Alternative real estate investments: Agriculture
An alternative investment is an asset that falls outside the three most commonly allocated asset types -- stocks, bonds and cash. Commercial real estate falls squarely into this category, and farmland is an overlooked corner of alternative investing.
Agricultural land is attractive for several reasons.
First, demand for food isn’t going away. With developed nations growing wealthier, consumers are eating more and spending more on food. Second, the supply of agricultural land isn’t expanding, even as global demand for meat, grains, vegetables and fruit expands.
This intersection of supply and demand means that investors who own farmland are likely to see the value of their investments appreciate in the coming years and decades.
For investors, farmland offers another selling point: While landowners wait for the inevitable appreciation in value of their agricultural properties, they can reap passive income, either from leasing the land to farmers or from producing crops and selling them.
Read on for more about alternative investments and how agricultural property fits into that puzzle – and how you might reap the rewards.
What are alternative real estate investments?
In financial lingo, asset classes are divided into broad categories. Stocks, bonds, and cash are considered the major building blocks of an investment portfolio, and anything else is categorized as an “alternative” investment. Alternative investments are asset types that fall outside the box of traditional investment opportunities. The list of alternative investments includes hedge funds, private equity and hard assets such as real estate and collectibles.
We can debate the wisdom of referring to commercial real estate as some sort of exotic or arcane investment – commercial property is a major asset class in its own right, and the “alternative” moniker adds a sense of mystery that does not really apply. Quibbles aside, many investors turn to alternative investments as a way to diversify. Over time, a diversified portfolio of holdings can reduce overall risk and increase long-term income.
Sophisticated investors long have used alternative investments to balance their portfolios. CalPERS, CalSTRS and other major pension funds allocate some of their funds to alternative assets because their returns historically have a low correlation with those of standard asset classes. Alternative investments are generally more complicated than stocks and bonds, and, in the case of real estate, are often considered higher risk because there is less third party analyst coverage of them.
What is more, alternative investments can have more complex legal structures than such mainstream investments as stocks. In some cases, alternative investments require investors to be accredited or have high net worth; however, through vehicles such as publicly traded real estate investment trusts and crowdfunding, real estate has become increasingly accessible for investors of all levels of wealth and experience.
Real estate asset classes and agriculture
Commercial real estate is subdivided into a variety of asset classes. Multifamily, office, retail and industrial are four of the biggest property types. Hotels, self-storage, and medical offices are important categories as well, and data centers are an emerging asset class. One asset class that is routinely overlooked is farmland.
The nation’s agricultural real estate was worth $2.7 trillion as of February 2022, according to the U.S. Department of Agriculture, and farmland covers wide swaths of the Midwest, the South and even California. What is more, farmland is central to the very survival of humanity – agricultural plots and pasture lands are the source of our food. Office space and distribution centers might be relatively new in historical terms, but farmland has existed since the dawn of civilization. And yet farmland is overlooked as an investment – probably because of its long history.
Alternative real estate investment strategies and agriculture
Most of the nation’s farmlands were claimed, cleared, and planted before the current era of commercial mortgage-backed securities, REITs and crowdfunding, so has developed its own, unique underwriting processes that have, in part, caused mainstream commercial real estate investors to largely steer clear of the sector. That is about to change, though.
The era of financialization is coming to the agricultural industry, and these deep-pocketed buyers are poised to pay more for farmland than current values. There is a catch, though: In the nation’s most productive agricultural region, California’s Central Valley, water is in limited supply. Some plots of land have guaranteed access to water supplies, while other locations seem doomed to dry up and become barren and worthless.
Investors in California farmland can look to two coming waves – first, the entry of institutional buyers, and second, a resetting of property values based on which farms have a supply of water and which do not.
Water-rich farmers stand to benefit, while water-poor landowners are likely to suffer.
Is agriculture the best alternative real estate investment?
Predicting future performance of specific asset classes is a fool’s errand. Perhaps hot asset classes such as multifamily and industrial will continue to deliver strong performance. Maybe unloved sectors like retail and office will experience a rebound. While it is hard to know which type of real estate will be the “best” or “worst” in the future, investors and analysts can make educated guesses about which property types are poised for growth by studying fundamental supply and demand.
The investment thesis for agricultural property is compelling.
Humanity’s demand for food is growing, but the globe’s supply of arable land is stagnant. That reality alone portends strong returns for agricultural land in the future. What is more, farmland is a low-volatility asset that is mostly owned either outright or with very low debt on it, seldom more than 50%. However, for investors who have not spent years learning the agricultural real estate market, finding a profitable deal is a challenge. To fill that void, farmland-focused REITs and crowdfunding platforms have emerged, as well as platforms like ours here at Bravante Farm Capital where we own and operate the farm ranches ourselves. All these investment vehicles provide investors with ways to gain exposure to farmland with minimal headaches.
Where are the best locations for agricultural real estate investments?
There are many potentially enticing places to invest in real estate, including Iowa cornfields, Texas cattle ranches, Wisconsin dairy farms and Florida citrus groves. But the best-performing region of the U.S. in recent years has been California’s Central Valley.
