Are Farmland Prices Really In A Bubble?

Iowa, corn

Photo: Carl Wycoff via Flickr

As food prices began to soar in 2007, farmland suddenly became a hot investment to many.For years, Jim Rogers has maintained that farmland is an excellent investment. Meanwhile,  countries like China and Saudi Arabia have been buying up farmland in a quest for food security.

All this has been driving up the price of rural land. In fact, just last week, an Iowa farm sold for $20,000 per acre, a record for the state.

Some argue it’s a bubble

Q3 agricultural land values in the seventh federal reserve district — which includes Iowa, Illinois, Indiana, Michigan and Wisconsin — jumped 25% year-over-year, and are expected to rise in the fourth quarter, according a report by the Chicago Federal Reserve.

Overall U.S. farmland prices surged to their highest level in over 30 years in the third quarter, even as crop prices fell, sparking concerns of a crash in rural land prices, which would only compound the housing crisis. Reuters reports:

In Nebraska, veteran auctioneer Randy Ruhter says he is seeing the same thing. Investors who want a 4.5 per cent to 5 per cent return on their investment will be lucky to get 3 per cent as land prices rise, and commodity prices soften, he cautions.

“So it’s the farmers that are buying,” Ruhter said.

…The consolidation of the farming industry means that the fall of one operator would likely have far deeper ripple effects in rural America.

Also, while arable land is limited in the developed world, it is cheaper and more available in the developing world, and is attracting foreign investment.

But some data suggests fears of a bubble are overblown 

Repayment rates for farm loans in the seventh federal reserve district climbed in the third quarter, according to the Chicago Fed. And creditors demanded higher levels of collateral for handing out loans.

Data from the USDA shows that the debt repayment capacity utilization (DRCU) ratio is falling. The DRCU represents the ability of the farm sector to repay debt over time using just farm income, and a ratio under 100% indicates that farms don’t need to draw on additional cash sources or take on additional debt to repay loans.

The DRCU ratio is expected to fall to about 38% in 2011, down from 46% in 2010. The decline is attributed to three main causes. First, farm sector debt is expected to fall from $246.9 billion in 2010, to $242.5 billion this year; second, interest rates are expected to stay low; finally, the sector is expected to see incomes surge.

Here is a chart showing that DRCU ratio is nowhere near the above 100% level it was at during the 1980s farm crisis in the Midwest.


Photo: USDA

So should you invest?

Those who argue in favour of farmland investment cite rising food demand and its stable returns as key reasons to invest. Farmland is also considered to be a “natural hedge” against inflation and allows investors to diversify their portfolio risk.

But farmland comes with its own risks, which include weather change and political risks. Many countries view sovereign purchases as land grabbing and require investors to involve the local community. Ethiopia, for example, has seen a wave of protests against land grabbing and countries like Brazil has moved to restrict ownership.

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