Should You Invest in Boring Farmland?

August 1, 2016

Should You Invest in Boring Farmland?

  • Global demand for food is going to increase by 50% in 2050, while farmland supply is pretty much fixed.
  • Historically farmland returns are an inflation hedge and have low volatility.
  • REITs give retail investment options.

Introduction

With low general yields and high stock valuations, you might want to look at other types of assets to improve your diversification and returns. An interesting asset to own is farmland.

In this article we are going to elaborate on the reasons why to and why not to invest in farmland, analyze the current farmland market situation and give some ideas you can dig deeper into.

Investing Rationale

The investing thesis is pretty simple, farmland quantity is fixed and therefore with more demand for food or more money being printed, prices can only go up.

With growing global population and higher protein intake per person, it is expected that demand for food will consistently increase in the future. In order to feed the larger population, food supply has to increase by 50% by 2050. But farmland won’t increase as there is a finite amount of land available.

figure 1 global arable land
Figure 1: Global arable land. Source: Food and Agriculture Organization of the United Nations (FAO).

Farmland is also relatively uncorrelated to economic cycles. You might postpone buying a new boat or going on that great trip, but you won’t stop eating during a recession. On the other hand, there is the food price cycle which is mostly influenced by weather, good weather means lots of food and lower prices. Food prices were hit severely in 2014 and 2015, but are now rebounding which is normal for food prices.

figure 2 food prices
Figure 2: Food price index. Source: FAO.

The rebound in food prices mitigates rent risk as low food prices put downward pressure on rents. Higher food prices will give stability to rents and lower the risks for farmland investing.

There are two returns you are receiving when buying farmland, one is the yield and the other is capital appreciation as farmland is protecting you against inflation. In the last two decades, farmland has rewarded investors with excellent returns (12.5% per annum) and low volatility (7.1%).

figure 3 farmland returns
Figure 3: Average annual returns and standard deviation: Farmland vs. selected asset classes. Source: Farmland Partners.

A risk may be that farm prices are inflated at the moment seeing the exceptional past returns, but if we look at the above food demand prospects the positive trend could continue.

figure 4 farm value
Figure 4: U.S. farm real estate value. Source: U.S. Department of Agriculture (USDA).

Another risk might arise from the current low yields on farmland. The yield range is from 1% to maximum 5%.

figure 5 farm rent
Figure 5: U.S. farmland rent per acre. Source: USDA.

If interest rates increase and expected yields also increase, farmland prices might go down along with all yielding assets.

Investing Options

The first option is that you buy farmland yourself, but that limits your diversification and most people don’t have the skills to properly manage farmland assets.

The second option is to look for private partnerships, but you have to carefully analyze the partnership and fee structure. As many private partnerships are externally managed, fees might be high and activities might not always be in your best interest, plus the minimum investment could be very high.

The third option, and one that is available to everyone, is to look at farmland real estate investment trusts (REIT). The first advantage of REITs is that they are liquid and you can sell them instantly on the stock market. As REITs typically have lots of capital, they are very diversified and can avoid local farmland risks. High capital amounts give REITs the opportunity to raise capital in the form of debt and further leverage on the positive farmland returns.

Unfortunately, or fortunately because the sector is not overcrowded, there are only three farmland REITs. Those are Gladstone Land (NASDAQ: LAND), American Farmland Company (NYSE: AFCO) and Farmland Partners (NYSE: FPI). International farmland options are Adecoagro S.A. (NYSE: AGRO) and Cresud (NASDAQ: CRESY).

Going into detail on these stocks is beyond the purpose of this article, so every investor will need to find the best investment for themselves. Keep in mind that all of these stocks are small caps, and CRESY and AGRO are Latin American stocks, which are much more volatile than other kind of investments. In order to facilitate your investment decisions, keep reading Investiv Daily as we are going to write a detailed article on how to invest in REITs soon.

Conclusion

Owning farmland is a long-term, boring investment, yields will vary in relation to the food price cycle and farmland prices will move accordingly but the long term structural trends will give it stability. The slump in food prices has created some fear, so farmland investments can be found below book value as seasoned farmland investors are reminded of the 1980s farmland bubble when farmland prices declined for 5 years. However, a similar slump in farmland prices this time around is unlikely since the 1980s were influenced by a strong increase in farmland supply from South America.

Also, big new investors are attracted by the sector, like the financial services TIAA-CREF which raised $3 billion in 2015 for its second global farmland-investment partnership. Big institutional players entering the field lowers the risks of owning farmland and bubble fears might burst quickly.

The main risk is related to yield. With increasing yields, asset values should decline, but if inflation comes along, fixed supply assets like farmland should be a good hedge. The second risk is that farm prices continue to tank, but this risk is being mitigated by increasing food prices.

By Sven Carlin Farmland Investiv Daily Share:
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