Outlook for U.S. farm economy still upbeatWASHINGTON — A one-third “correction” in farmland values might be coming if the government raises interest rates to normal levels, a key lending official says.
By: Mikkel Pates, Agweek
WASHINGTON — A one-third “correction” in farmland values might be coming if the government raises interest rates to normal levels, a key lending official says.
Farmers and others should keep their eye on the 10-year treasury bond rates, says Jason Henderson, vice president and branch executive of the Omaha Branch of the Federal Reserve of Kansas City. They also should keep an eye on general crop prices and futures markets. For example, U.S. Department of Agriculture forecasts indicate corn prices falling to $4.10 per bushel in 2013 and net returns for corn falling by 30 percent.
Henderson says the biggest effect is on people who have purchased farmland in the past 18 months, when turnover rate has been relatively low. He says farmers will use their land equity as collateral for machinery and other loans, but lenders are lending more on cash flow projections than they did in the 1970s, so the impacts of a correction should be less.
One of several speakers with the North American Agricultural Journalists annual meeting April 11 in Washington, Henderson acknowledges the impacts from such a correction would be less than the 1980s because farm debt levels are low and equity levels high.
He says U.S. Department of Agriculture reports indicate that real net farm incomes jumped 25 to 28 percent in 2010 and are expected to increase again by almost 20 percent in 2011. This is a result of stronger commodity prices and stronger results expected in the livestock sector.
“I grew up on a dairy farm, so one of the things that I learned is that I’ve never seen a tractor that a farmer didn’t want to buy,” he says.
Four-wheel-drive tractor sales rose 30 percent in 2010, according to the Association of Equipment Manufacturers “and in the first two months of this year, are up another 30 percent.”
“It’s not just tractors, it’s combines and grain bins and irrigation systems,” Henderson says, “strong capital investment in the farm sector.”
Farmers also are buying their neighbors’ farms.
Across the middle part of the country, especially in the Corn Belt, farmland values are rising. A Federal Reserve study comparing Dec. 31, 2010, to a year earlier, shows Iowa farmland values up 18 percent, Nebraska up 18 percent, Kansas up nearly 20 percent.
Henderson says his Fed district survey just closed, and there are indications that numbers will be “much larger” with farmland values rising more than 20 percent. He’s still getting phone calls from the coasts, as people seek investments with better rates of return than others. He says land in north-central Iowa land is hitting $10,000 an acre, and irrigated cropland in eastern Nebraska at $8,500 an acre, which is 60 or 70 percent above levels five years ago, with the bulk of purchases by farmers.
There are some hiccups. Drought conditions have been limiting gains in Oklahoma and Texas, Henderson says. Also, Oklahoma land values are more correlated with natural gas prices than with grain prices, but that now that exploration there is shifting from natural gas to crude oil.
“And look at North Dakota,” Henderson says. “Farmland values are almost 24 percent above year-ago levels. A lot of that is driven by the fact that they struck oil.”
He says that even Nebraska has three drilling rigs.
“Personally, I think they’re trying to dig really deep and trying to extend straws to North Dakota and Oklahoma,” he jokes.
In a question-and-answer session, one reporter questioned whether the oil influence in North Dakota is very important, as mineral rights often are dissociated with surface rights, but Henderson says he thinks it still is an influence because sometimes the mineral rights go with the land and because some with oil revenue can purchase land at higher values.
A potential correction in land values has to do with a number of issues, including debt, but the strongest indicator is the price-to-earnings ratio for land.
“You see these ratios are at an all-time record high,” he says. “They’re higher than what they were in the 1980s. For every dollar you want to earn on investments, you have to spend between $22 and $26. In the 1980s, it cost you about $20, and when the farm crisis bottomed, it was about $10. So land values are very expensive.”
One of the biggest risks for land values is interest rate risk, Henderson says.
The key equation is that land values equal expected revenue divided by the capitalization rate. The capitalization rate is the opportunity cost of investment that you have to give up to own land. For example, if the 10-year Treasury yields are 7 percent, your “cap rate” is 7 percent — the percent you have to give up to buy land.
Consequently, years of low interest rates in the 1970s correlated to years of higher farm income. Higher interest rates in the 1980s correlated to lower farm income.
“Over the last decades, we’ve gone in the opposite direction,” Henderson says.
Higher interest rates lead to higher capitalization rates. If yields on 10-year treasury bonds rise, people are less likely to buy land. That will shrink demand and bring down prices. Shifting capitalization rates can have a big impact on land values.
