Interest rates plunge

Brian Eggebrecht has been farming for 30 years and remembers the sky-high interest rates of the early 1980s. That makes today's rock-bottom rates even more attractive.

"This is huge," says the Malta, Mont., producer. "How often in your farming career are you going to have an opportunity to lock in these interest rates and upgrade your operation?"

Yields and crop prices are the numbers that usually generate the most attention in agriculture, at least among people not directly involved with it. But quietly, behind the scenes, low interest rates are impacting most financial aspects of area agriculture.

"The low rates are a major boon," says Robert Wishek, president of McIntosh County (N.D.) Bank, which has offices in Ashley and Zeeland.

The Federal Reserve System, the nation's central bank, is holding down rates to stimulate the economy. Many people outside agriculture, including homebuyers, also benefit from lower rates, Wishek and others in ag note.

Farmers, ag bankers and others say low interest rates are a factor in several important agricultural trends, including:

•Rising land values. The return on investments such as certificates of deposit is extremely low, which makes buying farmland more attractive.

•Strong sales of farm machinery. Low interest rates make buying equipment easier when some or all of the money is borrowed.

•Healthier balance sheets for most farm operations. Lower rates mean less interest is paid out on farmers' and ranchers' loans.

•Further consolidation in agriculture. Farm operations are getting bigger and fewer, a trend strengthened by low rates that make it easier for farmers to buy all or part of neighboring farms.

•Strong U.S. grain exports. The rule of thumb is that low interest rates weaken the value of the U.S. dollar, which makes U.S. ag products more affordable to foreign customers.

Don't overestimate the importance of low interest rates, experts say.

The combination of strong grain prices and generally good yields in recent years is the main factor in area agricultural economics today, says Dwight Aakre, North Dakota State University Extension Service farm management specialist.

But low interest rates are important, too, he and others say.

Low rates are a "positive" for farm equipment sales, says David Meyer, president and CEO of Titan Machinery, a West Fargo, N.D.-based company that operates agricultural, construction and consumer products dealerships in the Upper Midwest.

Low rates have "really helped farmers upgrade their operations," says Kent Thiesse, farm management analyst and vice president with MinnStar bank in Lake Crystal, Minn.

Producers have invested in buildings and tile drainage, as well as farm machinery, he says.

A look at the math

Some farmers are borrowing money for as little as 3 to 4 percent, roughly a third of what they paid a decade ago, area bankers say.

That ties in with the so-called prime rate, a widely followed rate determined by the rates charged by 30 big banks across the country. The prime is used as a base rate for many types of loans.

Today, the prime rate is 3.25 percent, compared with 9.23 percent in 2000 and a stunning 18.87 percent in 1981, when rates were at their highest.

Let's assume a farmer borrows $100,000 to be repaid over 20 years.

At 19 percent, the monthly payment is a staggering $1,620.68. Of that amount, in the first month, $1,583.33 is interest and a mere $37.35 is principal. During the life of the loan, the total payment for both principal and interest is $389,000.

At 9 percent, the monthly payment is $899.73. Of that amount, in the first month, $750 is interest and $149.73 is principal. During the life of the loan, the total payment is $216,000.

At 3.25 percent, the monthly payment is $567.20. Of that amount, in the first month, $296.36 is principal and $270.83 is interest. During the life of the loan, the total payment is $136,000 to $253,000 less than at 19 percent and $80,000 less than at 9 percent.

At a rate of 3.25 percent, 52 percent of the first monthly payment goes to pay down principal. In contrast, at 9 percent, only 17 percent of the first monthly payment goes for principal. At 19 percent, a miniscule 0.02 percent of the first monthly payment applies to the principal.

For farmers and ranchers looking to expand or otherwise improve or upgrade their operation, a loan at 9 percent might not make economic sense, while a loan at 3 or 4 percent could be economically sound, Eggebrecht says.

"The lower rates can make a huge difference in whether it pays to do something," he says.

An example

Here's a hypothetical example: Say a farmer is deciding whether to buy a quarter of land, or 160 acres, at $3,000 per acre, for a total of $480,000. Of that amount, he'd pay $240,000 in cash and $240,000 with borrowed money.

If he borrows the $240,000 at 9 percent for 20 years, he'll pay $278,100 in interest in the life of the loan.

If he borrows the $240,000 at 3.25 percent, he'll pay $86,700 in interest in the life of loan. That's a whopping $191,400 less than borrowing at 9 percent.