California also leads the U.S. in agricultural output – and by a wide margin. By most estimates, California’s agricultural output is about $50 billion a year, well ahead of the No. 2 state, Iowa. A Mediterranean climate combined with the state’s rich soil make California unique among U.S. agricultural producers. Mild winter temperatures allow permanent crops (as opposed to row crops like corn, wheat and soybeans) to thrive in California. The result is an amazingly diverse farming economy that produces 400 cash crops. California’s Central Valley is a major producer of such crops as almonds, pistachios, avocados, and oranges.
By contrast, Iowa is the nation’s No. 2 farm state, but its agricultural sector is dominated by corn, hogs, and soybeans. California’s variety of crops is a boon for investors. As an investor in California farmland, you can build a portfolio that encompasses agricultural land producing a variety of commodities.
Of course, soil and climate are crucial to a thriving agricultural economy, but they are only part of the puzzle. Water is an important input – and that is precisely the topic that requires investors to engage in some deep analysis. While California does not receive abundant rainfall, the state’s farmers do benefit from a system of dams, aqueducts, canals, irrigation districts, 12 major reservoirs, underground water banking, and a plentiful mountain range to the east that captures and releases water year round to those areas of the central valley we are focused on here at Bravante Farm Capital.
To understand the importance of water in California’s Central Valley, it is crucial to know about the region’s geography. The Sierra Nevada mountains on the east side of the valley get snowfall during the winter, which helps to replenish the reservoirs. The snowpack percolates into the underground water and replenishes the aquifer. Winter snowpack acts like a water bank, storing water high in the mountains until it melts in spring and summer to replenish water supplies. In years of little snowfall, some farmers can’t plant crops on their land.
Farms on the east side of the Central Valley generally have access to high-quality underground water, while farms on the west side of the valley struggle to tap into underground water supplies. Farms in areas with guaranteed water supplies will enjoy value increases. Other areas are going to dry up and become barren and worthless. For now, California farmland typically sells by price per acre, irrespective of the plot’s yield per acre. As a result, prices are undervalued. However, as institutional investors move into the farmland market, they are increasingly using more rigorous analyses – and paying up for the most productive land as a consequence.
The Central Valley offers a unique opportunity: Savvy players can buy the best ranches now, based on soil quality and access to water. Institutional buyers already are coming into the market. As that trickle turns to a flood, these sophisticated buyers will begin underwriting land value in a way more closely aligned with their usual metrics, such as yield and capitalization rates. Because Central Valley farmland currently is sold by the acre without much analysis of the yield on that acre, property prices appear grossly undervalued. A farm may yield a 25% return on the cost per acre - so when institutions begin buying up land and underwriting to cap rates, there is a real potential for multifold growth in the value of the best sites.
Investing with the farmer vs investing via a platform
Direct investment in an agricultural property is one way to play this asset class. An investor could buy a farm outright, or partner with a farmer who is already working the land. This direct ownership approach requires expertise. To succeed in this space, an investor must analyze many factors – soil quality, water availability, weather patterns, crop cycles, threats from pests and market conditions just to name a few.
If direct ownership sounds too daunting, real estate investment trusts offer another possibility. These are publicly traded landlords that allow investors to play the real estate market by assembling property portfolios and then offering ownership through shares of stock. REITs are required to pay at least 90% of their profits as dividends, and most pay 100% of their taxable profits to shareholders, so the vehicles typically generate healthy yields. What is more, REITs trade as stocks, so investors can easily enter and exit these companies with few restrictions and low transaction costs. Farmland Partners and Gladstone Land Corp. are two such options.
Another possibility is to invest in a crowdfunding platform. In recent years, a new breed of crowdfunding companies have emerged to allow investors to get into the farmland game. In general, these companies but a piece of agricultural property on behalf of investors, who can get a small piece of a project for as little as $10,000. All the platforms promise to make investing easy by screening properties, negotiating purchase terms and then helping to manage the farmland as it produces crops. The investor simply signs up and sends the money. One potential downside to crowdfunding: You will have to work to diversify. The platforms’ investments typically are limited to one property growing one type of crop. So if you want geographic diversification and exposure to a variety of types of agricultural products, you will need to invest in multiple deals.
Conclusion
As demand for food rises and the supply of farmland remains stagnant, investors would be wise to consider adding some exposure to this asset class. Agricultural real estate offers a compelling opportunity. While the sector largely has been ignored by institutional investors, these major players are beginning to bid up prices for farmland in key regions such as California’s Central Valley.
However, this opportunity isn’t as simple as buying farmland in California and waiting for the value to increase. Water supply is a significant wrinkle. Those properties with access to abundant water are likely to enjoy significant increases in value in the coming years. But farmland that lacks access to water will lose out in this race for value. Divining the probable winners and likely losers is no easy task – analyzing each parcel’s potential requires a knowledge of crop types and soil quality, not to mention having a good handle on water supplies. Farmland with access to surface water and groundwater will thrive, while parcels that lack a predictable supply of water are likely to lose value in the future.
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