On a hypothetical piece of land with a 200-bushel corn yield expectation, at $5.35 cents per bushel, and 25 percent of gross revenue paid to land rent, then the “cap rate,” or rate of return is 3 percent, and the land value can be $8,900 per acre. But if the needed rate of return is 8 percent, all of a sudden, the farmland value goes below $3,400 an acre.
“Depending on your assumptions and what you want in terms of crop prices and rates of return, you can have a wide spectrum in terms of farmland values,” Henderson says. “Historically, capitalization rates are about 7 percent on farmland. Today, capitalization rates are about 4 percent.”
A related issue is the long-term price of corn.
“What’s the long-term price of corn? Seven dollars? Five? Three? Farmland is a 20-year investment,” Henderson says.
The value of land is connected to the probability of long-term low interest rates.
On another topic, Henderson says availability of farm credit is not an issue, especially for crop producers. He says one of the biggest issues he’s hearing from lenders across the Corn Belt is lack of loan demand because “not enough farmers are coming in for operating loans on inputs.” They are, however, looking for loans on farm equipment, which is significantly higher. Banks and the Farm Credit System lenders are increasing farm debt at 2.5 to 3.5 percent. While machinery loans are a small part of commercial bank portfolios, the category is up 72 percent on a year-over-year basis in the first quarter of 2011.
Banks are lending at historically low interest rates, between 4 percent and 5 percent, he says, but credit standards will remain “relatively high” because delinquency rates — while better than the economy in general — are at the highest levels since the 1980s. This is primarily in the dairy and hog sectors.
Here are selected remarks from other officials who addressed the NAAJ:
n Joe Glauber, U.S. Department of Agriculture’s chief economist, says one thing that should help with the tight conditions in the U.S. corn market is that there is more feed wheat available in some areas. Ethanol production continues to grow, but at a slower rate. He says ethanol production hasn’t yet been limited by a “blend wall,” but that may come if the country can’t export its surplus. Part of this is related to the fact that they forward-purchased corn during periods of lower cost. He says there still is strong production, largely because of good returns to producers.
- Michael Taylor, deputy Food and Drug Administration commissioner, says his agency is working toward implementation of the Food safety Modernization Law, which has distinct mandates for domestic and foreign inspection. The domestic mandate requires inspection of high-risk facilities at least once in the next five years and, after that, increases to once every three years, which Taylor thinks is feasible with current resources.
Foreign inspections are pegged at 600 for the current fiscal years and a doubling of that rate for the next five years to a total of 19,200 per year by 2016. That would “require significant new resources,” he acknowledges, and the availability of those resources in a period of budget cutting is unclear. He says it may take two years to implement third-party certification system for qualified audits, and it might take 10 years to get it up and running.
- Robin Schepper, executive director of Let’s Move, and Sam Kass, a chef and senior policy adviser for health food initiatives, speaking from the West Wing of the White House, talked about efforts that have been spearheaded by first lady Michelle Obama to improve nutrition and reduce obesity. They discussed a variety of efforts to inform people about where healthy food is grown and improve physical fitness,, in part as a way to cut diabetes rates in youth and adults, in part to ensure enough physically fit military prospects, if those needs arise. While incentives and recognition programs are expanding, Schepper and Kass couldn’t point to any analogous program that has worked, as opposed to negative campaigns for smoking. After talking about high-quality food and nutrition programs, the White House staff handed out a small box of souvenir M&Ms,
- Douglas McKalip, a senior policy adviser for rural affairs, says the administration has plans to make sure that 98 percent of America has broadband internet access. Currently, only 1 percent of urban America is without broadband, while 20 percent of rural America is without it. He says rural America has been recovering jobs during the recession at twice the rate of metropolitan areas, but he acknowledges that the benefits and income aren’t necessarily comparable.
- Tom Buis of Growth Energy and Bob Dinneen of the Renewable Fuels Association both appear bullish on their groups’ cooperation to keep ethanol a growing industry, despite attacks from environmental groups and petroleum competitors. Buis, a former head of the National Farmers Union, says the industry is a victim of its own success because the “competition understands we can produce.” A 45-cent-per-
gallon tax credit is set to expire Dec. 31. Buis and Dinneen note recent studies that indicate subsidies for the oil industry are much higher, proportionately, than for ethanol. They say ethanol has accounted for 11 percent of the run-up in food prices. Some 12 percent of the price of food in America goes to farmers, while 88 percent goes to the marketing side. When asked how livestock producers will survive if corn prices are high and supplies are rationed, Buis said, “No one has run out of corn. I’ve been around for 58 years, and I never recall running out of corn.”