Some producers, who have benefitted from high prices and good yields, might be able to pay cash for the entire 160 acres in this example.

But there's value in holding on to cash and borrowing part of the purchase price, Thiesse says.

That way, producers maintain liquidity and have money in reserve for cash flow and to deal with financial problems that pop up, he says.

Effect on farmland value

Low interest rates do more than make farmland easier to buy with borrowed money. They also make farmland more attractive financially and push up its price.

"The other alternatives aren't very good," Aakre says of buying farmland.

One example: Despite terrible drought, the average price of Iowa farmland rose 7.7 percent from March to September, according to a survey by The Iowa Farm and Land Chapter #2 Realtors Land Institute.

A number of factors were cited for the upturn, including unattractive returns in competing investments, according to the survey.

Rates on CDs and similar investments are so low that some investors prefer to buy land with money that otherwise would have gone into the bank, farmers and others say.

Say you have $100,000 to invest, money that you're thinking about investing in, say, a six-month CD. In 2000, according to information from the U.S. Federal Reserve System, the average rate on a six-month CD was 6.57 percent, producing a return on $6,570 on the investment. In 2005, the average rate on a six-month CD was 3.73 percent, producing a return of $3,730 on the $100,000 investment.

Today, the average rate on a six-month CD is 0.34 percent, producing a measly $340 return on the $100,000 investment.

Capitalization rate

An investment in land potentially can provide higher returns than those available in CDs and similar investments, farmers and others say.

Say an investor buys 100 acres at $1,000 per acre, for a total investment of $100,000. If the land provides an annual return of, say, $40 per acre, the investor will have a return of $4,000, or 4 percent, on the $100,000. That dwarves the current return on CDs and similar investments.

Low interest rates definitely are encouraging farmers and others to pay more for land, says Erik Younggren, a Hallock, Minn., farmer.

"You go to a (farmland) sale and it's not just farmers bidding," he says.

Buying farmland, however, does have its downside from an investment perspective.

Land doesn't provide the liquidity of cash. And land can decline in value, says Wishek, the North Dakota banker.

"People say, 'Well, we'll still have the land' (if land prices decline sharply.) But it would be a worth a lot less," he says.

The so-called capitalization rate should be considered, too. It refers to the rate of return that an investor can expect to receive on a real estate investment property. Put differently, the capitalization rate is a property's yearly income divided by its total value.

If an investor receives $5,000 on a $100,000 property, the capitalization rate is 5 percent ($5,000 divided by $100,000). If the cost of the property is $250,000, the capitalization rate is 2 percent ($5,000 divided by $250,000).

Wishek and others say the rising cost of farmland is making the capitalization rate increasingly less favorable to investors.

North Dakota farmland values rose an average of 14 percent in 2011, according to a survey by the North Dakota Chapter of the American Society of Farm Managers and Rural Appraisers.

By all accounts, farmland values across the region have continued to rise in 2012.

Two examples:

•Farmland in North Dakota's Walsh County recently sold for $10,000 per acre, which is thought to be a state record.

•Farmland in South Dakota's Brown County recently sold for $13,000 per acre, which is thought to be a county record.

Other impacts on ag

Farming operations have been getting bigger for years, as economies of scale encourage producers to expand.

The combination of high crop prices and low interest rates intensifies the trend toward bigger and fewer operations, Aakre says.

Big, established operators sometimes can borrow money at lower interest rates than smaller producers, helping the bigger farmers expand, he says.

"It's going to make it more and more difficult for young producers to get started on their own," he says.

Low interest rates also benefit farmers and ranchers by helping boost U.S. ag exports, Aakre says.

The United States will export a record $137.4 billion of food this year.

Many factors went into the record exports, including the weak U.S. dollar, according to the U.S. Department of Agriculture's Foreign Agricultural Service.

When the dollar is weak, U.S. products are cheaper for foreign consumers.

Too much of a good thing?

A key question facing area agriculture is whether low interest rates have encouraged some farmers to become overextended, taking on too much debt and financial risk.

Thiesse says farmers in his area generally have been responsible.

Eggebrecht also says producers generally have been prudent financially.

Aakre is more cautious.

"I think it's a real possibility (that some farmers have become overextended.) You hear about some of these extreme land prices," he says. "And some (producers) have made extremely expensive shop investments. You have to worry about how well they'll pay back."

No matter how low interest rates are, "You still have to pay back the principal," which ultimately could prove difficult for some producers, Aakre says.

"So there are some concerns."