Rent an Acre or Buy an Acre, That is the Question
Farmland 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 a farm operation grows, there can be important differences resulting from expanding through rental or through acquisition of additional farmland. 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 scenario, 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 scenario, 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 for complete control over the land. An owner-operator is in complete control of how long to farm the ground, while a renter is always subject to risk of losing the land if ownership changes or another renter is selected to farm the land. An owner-operator also has complete 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%; in the Corn Belt and Delta, that share is over 50%, whereas in the Southeast region, where permanent crops are much more common, the share can be less than 20%.
3. Investment portfolio: 98% of farms in the U.S. are family farms and thus it is typically viewed that a farm’s assets are the family’s assets. Farmland ties up a significant amount of wealth. Compiling USDA data, the average value of the real estate per farm in the U.S. is $1.28M (2012 Census of Agriculture, USDA and NASS; 2014 USDA Average Farmland Real Estate Values), and the asset is illiquid due to limited transaction volume (see #4). 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 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% of farmland acreage in Illinois changes ownership at arm’s-length per year. Ability to expand by acquisition is further constrained by the need for new land to be in close proximity to the current farm 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 grow the farm 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 farm operation.
In summary, the question to buy vs. rent is a choice between ownership returns vs. 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, availability of suitable purchase vs. leased land will trump all other considerations.
To explore farmland values in Iowa, Illinois and Indiana, visit AcreValue.