Why California is the Best State to Buy Farmland.
As more investors seek to diversify portfolios, or perhaps plan bulwarks against inflation, the good news is that more practical opportunities in recent years have opened up to own farmland.
As with other types of real estate, passive investors can buy agriculture-oriented equities, or farmland real estate investment trusts (REITs). But the most interesting development in recent years has been select private-equity farmland partnerships, such as Bravante Farm Capital.
The emergence of private-equity and other, emergent institutional buyers of farmland will impact farm values in two ways. 1) More investors will be able to acquire farmland and will enter the space. 2) The buyers will not only pay for farmland based on per-acre comparable sales (as it customary today) but will gravitate to toward income-models for farmland acquisition. This will result in higher values being placed on well-operated farms. More on this later.
Regardless of vehicle, currently investors globally are seeking security and stable returns, in what appears to be an increasingly risky world. No longer are pandemics or revanchist wars mere topics of speculation.
And investors do find refuge in agriculture: From 2000 to 2020, U.S. farmland returned an average annual rate of return of 11%, roughly keeping pace with the stock market in the 20-year period but—and this is key—with significantly lower volatility, recently reported Manulife Investment Management.
Farmland prices have increased by more than 6% annually compounded for the last five decades (unlevered), with values decreasing only during five years in that period, according to the National Council of Real Estate Investment Fiduciaries (NCREIF) farmland index.
Moreover, this is the average return for all farmland across America, including large fractions that are not optimized for profits, such marginal farmlands, or occupant-owners who are content with the status quo, or other capital-starved owners who operate small, inefficient farms.
The reason for solid farmland prices is basic. People eat food every day, and there is almost always a market for product.
But in addition, the amount of arable land is decreasing in certain regions of the US, due to urbanization and loss of water resources, especially underground aquifers.
For example, the Ogallala Aquifer, which lays underneath the Great Plains and irrigates huge swatches of the American Heartland, is expected to “go dry” in large parts another 20 years, due to over-pumping extending back to 1940. Parts of the remarkable productive San Joaquin Valley in California face a similar future.
The best states in which to buy farmland is a bit of trick question and depends somewhat on what crops or lifestyle is wanted. For passive investors, the best opportunities are likely found in California.
But why?
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California
There are more than 80,000 farms and ranches in California, which despite the glitzy reputation as the movie capital of the world, is the nation’s leader in producing citrus, grapes, vegetables and nuts, and has a generally moderate, Mediterranean climate which is exceptionally good for food production.
But, perhaps due to the attractions of the coastal glitz and bright lights of the big cities across the country, the state’s farm owners are getting older and their heirs are often uninterested in continuing the family farming business. The average age of a California farm-owner in 2017 was 59, and tracking higher, reported the USDA Census of Agriculture. Many who own farms we are targeting for acquisition are well into their 70’s and are keen to retire.
Obviously, a lot of California farmland will be coming to market in the coming seasons and years, and much will be “legacy land” in older, less profitable crops, or on farms and ranches managed for comfort and not to optimize profit.
This land will largely be sold on a “per acre” basis, that is, based on “comps” or in comparison to recent sales of similar farmland. The actual productivity or profitability of the individual farm in question is not considered by lenders, often due to banking regulations. Farms, oddly enough, are treated by regulated lenders (that is, the banks) like single-family detached houses: When you buy a house, the per-square-footage and neighborhood dictate loan sizes, and that is determined by comps.
For shrewd investors, the standard bank-lending practice is opening up opportunities. First, here at Bravante, we are carefully select farmlands that are more profitable, or situated such that boosting profitability is clearly possible through redevelopment i.e. by planting higher profit crops. The basics of good farmland rarely change, and include good soil, abundant water and access to infrastructure and market.
But should we exit farm-holdings in the future, we will be positioned to seek out the greater number of institutional buyers playing the market, who are willing to pay for agriculture assets on an income basis, like other operating businesses. Such institutional buyers will get as much bank financing as possible, and then top-up bids with equity or second (non-bank) mortgages.
Even if we do not sell and instead hold our farms for the income streams they provide, we anticipate being able to refinance them based on the new, far higher valuations. This will mean investors will get some or all of their capital back, while leaving them in the deals, earning income despite now having no money in the deal.
In short, over time we will be able to reduce investor risk to zero while still providing continuing income streams from crop sales.
Seller’s Market
For several decades, the world has been an asset-seller’s market. Despite geopolitical turmoil and pandemic, there remains a global capital glut. Sellers of any asset, including farmland, who know how to cater to institutional buyers as we do, will likely do well.
