Flexible lease: Exploring the advantages and disadvantages

Flexible lease: Exploring the advantages and disadvantages

As commodity prices increased since 2008 there has been an interest among producers and landowners to explore the flexible lease concept. Flexible crop leases have been more in place in the Midwest, but within the last few years have seen increased interest in the Southeast and Mid-South.

Farmers 20 years ago used what I would call an informal flexible lease. They had farmland leased on cash rent and it they had a real good year they would increase the rent to the landowner. It was not called a flexible lease, but the landowner knew if the year was above average, they would receive extra rent. Probably today’s flexible leases are a little more complicated than that, but they are still the same concept.

Basically, there is a fixed-cash rent with a mechanism in place that can provide a bump in the rent if certain conditions are met — usually price- and/or yield-related. Some flexible lease agreements have a base rent which not only can be adjusted upward in good times but can be adjusted downward in a poor year.

As part of University of Tennessee Extension PB 1816-B Farmland Cash Leases, we have a section on flexible cash leases. http://bit.ly/TennFarmLegacy.

Advantages and disadvantages of flexible cash leases relative to fixed cash leases:

Advantages to the landowner:

Enable the landowner to share in increased income resulting from higher yields, higher prices and/or lower input prices, depending upon the structure of the formula for calculating the flexible rent.

By sharing the production and price risk with the tenant, the flexible cash lease may make the process of entering into multiple-year leasing arrangements easier, which can reduce economic costs associated with renegotiating lease terms on an annual basis.

May help avoid situations in which landowners feel they have to find a new tenant if they want to increase the rent.

Advantages to the tenant:

Reduced production and/or price risk means that rent may decrease in years in which yield(s) decrease, output price(s) decrease or input price(s) increase.

By sharing production and price risk with landowners, the flexible cash lease may make the process of entering into multiple-year leasing arrangements easier, which can reduce economic costs associated with renegotiating lease terms on an annual basis.

Disadvantages to the landowner:

Increased price and production risk, since the rent received may decline in years when yield(s) or output price(s) decrease or input price(s) increase.

Formula for adjusting rent based on yields and/or prices is more complex and may be more difficult to develop than a fixed cash rental amount.

Poor management by the tenant can lead to reduced yields and lower income to the landowner (if yields are included in the formula for calculating rent).

Disadvantages to the tenant:

Will result in higher cash rent and lower income when yield(s) increase, output price(s) increase and/or input price(s) decrease.

When individual farm yields are included in the formula for calculating rent, the tenant’s incentive to maximize yields may be reduced by having to share the rewards of superior management with the landowner.

The formula for adjusting rent based on yields and/or prices is more complex and may be more difficult to develop than a fixed cash rental amount.

There are many ways to adjust cash rent. The three most common are adjusting for changes in commodity price only, both commodity price and yields, and output price, yields and input costs (this method is not very common in Tennessee, but is used in other places). Along with these methods of adjustment, there are some leases that are a fixed cash lease or a percentage of the crop whichever is greater.

Whichever method is used, it is generally advisable for both parties to the lease to agree and have in writing where applicable the base rent, base commodity price, base yield and base input costs. The same would apply to how the actual commodity price, yield and input costs are calculated. All of these that are used should be easily discoverable by both parties.

PB 1816-B (http://bit.ly/TennFarmLegacy) outlines some ways to calculate flexible rent as well as some worksheets that can be used. Flexible cash leases provide a way for producers and landowners to share in some of the price and production risk while keeping much of the simplicity of a cash lease. There appears to have been more interest in flexible leases when commodity prices were rising and maybe not as much interest as they have come down.

An additional note on cash rent data that has been provided by the National Agricultural Statistics Service — due to lack of funding, the county level cash rent data will not be available in 2015, but will return in September 2016. Only state level data will be available in 2015. This data will be missed because it did serve as a benchmark for comparison on cash rent changes that were occurring on a county level. I hope that it does return in 2016.

Hide comments

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Publish