The 'sleeper hold' for farms may be not taking into account interest rates in estate plans
"If your farm estate plan expects your farm heir to buy out siblings at fair market value or even a discount, you need to do the math with current interest rates. You may have a formula for the interest rate, but even that formula would have gone up, and that is a painful change at these land prices."
I remember in elementary school hearing about “the sleeper” hold, which was a chokehold that basically cut off someone’s air to breath. I think that’s about the same hold they are using in MMA fighting today. Usually that ends the fight as someone "taps out" because they know they are beat, and they have lost.
So here we are with high land prices, high commodity prices, rising input prices, and completely unrealistic expectations of heirs not on the farm. These issues make farm continuation planning a challenge.
Let’s start with an example from only a year ago. Let’s assume a 600 acre farm with land valued at $13,000 per acre. The family has three children with one child farming. At fair market value that makes the land worth $7.8 million or if divided equally between three children about $2.6 million each. For one to buyout two, that would take a $5.2 million loan after your death. With a 30-year loan at 4% interest, the payment would be $752 per acre. Keep in mind, this example is not having all the other land paid for and just buying “the new 80.” This reality is buying “the old 400” that was paid for once already. I got to a 400-acre buyout because that is one buying out two-thirds of the 600 all at once. Keep in mind, the older generation probably acquired that land over a period of 30-50 years.
So how many farmers do you know of who buy one and half times their farm acres in less than one year? How many farmers buy 400 acres after owning 200, or buy 1,000 after owning 500, or buy 2,000 after owning 1,000. All in one year. It hardly ever happens.
These loan payments only work for the farming heir if commodity prices “out inflate” the input prices. We know that’s not going to happen for long, especially 30 straight years. If it did, then land prices would go even higher, which compounds the problem.
So where does the “the sleeper” come in? It already has. Interest rates are up about 3% from a year ago, so now to buy out those same 400 acres the loan payment is $1,047 per acre. The interest rates alone have increased the buyout cost by $300 per acre! Good night, sleep tight. That farm will be owned by someone else.
Now this does not matter to you if you do not care about keeping your farm together, but I know a lot of families that it does matter to. Also keep in mind this interest rate issue may not be over. It might get worse before it gets better. Many remember the '80s. Maybe it will not get that bad, but learning from the past is why knowing history is important. We need to learn from history so that it does not repeat itself.
If your farm estate plan expects your farm heir to buy out siblings at fair market value or even a discount, you need to do the math with current interest rates. You may have a formula for the interest rate, but even that formula would have gone up, and that is a painful change at these land prices.
About the only thing left to make this is an absolute right hook for an instant knockout would be for everything to stay the same and then commodity prices drop $2-$3 a bushel.
So, while you are combining this year, trying to negotiate your seed, chemical, and fertilizer prices for the next year, don’t fall asleep on what interest rates are doing to your estate plan. You may think you have a plan in place but the next thing you know an arm around comes from behind across your throat and the sleeper is gripped tight. Goodnight farm.
Myron Friesen is the co-owner of Farm Financial Strategies Inc. in Osage, Iowa. He can be contacted at 866-524-3636 or email@example.com.