Farmland purchases have been a solid long-term investment for farmers, but that doesn't mean it always pencils out. If you ask young farmers what their No. 1 need is the overwhelming response will likely be land. Even during one of the worst droughts in history, farmland values are high and don't show any sign of regressing.
Reasons behind record level land prices include record high corn and soybean prices and low interest rates. Also, investors are providing price support toward the long-term farm asset. With limited growth in other sectors of the economy, farmland returns on investment look good to outside stakeholders.
However, these high prices could spell trouble, especially for young producers. An important thing farmers need to consider when buying land is what can I expect for my rate of return?
Tina LeBrun and Wayne Schoper
For the past 50 years land has brought a 9% to 10% range for rate of return on assets. This is a good rate to set as a target still today. Returns have been higher or lower for individual tracts and for shorter time periods, but it is a good rate to aim for.
To determine your rate-of-return potential, use this formula: (return + growth) price 100%. Return is the annual income earned from the land. Growth is expected annual growth in land price, and price is what you paid for the land.
Producers often want to own the land they farm, but you don't have to. Ask yourself, where can I get the best rate of return on my capital? In the agriculture economy we are currently experiencing land is a good long-term investment, but not fast turning. Many Ag economists would support the theory that young producers should look for quick-turning investments with high margins. Most importantly, producers you should not commit too much of your debt-servicing capacity to buying long-term assets. With the current input costs we are experiencing, it doesn't take many acres to consume the leveraging capacity of a young farmer. Producers need to consider the time commitments they are willing to make on any farm business investment.
Farmland is a valuable asset, but it can account for a huge amount of overall debt. When considering if you should buy land keep in mind that your total debt should equal 50% or less of your entire operations worth. When defining debt, you must include all debt, farm and personal. Many producers tend to look at debt loan by loan, but you need to think about debt for your operation. Financial lenders want to know your living expenses when you're getting a farm loan because it's another draw on your cash.
Another way to judge farmland investments is in terms of the repayment level. A good guideline to follow is to keep principal and interest payments from exceeding 15% of long-term average gross income. This is an easy number to calculate and typically keeps people out of financial trouble.
Since many young producers have limited capital resources, there can be other alternatives than land that allows them to grow their operation. Another good option is running an existing machinery base over more acreage via cash renting or custom farming. Farm management skills can teach producers to think outside the box while keeping an eye on their financial levels. This has become a key component to many farm businesses that are maintaining a healthy financial scorecard in today's agriculture environment.