The reasons for the worldwide perennial glut of capital are debated, and some lay blame on “too easy” central banks. Perhaps so, but this glut of capital has persisted for nearly 40 years, even as low inflation became the global norm (until very recently).
Others credit income-stratification for the surfeit of capital, and the creation of a super class that accumulates capital continuously, while others point to very high savings rates all across the Asia Pacific (sometimes the result of government mandates or incentives). Many governments have automatic savings and pensions plans for employees, and many governments require all business operators to carry insurance, which also results in accumulations of capital.
In any event, too much money chasing too few deals has been a perennial complaint in real estate circles for a couple generations and counting, and this is especially true in the United States particularly since the end of the Global Financial Crisis years of 2007-2010.
Increasingly, this glut of capital is entering the agriculture real estate markets, as vehicles, such as private-equity funds, realize the benefits of investing in farmland and begin institutionalizing the market.
Water
In addition, large parts of California’s famed San Joaquin Valley are showing the same signs of an over-pumped (over drafted) aquifer that are now manifest over the Great Plains’ Ogallala Aquifer. Wells are drilled ever deeper, resultant water quality is declining, and ground subsidence in many areas is problematic.
The State of California has implemented parts of its Sustainable Groundwater Management Act (SGMA) passed in 2014, in an effort to prevent further declines of the aquifer. Whether through state action, the rising expenses of pumping, or the aquifer “going dry”—and many wells have already dried up—much land in San Joaquin will likely have to be re-purposed away from water-intensive farming in the years ahead.
This will increase the value of farmland remaining in those parts of the San Joaquin that still have access to abundant, good water. Those farmlands concentrated are in the middle part of valley, a section of the valley some are calling “The Oasis.”
Several private-equity managers, such as Bravante Farm Capital, are taking a close look at those promising sections of the San Joaquin. Some private equity investors are buying land the now will become fallow when SGMA turns off their wells and are underwriting to a limited number of years of productive farming until the land no longer has water and becomes valueless. In some ways this strategy is similar to buying a building with a limited term ground-lease and calculating value based on projected revenue streams until the building reverts to the ground-lease holder.
However, here at Bravante Farm Capital, we take a different, longer term approach. Our strategy is to acquire under-utilized farmland in areas we know the water supply is going to last long into the future, upgrade to higher-quality or better-yielding crops, and introduce modern farming techniques where applicable.
Thus, we plan a “triple play”: First, acquire farmland in areas of the San Joaquin Valley that will be unaffected by future water shortages, and which is presently sold on a per-acre basis.
Secondly, select under-developed or legacy farms that can be readily improved, which have good soil and access to infrastructure.
And then thirdly, either sell to institutional buyers who will pay for the improved profit and loss statements that result based on cap rates and yield, or refinance to return equity to investors and then hold the farms for the long run.
One key throughout investment history: Institutional buyers prefer Class A real estate with stable tenants, predictable income streams, and little or no redevelopment or value-add risk. With mountains of capital to place and limited staff for due diligence, institutional buyers will pay a premium for a farm that meets these bond like income criteria – and this is just the type of farm that we here at Bravante Farm Capital are creating.
Predictability
The impression many investors have that farming is susceptible to boom and bust depending on the weather is another reason it has been an overlooked asset class for so many years.
However, savvy investors understand that, not only are there protections against bad crop years through widely available and commonly used crop insurance, but also because in the long run, farming has proven to be less subject to the volatility of other real estate asset classes and certainly less so than the stock market.
Of course, private-equity investors can also develop crops that are somewhat resistant to weather variations, such as grapefruits, lemons and oranges, based on the generally hardy citrus tree and appropriate California weather, and by buying land with more predictable micro-climates.
While nothing is guaranteed in life, a well-operated citrus farm (aka ranch) will return as good as if not better returns over time than other more popular real estate asset classes like apartments or self-storage for example.
In addition, the predictability and hardiness of citrus farming has attracted many smaller and medium-sized operators into the sector in previous decades—the same farmers looking to sell in the years ahead.
Conclusion
That farmland is rotating into public view as an investable asset is hardly news; one only has to scan headlines to find out mega-investor Bill Gates is now the largest private farmland owner in the US, with title to about 300,000 acres. Gates recently posted on the social-media website Reddit that, “My investment group chose to do this. It is not connected to climate. The agriculture sector is important.”
No doubt, Gates and his investment team are eying the same fundamentals as we do here at Bravante Farm Capital: A still-growing global population, decreasing arable lands, and a sector ripe for improved economies of scale, management, and operations.
For investors seeking relative security from loss of capital, but higher yields, farmland in the 2020s is a very promising option.
