Main factors aligned to drive up farmland prices
Using the Survey of Farmland Values and Cash Rents released by Purdue University each August, the average price per acre of average productivity land in Indiana has increased by about 30% from June 2021 to June 2022. The long-term average annual increase in farmland values since 1973 is closer to 5.5%. What explains the recent strength in farmland values?
The main variables affecting farmland prices include the cash rent or net return to land; working capital; interest rate; inflation; investment potential of farmland relative to other investments such as the stock market, corporate bonds or similar assets; and the provision of land.
Related: Where will land prices go in 2023?
Let’s first look at cash rent or net return on land and working capital. Next, we’ll look at interest rates, inflation, farmland investment potential, and land supply. Both sets of factors have contributed positively to recent strength in farmland values.
Cash rent, working capital
Cash rents are mainly driven by net land returns. Using a case farm in west-central Indiana, the actual net return from the land has averaged about $260 per acre per year since 2007. During this time, the annual cash rent in central -western Indiana for medium productivity soil averaged $240 per acre. Thus, the average net return to land was greater than the average cash rent.
In addition, the net return to land has recently been significantly higher than cash rent. In 2020 the cash rent was $252 and the net land return was $331 per acre, while in 2021 the cash rent was $262 and the net land return was $510 per acre . Net land return and cash rent projections for 2022 are $289 and $400 per acre, respectively.
The relatively high net return to land in recent years has also bolstered working capital, an important source of funds when making installments on farmland.
Long-term capitalization rates are an important factor influencing the value of farmland. The capitalization rate depends on the long-term rate of US Treasury bills, called the risk-free interest rate, inflation and the risk premium between the long-term interest rate on land and the long-term rate. US Treasury bond term. If any of these factors increase or decrease, the capitalization rate on farmland is likely to increase or decrease.
The value of agricultural land is inversely proportional to the capitalization rate. Thus, a higher capitalization rate leads to a decrease in the value of agricultural land.
What affects the cap rate? Inflation has been relatively high over the past two years. In addition to putting upward pressure on interest rates, note that farmland is seen as a good hedge against inflation.
When these two opposing forces are combined, we generally see a positive relationship between farmland values and inflation. Until recently, the risk premium and interest rates were relatively low, which contributed to the increase in the value of agricultural land.
Meanwhile, the farmland market is often considered to be very thin, meaning that the supply of farmland in the market is a very small percentage of the state’s total farmland. The tightness of the land market often translates into strong demand when land becomes available locally.
Finally, due to its low correlation with stock market returns, agricultural land is also attractive to institutional investors. Thus, this second group of factors has also contributed to the recent strength in farmland values.
Langemeier is an economist at Purdue Extension and associate director of the Purdue Center for Commercial Agriculture.