Rising Farm Land Prices Lead to Sustainable Lending Approach
Dec 11, 2012
Omaha, Nebraska – (December 11, 2012) – Rising land prices and continuing volatility of commodity prices top the list of financial planning factors for farmers to consider as the beginning of another year approaches.
"Farmland price increases are on a par with the most dramatic seen in the last 50 years,” observes Bill Davis, chief credit officer with Farm Credit Services of America (FCSAmerica). “The prices farmland is bringing clearly reflect the buyers’ view that returns over variable costs will stay high and interest rates will stay low."
FCSAmerica is the leading agricultural lender in its four-state area, which includes Iowa, Nebraska, South Dakota and Wyoming. The financial services cooperative has assets of $18 billion and more than 60,000 customer/stockholders.
Davis says the current large increases in farmland prices – in the range of 200 to 300 percent during five- and 10-year timeframes – are driven by three factors: strong domestic and export demand for commodities, historically low interest rates, and very strong net farm income from cropping enterprises.
"We believe at least two of these three factors will reverse over the next three to five years," Davis explains. "The most likely event is a significant reduction in net farm profit levels as we see supplies respond to higher demand levels for commodities. Interest rates also are likely to increase eventually, making alternative investments more attractive than they have been recently.
"In short, over the long term farmers won’t be as profitable as they have been and that will affect the prices they are willing to pay for farmland," Davis notes.
Even if farmland prices do drop somewhat in the future, Davis says his company believes most producers are in a position to weather a moderate decline.
"Most of the farmland value increases we’ve seen over the past seven years appear to be supported by long-term domestic and world demand for agricultural commodities," he says. "Most buyers are farmers and they generally are in a very strong financial position. They have made these purchases with relatively modest financial leverage."
Sustainable Lending Strategy
To manage the financial risks associated with rising land prices and expected commodity price volatility, FCSAmerica is still very active but has taken a conservative approach to real estate lending.
"Since 2008, when we began to see these escalating farmland market prices, we’ve used a risk management strategy that includes a cap on the amount we will loan for land purchases," Davis explains. "The caps are part of our ‘sustainable lending strategy.’ They apply to 11 cropland zones in Iowa, Nebraska and South Dakota. Lending limits in the zones range from $5,900 per acre in northern Iowa to $2,000 an acre in western Nebraska."
Davis gives this northern Iowa example of how the caps are derived:
- Assume a 200-bushel-per-acre corn yield and a $4.50 per-bushel price.
- Estimate costs based on the benchmark Iowa State University variable and fixed-cost budgets.
- Assume a 3.5 percent capitalization rate, or return on investment.
"Using these assumptions, we see a return to real estate of $320-$350 per acre," he says. "The sustainable market value of the land would be $9,000 per acre. We would lend up to 65 percent of that, or $5,900 per acre."
Davis says FCSAmerica’s current strategy is not intended to be permanent. "Our goal is to return to more traditional loan to market value controls after profit margins normalize and farmland values stabilize," he adds.
"Customer reaction has been supportive. No one wants overextended credit," Davis adds. "They appreciate being counseled to approach land purchases from a position of financial strength. We assist our customers in managing risk by limiting lending and their debt services obligations to a level that can be supported by cash rent plus a normalized profit margin."