Southeast region, where permanent crops are much more common, the share can be less than 20 percent.
3.Investment portfolio: In the U.S., 98 percent of farms are family farms. Therefore, a farm’s assets are typically considered the family’s assets. Farmland ties up a significant amount of wealth. USDA data shows that the average value of real estate per farm in the U.S. is $1.28M, and the asset is illiquid due to limited transaction volume. It is important to evaluate farmland investments against the family’s broader portfolio of assets — residential real estate, stock, bonds, cash etc. — and consider how farmland fits with the investment horizon, risk appetite and opportunities for alternative investments.
4.Turnover: The turnover of farmland is known to be very low. One University of Illinois study concludes that about 1 percent of farmland acreage in Illinois changes ownership each year. The ability to expand by acquisition is further constrained by the need for new land to be in close proximity to the current farming operation. A farmer may wait an entire lifetime for adjacent land to come up for sale. And the choice to rent vs. buy may not be a choice at all. As Jeremy Jack of Silent Shade Planting in Mississippi puts it, “You can’t just get land when you’re ready; land comes to you when it’s available.”
5.Capital allocation: A farm operates with a finite amount of capital (debt and equity) it can deploy to sustain and expand the operation. How much capital is available and what’s the optimal mix of capital allocation to land vs. machinery and other assets? If the objective is to expand and scale quickly, then tying up a significant amount of capital in land can limit the capital available to increase the scale of the total operation.In summary, the question of whether to buy or rent is a choice between ownership returns or operational returns while considering optimal capital allocation between the equipment base and land base, given the farm’s business objectives and the family’s broader investment portfolio. In the case of permanent crops, leasing may not be a viable alternative and, ultimately, the availability of suitable land to purchase or lease will trump all other considerations.To explore farmland values in Iowa, Illinois and Indiana, visit AcreValue.
You might also be interested in the supplement to this Handbook: Planned Grazing: A Study Guide and Reference Manual.