With major commodity prices significantly below the peaks reached a couple years ago, the expectation is that farmland values — which rose sharply along with commodities — are in for a downturn, perhaps as much as 34 percent, says Bryon Parman, assistant Extension professor of agricultural economics at Mississippi State University.
That’s based on quality Delta irrigated farmland, given current commodity prices and interest rates, and assuming that operating costs (excluding land) come down by 20 percent, he said at the annual meeting of the Mississippi Agricultural Economics Association.
“The price drop in the Plains and Corn Belt states would most likely be much more dramatic,” Parman says, “given that the appreciation for farmland was much larger there. The places that are going to be hit hardest are the places that were hit the hardest in the 1980s agricultural downturn: Iowa, Illinois, Indiana. Fewer than normal land sales are already being seen in some regions, which is typically the first sign of value weakness in the farmland market.
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“You’ve got sellers, who’ve seen land going for $10,000 to $14,000 per acre, who are ready to sell, but buyers aren’t willing to pay that kind of price, and lenders aren’t willing to put up that kind of money. So, you have a stalemate. But at some point, something’s got to give. And if commodity prices stay low enough, long enough, in the end the seller is going to be the one who has to give.”
Liberal lending practices in recent years are already being altered, as banks and other lenders brace for a correction, Parman says. “A lot of lenders have seen this downturn coming, and they’re making people put up more collateral, putting equipment into loans — instead of making just pure land loans.”
Opportunities to buy
A bright spot in this scenario, he says: “The future should present many opportunities for the financially secure farmers to pick up land at somewhat bargain prices.”
For last couple of years, Parman says, “I’ve been singing something of a gloom-and-doom song about land values, primarily because I’ve believed — based on what land was selling for and renting for, and given where commodity prices were in reference to historic averages and means — those prices were basically unsustainable.
“Four years ago, the Federal Reserve board of governors recognized the potential for a problem with land values in the future, saying capitalization rates for farmland and cropland appeared to be well below historical norms, and that there was too much optimism on the part of both lenders and farmers about where land values were and where they were heading in the future.”
“Looking regionally at the percent of change for irrigated farmland values between 2004 and 2015, the largest increase was in the Northern Plains, a 286 percent jump. Corn Belt states saw a 131 percent increase; Delta states, 118 percent; Southern Plains, 100 percent; Pacific states, 97 percent; and Mountain states, 65 percent.
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“Dryland cropland saw much the same magnitude of increase: 297 percent in the Northern Plains, 127 percent in the Corn Belt, 105 percent in the Mountain states, 100 percent in the Southern Plains, 89 percent in the Delta states, and 54 percent in the Pacific states.”
Majority of farm assets is land
In a MSU survey this spring of land values being seen by lenders and loan officers, Parman says, Delta irrigated cropland averaged $4,339 per acre, and dry land averaged $3,163 per acre. Non-Delta irrigated cropland averaged $3,061, non-Delta dry land $2,457, and pastureland, $2,455.
“Those figures reflected an increase of 189 percent for irrigated cropland, 136 percent for dry cropland, and 93 percent for pastureland. The increase in pastureland, both in terms of rent and sale value, was not surprising, given what cow/calf operators experienced the past year in terms of revenue — landlords are trying to extract some of that through increased rents and sale values.”
The rapid rise in commodity prices from 2005 to 2013 pushed farm incomes to record levels, Parman says, “and high returns put upward pressure on overall land values and cash rents. Corn and soybean prices shot up dramatically, and land prices rose with them.
“I can remember, in the early 2000s, selling corn out of the combine at $1.95 to $2.05 per bushel — and that was enough to make a decent living. In recent years, we’ve seen, at times, people contracting corn to ethanol companies for $8.50 per bushel, which increased their margins, but also pushed up land values and rents. The same is true for soybeans. Today, prices are low relative to the highs we’ve seen for corn and soybeans, but they’re still nowhere near the lows of the early 2000s.”
Why are land values so important in the agricultural economy? “A big reason,” Parman says, “is that, on average, 84 percent to 85 percent of all farm assets is land. So, changes in the value of agricultural real estate can have a tremendous impact on the dollar change in owner equity and total assets.”
Two possible scenarios ahead
With the expectation that land values will fall in the period ahead, he says, there are two scenarios that are most likely.
Scenario 1: Land values fall rapidly, bottoming out in the next couple of years, resembling the 1980s fall. Commodity prices stay low; input costs are slow to adjust downward; and interest rates rise quickly. “This would put a significant percentage of the nation’s cropland up for sale at the same time. When you have a glut of land hitting the market at the same time, with not many buyers having money to purchase it, that’s going to drive land values down pretty fast.
“Highly leveraged farmers are not the only ones that will be stressed in this situation; those who are relatively financially healthy can also find themselves in trouble, depending on their need to finance year-over-year losses. In order to obtain an operating loan, producers would either need to put up more collateral for existing loans, or sell assets to make up the difference. This would start a spiral downward, values would keep falling, more people would be in trouble as values fell, and more and more land would hit the market. Nobody wants to lend on land that’s falling in value, and nobody wants to buy land that in the next year is going to be worth much less.”
That’s pretty much the worst case scenario, Parman says, similar to what happened in the 1980s. “But while many older generation farmers and bankers have seen this kind of situation before, there are a lot of new farmers and lenders who’ve never seen land values go any direction but up, who’ve been assuming an appreciation of 10 percent per year for the next 20 years to justify a land purchase — similar to what we saw when the housing bubble burst a few years ago. There are a lot of people in agriculture today who just aren’t prepared for this kind of scenario.”
Scenario 2: Land values correct slowly. Commodity price projections out to 2020 are overly pessimistic, with corn closer to $5 and soybeans closer to $10. Input costs adjust to a new normal of lower commodity prices. Interest rates adjust slowly, and foreclosures don’t decimate the highly leveraged farmers in any single year.
“You wouldn’t have a glut of land hitting the market as fast,” Parman says. “You wouldn’t have as many distressed farm sales in any one period of time; you wouldn’t have a massive disaster.
“In this case, only the highly leveraged farms are in danger, and those that go bankrupt do so over a period of years. This keeps lenders, who have large shares of their portfolio backed by land, from nearing collapse. Returns to land aren’t as low, helping to prop up prices.
“Fewer farms are forced to sell in any one year, preventing a glut of land for sale, and keeping asset values from spiraling downward. Without the asset value death spiral, banks would be under less pressure to request additional collateral or cash to offset declining land values, keeping funds available for those most in need.”
Change can occur quickly
Land prices can change quickly, Parman says. “With 85 percent of farm assets in land, debt-to-equity ratios can adjust dramatically, with no change in borrowing habits by producers. If farmers are forced to finance losses, those losses may be collateralized with land, increasing the debt-to-equity ratio, and they may find obtaining operating loans more difficult.”
What about lender exposure? “The last time we saw a big drop in land values across the country, lenders — especially savings and loans — were hard hit. Federal Farm Credit Funding Corp. represents 40 percent of all agricultural lending and loans across the U.S. In 2015, almost half their portfolio was collateralized by land. That is subject to a change as land values change. A decrease in land values could be detrimental to their holdings.”
In Mississippi, Parman notes, the loan-to-value ratio was about 80 percent. “I’ve heard some anecdotal instances of 90 percent, but that’s outside the norm.” In the 1980s, he says, the average loan-to-value ratio for land was about 60 percent prior to the crash.
Looking ahead, what could be the bottom for Delta farmland?
“Anyone who has a strong cash position is probably going to have opportunities in the next few years to pick up farmland at a somewhat reasonable cost. When everyone’s selling, that can often be a good opportunity to buy.”