Sunday, September 17

Week 324 - Farmland REITs; Contract Farming

Situation: Farmland prices have come down over the past 3 years, reflecting the drop in prices paid for farm commodities and the resulting loss of farm income. This year’s harvest may be a record-breaker, further aggravating the problem. In central Nebraska, cropland prices have fallen from almost $11,000/acre to less than $8000/acre, and rents have fallen from almost $500/acre to less than $250/acre. Now is not a good time to speculate in farmland, unless you’re knowledgeable about local agriculture. Even then, you’d need to employ two experts: a farmland broker and a farm management company. 

Why not simply buy shares in a farmland Real Estate Investment Trust (REIT)? Until 2013, those didn’t exist. Now there are two small ones: Farmland Partners (FPI) and Gladstone Capital (GLAD). “These REITs generate income by leasing land to tenant farmers. But rents can slump when crop prices are soft.” 

The problem for investors is that there is a lot of marketing hype about the enduring and recession-resistant benefits of owning a working farm through several market cycles. But derivative ownership shares, that is, in REITs and companies having large holdings of cropland rented to tenant farmers, tend to track spot prices for the crops being harvested. Those prices vary remarkably, depending on weather, logistical bottlenecks elsewhere on the planet, and technological innovation. Trends in farmland value are closely tracked by the US Department of Agriculture, confirming that cropland rents vary more than farmland prices. 

Moving on to ranch land valuations, we again see that rents are driven by commodity prices but to a larger degree. This is because meat processing companies closely control their supplier’s use of land and inputs, so as not to be driven out of business by unpredictable oversupply or undersupply events. For example, drought or disease can cause a collapse in herds or flocks.

Over the past 50 yrs, farmland has not been a significantly more rewarding asset than stocks. For example, farmland in southwest Iowa (Audubon County) that sold for $379/acre in 1967 is now worth ~$7200/acre, giving a price return of 6.1%/yr. Compare that to the 6.7%/yr price return for the S&P 500 Index. Both asset classes produce income (rents or dividends), with farmland rents being higher than dividends on the S&P 500 Index. Total return for each asset class has been impacted by inflation, which has averaged 4.1%/yr since 1967. Cropland rents have been little better than 3%, bringing total return to 5.6%/yr after inflation. Reinvesting dividends on the S&P 500 Index over the past 50 yrs also brings total return to 5.6%/yr after inflation. 

     A: Explain the 4 ways to invest in farmland (other than buying parcels of good cropland and renting those out): Those are to buy shares in 1) a farmland REIT; 2) a land trust that rents cropland to tenant farmers; 3) a seed producer that contracts for using part of a farmer’s land for research on different genetic strains; 4) a meat packer that contracts for conditions under which a farmer will produce broiler chickens, hogs, or beef cattle.
     B: Generate a spreadsheet with valuation metrics that illustrate the benefits and risks of owning shares in each publicly-traded companies in those 4 categories.  

Execution: see Table.

        Farmland REITs: Farmland Partners (FPI); Gladstone Land (LAND).
        Land Trusts: Texas Pacific Land Trust (TPL); Alexander & Baldwin (ALEX).
        Seed Producers: Monsanto (MON); Pioneer Hybrid (a subsidiary of duPont, DD); Syngenta AG (SYT). 
        Meat Packers: Hormel Foods (HRL); Tyson Foods (TSN); Sanderson Farms (SAFM); Pilgrim’s Pride (PPC); Seaboard (SEB); Leucadia National (LUK).

Bottom Line: Farm operations are high risk endeavors. An investor can only ameliorate those risks by learning to farm, and having the good fortune to have a significant equity position in several hundred acres of irrigated cropland. That will offer the scale (and financial underpinning) needed to efficiently deploy the equipment and agronomy tools needed for precision agriculture. For those who only want “a piece of the action,” there are 10 publicly-traded stocks issued by companies that either own farmland or control the way it is used (see Table). Aside from Hormel Foods (HRL), those are high-risk stocks. 

Risk Rating: 8 (where 10-Yr US Treasury Notes = 1; S&P 500 Index = 5; gold = 10)

Full Disclosure: I dollar-average into MON, and also own shares of HRL.

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