Smart Money vs. Scared Money: Reconsidering Farmland in Today's Market
Throughout my 20-year career at Peoples Company, I have been involved in billions of dollars of real estate transactions and have witnessed firsthand the financial performance of U.S. farmland through numerous economic shocks including the great financial crisis, Ben Bernanke’s quantitative easing experiment, Trump’s trade wars, the COVID-19 pandemic, Russia’s invasion of Ukraine, and now the nation’s battle with persistent inflation. On a pure return basis, farmland has outperformed most traditional equity and fixed income strategies, and has done so with incredibly low volatility compared to other asset classes over that time period. Savvy investors have been attracted to numerous characteristics of farmland as an investment including its positive correlation with inflation, low or negative correlation with publicly traded equities, and steady annual income in conjunction with reliable long-term appreciation. However, farmland is traded in thin-market conditions where less than 2% transacts in the open market on an annual basis, and in heterogeneous and large transaction sizes compared to equities. Farmers represent approximately 70% of all purchases, and many sales are considered “private-market” in that they were not listed publicly or sold at auction. Thus, although many recognize the desirability of farmland as an asset, fear of a mistiming or of simply not gaining access to a feasible transaction is a major barrier for many investors to make farmland investments.
Farmland is often a multi-generational asset. Many farms in operation today are century farms, meaning they have been held by a specific family over one hundred years. Thus, as the saying goes, “the best time to buy a farm is when someone wants to sell.” Novice investors who try to play the market by waiting for the optimal time to buy are often frustrated by the difficulty of actually completing a transaction, while those who understand farmland realize that the specific entry point is not always the main driver in an investment thesis with longer duration portfolio considerations. The primary focus of seasoned investors is to purchase the “right farm” with the recognition that price paid becomes less important with the passage of time; and that the effort to build their total position is often a multi-year endeavor during which their other assets may also move either up or down in value. Interestingly, over the previous 20-year period, even diversified indexes like the S&P 500 or the NYSE or NASDAQ recorded negative total returns 4 or 5 years each with the maximum drawdown in 2008 often exceeding 50% of asset value and requiring 2-4 years just to get back to even. By contrast, the NCREIF Farmland Returns performance had zero total negative return years in that period, and even at worst 1.3% return in permanent crops and 4.2% minimum in total annual row crops. Individual properties, like individual stocks can have better or worse performance of course, but the comparison of these broadly diversified indexes provides a powerful indicator of relative performance. Moreover, during that same period, farmland provided positive inflation hedging characteristics and offset through negative correlation with equities and much of the risk in a diversified portfolio setting. This complementary feature to other investments while providing inflation protection is currently front-of-mind for investors concerned about the current economic conditions as well. At the same time, the recent incredibly strong performance of farmland with high teen to low twenty percent annual appreciation has raised red flags about the “entry point” for farmland investments.
During my time in the industry, I have collaborated with some of the most sophisticated landowners helping them to locate and aggressively purchase farmland during some of the strongest times in the market. These investors often were viewed as having paid a premium relative to the overall market to acquire high quality assets in the best farming regions. Early in my career some of these transactions made less intuitive sense but as I have followed the subsequent performance of these portfolios as well as the broader farmland market, I recognize several key tenets of successful investing. First, strong land prices bring exceptional assets to the market that otherwise would not be for sale. These types of farms have delivered long-term outperformance for their owners and can rarely be acquired at-will or on a regular time pattern. At the date of acquisition the purchase price may seem strong, but as time passes the relationship to broader market forces and to their other investments becomes the primary features driving performance. And, farmland with its strong appreciation tendencies includes the natural tax advantage of assets where the capital gains can be deferred and compounded. Farmland owners’ heirs will never complain about the original purchase price on an asset with stepped up basis - and other advantages. And, as noted elsewhere it should be viewed in the context of other assets over the horizon intended to be owned, not as a single period return generating asset in isolation.
That last point seems to be questioned more adamantly than usual in the current economic environment. As we head into the typically bustling fall land market, escalated interest rates are cited as taking a toll on farmland. Midwest farmland generates current income or cap rates ranging from 2.5% to 3.0% while farm mortgages are now steadily averaging 7.0% to 8.0% forcing leveraged buyers out of the market and creating suppressed demand. It is important to note that the aggregate leverage on farm real estate is less than 14% in total and thus the nationwide impact of interest rate hikes has been less detrimental to farmland than to other real estate markets including commercial and residential, but buyers requiring new debt to purchase are clearly impacted and the overall burden of the cost of capital is elevated in any case thereby deterring numerous buyers from participating at these strong price levels.
Perhaps an even more considerable factor impacting the farmland market is the new competition from alternative investments with higher yields. Currently, CD’s, bonds, T-bills, and other liquid investments are generating short term yields of 4.0% to 5.5%. At these rates, some farmland investors and institutional owners are beginning to cash in their farmland investments, becoming sellers rather than buyers and taking their money to these other opportunities. The question that raises is how could one get “back in” if and when the yield curve normalizes and other asset prices have adjusted in response.
After thinking through these current conditions along with lessons from the past, I have concluded that the market may be setting the stage for one of the most opportunistic buying opportunities in my career. As individual leveraged buyers’ participation is limited and cash buyers exit the market, the market is open to investors who understand the historical performance of farmland, are not hypersensitive to purchase price, and want to take advantage of lower demand. While farmland values could soften to recalibrate with increasing Fed funds rates, prices may also remain strong and increase if inflation persists or reaccelerates. The confidence in the view that farmland will continue to provide an effective hedge against inflation and maintain its key diversifying position in portfolios as an appreciating generational asset has never been stronger.
One of the young members of our farmland diligence team recently quipped, “Scared money doesn’t make money.” Smart money seems to know that timing purchases of generational assets including farmland is a coinflipper’s folly and that hindsight will smooth out any current over/under payments for portfolio building transactions. The limited supply of high quality farms that are currently transacting in the market present an extremely rare opportunity. Even if the market softens, in the long-term investors can be confident that acquisition economics will be largely irrelevant. While purchasing an alternative short term asset with higher current cash yield and limited appreciation opportunities may be appealing now, these vehicles do not provide the benefits of farmland and generational value. Smart money stays focused on the long-term impacts of portfolio-wide positions while transacting in the present.
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