Outlook Update for Indiana Farmland Values and Cash Rent
Prepared by
Craig L. Dobbins
Department of Agricultural Economics
Purdue University
January 2, 2001
Indiana land values
In
spite of continued low cash commodity prices, land values in Indiana remain
strong. As commodity prices were declining, the June 1998 Purdue Land Value
Survey indicated that Indiana land values had finally reached a new high. Many
people that watch the market for agricultural real estate began to wonder how
far land values might decline. The June 1999 Purdue Land Value Survey reported
a 2.7% to 5.3% reduction in farmland values. Given the continued low grain and
livestock prices at the time, a decline in land values was not a surprise. Many
thought that more downward adjustment in farmland values was likely. However,
in spite of continued low grain prices, the June 2000 Purdue Land Value Survey
reported a 2.7% to 5.4% increase in state wide land values.
Top-quality land had an estimated value of $2,715 per acre, average quality land had an estimated value of $2,173, and poor-quality land had an estimated value of $1,630 (Figure 1). These values were about $100 per acre above the previously reported highs in 1998.
In September 2000, our outlook called for land values to remain steady. While we have not conducted an extensive survey to assess land values, an informal check with several professionals around the state indicates that land values have not changed much. This is different than the report from the Chicago Federal Reserve Bank. The quarterly report on farmland values and credit conditions from the Chicago Federal Reserve Bank indicates that farmland values in the northern two-thirds of Indiana, the area of Indiana in the Chicago district, increased 3% since July. This survey indicated that farmland values in the northern part of the state increased 4% while farmland values in the central part of the state increased 3%. For the period, October 1, 1999 to October 1, 2000, farmland values were up strongly, averaging 10% for the state. The northern part of the state was up 8% and the central part of the state was up 12%.
What accounts for the strength of farmland values?
1. There have been increased government payments in response to low commodity prices. While these direct AMTA and emergency payments have not offset all the lost income associated with the price declines, these payments have quickly been capitalized into land values.
2. The nonfarm economy has been strong. This has resulted in a strong development demand. The sale price of land moving into nonagricultural uses averaged $6,532 per acre in the June 2000 survey, 2.5 to 4.0 times the agricultural value. To avoid payment of the capital gain taxes, many owners of the tracts moving into nonagricultural uses have used the provisions of the federal income tax code to make a real estate exchange rather than a sale. This has created a demand for land away from growing cities and towns. Both the general economy and the demand for development land appears to be slowing. A slowing general economy is likely to also dampen the demand for rural home sites and recreational land.
3. It is generally believed that the current owners of farmland are financially strong. There is very little farmland that must be sold in order to pay debts. If financially strong sellers don't get the price they want, they may decide to wait. This limits the supply of land, maintaining the price.
4. The purchasers of farmland are financially strong. Observations from sales indicate that many sales have large down payments or are cash purchases. As a result, less consideration is given to the debt repayment capacity of the land investment.
5. Finally, long-term interest rates last summer were increasing and are now beginning to decline. The farmland market like other real estate markets is interest rate sensitive. As rates decline, this will be a positive for the farmland market.
As
we look ahead, what happens in the general economy will have a big influence on
Indiana's farmland market. Tax-free exchanges have become an important
influence in this market. A slow down in the general economy will likely cause
some softness in the market, but a sharp reduction in farmland values is not
expected. Farmland is in financially strong hands. If sellers don't receive the
bid that they want, they are likely to wait. This may remind farmland investors
that farmland is an illiquid investment and sales may slow, but farmland prices
are expected to stay close to current levels.
Indiana Cash Rents
The pattern of cash rents is very similar to that of Indiana farmland values. In 1998, the Purdue Land Value Survey indicated that the rent for top land was $155 per acre, average land was $112 per acre and poor land was $86 per acre. The 1999 survey reported a reduction in rents of $2 per acre. This decline ended an eleven-year series of fairly steady increases in rents. Some viewed this as the first sign that while sticky, the low commodity prices were beginning to cause rents to adjust downward. However, as with farmland values, the 2000 survey reported an increase in cash rents. Top, average, and poor land each gained $2 per acre, putting rents back at their 1998 level.
What helps to explain the strength of the rental market?
1. Increased direct government payments. While the Freedom to Farm legislation funnels these payments to operators, these payments have quickly been bid into cash rents. While the size of the direct government payment, has become a new source of risk for operators, there are very few people, anywhere — not just farm operators, that think the current emergency payments will be eliminated. While some expect the amount to be reduced, the expectation that AMTA payments will be doubled is firmly entrenched in planning expectations.
2. Technology is allowing a single farmer to cover more acres. Machinery continues to get larger. Biotechnologies such as Round-Up Ready™ soybeans relax the timeliness constraints faced by farmers in the spring. Many farmers are aggressively seeking to expand the size of their businesses in order to capture the economies of scale associated with spreading costs across more units of production. This is creating a strong demand for rented land.
3. Another influence is longer-term price expectations. Many market participants are still expecting commodity prices over the next several years to average well above current prices. By being at the market or a little above today, operators can gain control of land. While this may result in low income or losses today, the expectation (hope) is once the operator has gained control of the land a larger future return will be forthcoming.
While there are positives, there are also negatives for the rental market.
1. Government payments for this year are scheduled to decline. The AMTA payment rate on corn is expected to decline from $0.33 in 2000 to around $.26 in 2001. Even if these payments are doubled, income from this source will decline.
2. There will be cost increases in the production of crops because of increased energy costs. Diesel fuel, LP gas and nitrogen prices are likely to be much next year than this year.
These changes will further shrink the profit margin from crop production. A comparison of estimates of the return after all costs is presented in Table 1. The government payment for corn assumes a base yield of 110 bu. per acre, a payment rate of $0.33 per bushel in 2000 and $0.26 per bushel in 2001, and the doubling of the scheduled payment. The government payment for soybeans assumes a $0.14 payment from the Oil Seed Payment Program.
Production costs for corn and soybeans were taken from a draft copy of the 2001 Purdue Crop Guide. The details of these estimated budgets are presented in the appendix. As the result of higher fuel and nitrogen costs, corn production expenses increased about 13%. Soybean production costs increased about 7%.
The estimated return after variable costs declines from $174 to $173 per acre. This reduction is not as large as expected, because of the improved pricing opportunities for corn in the market at the time of the estimates and the assumed additional government assistance. The estimated 2001 return after all expenses is -$44.
