Why now is the best time to invest in agricultural farmland
After a period of unrestrained optimism among investors, pessimism is making a comeback. That is bad news for holders of tech stocks, cryptocurrencies and other frothy assets. But for owners of farmland, the reality check of 2022 could prove profitable.
A quick bit of context: In the early days of the coronavirus pandemic, investors grew concerned by the threat COVID-19 posed to global economies. Stock values plunged as investors fretted about protracted lockdowns and mounting death counts. But then the Federal Reserve and other central banks responded quickly, and values of stocks, real estate and other assets skyrocketed through 2020 and 2021. The coronavirus inspired an “everything bubble” that buoyed cryptocurrencies, collectibles, and other assets.
As investors partied, the dark cloud over the economy lifted. Drugmakers promptly developed vaccines, governments eased lockdowns, and economies came roaring back. But the downside was that inflation, a foe long vanquished, hit levels not seen in four decades. Then came 2022 – as the Fed declared war on inflation, values of stocks and cryptocurrencies beat a hasty retreat. However, real estate values held strong – and there is reason to believe farmland in particular will keep its value even in a bear market.
That is the short-term rationale for buying farmland, but there is also a longer-term thesis: Agricultural real estate is poised to benefit from macro trends. The world’s consumers are getting more affluent as the global population grows and that creates a compelling opportunity for owners of a key asset in the food supply chain. In the U.S. and Europe, workers are enjoying rising wages. And in China and India, hundreds of millions of people have moved out of abject poverty to join the middle class.
The growing affluence and increasing overall numbers of the global population is pushing demand for food upwards. People who once subsisted on starch-heavy diets have begun consuming more protein, more fruit, more vegetables, and more nuts. And with a growing population, not only has the demand for foodstuffs shifted to a higher quality diet, it has grown in nominal volume also.
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Is agricultural farmland a good investment right now?
This global shift in consumer preferences in combination with a growing population means farmland values will likely outstrip those of other real estate asset classes. This is particularly true in comparison to those asset classes like multifamily apartments where investor demand has already driven values to historical highs.
Institutional investors have identified this trend – and these deep-pocketed buyers see farmland as a relatively untapped opportunity. Once the trickle of institutional investors 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. This promises to drive up land prices in areas such as California’s Central Valley, a major producer of almonds, pistachios, avocados, citrus, and other crops.
Central Valley farmland is currently sold by the acre without concern to the land’s potential to yield income (as implausible as that sounds). As a result and though farmland prices have been steadily increasing, there clearly remains considerable upward potential in values. A farm may yield a 30% return on the cost per acre - so when institutions begin buying up land, and valuing acquisitions based on cap rates, there is potential for strong growth in the value of the best sites.
Hedge against inflation
As of April 2022, the pace of inflation in the U.S. was 8.3%, down from 8.5% in March, according to the Labor Department. Inflation has not been at such high levels since the early 1980s. During the low-inflation era of the 1990s, 2000s and 2010s, investors all but forgot about the corrosive effects of rising prices. Now that inflation is back with a vengeance, it is worth looking to hard assets as a way to protect your portfolio from rising prices.
Real estate offers a hedge against inflation because the main component of income in real estate, rents, rise at least as quickly as inflation and disproportionately add to asset values when they do. Even more so, agricultural land is especially attractive as a way to protect your assets from rising prices because the cost of food is a major factor in determining how inflation is measured and so is directly correlated.
Farmland is a hard asset that produces income from food crop production and prices of those products rise in an inflationary environment. That means farmland provides investors a two-pronged hedge against inflation: Land appreciates, and a landowner’s operating income climbs along with commodity prices.
Increasing investor accessibility
For much of human history, investing in farmland meant buying the real estate directly. That strategy raises all sorts of issues. To profitably pick a site, you need to know about soil quality, water availability, weather patterns, crop cycles, horticulture, and market demand. These are daunting barriers to entry not least because, to be truly successful, you must actually live on the land you farm.
Unlike multifamily apartments that can be purchased nearby and managed while conducting other day to day business, to be successful in farming you must leave the city and move to a rural area. Not many city dwellers are willing to make this sacrifice and so demand from investors has always been lower for farmland than it has for asset classes like apartments or self-storage buildings for example that can be managed without any major shift in lifestyle.
However, in recent years, a new breed of crowdfunding platforms has emerged to provide investors an entry point into the farmland game without the need to leave the city to enjoy the financial rewards. These companies take on the due diligence duties, researching sites and negotiating deals with farmers. In general, these companies buy 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 of the platforms promise to make investing easy by screening properties and negotiating the deal. The investor worries only about signing up and sending the money.
One disadvantage of crowdfunding is that investors are relying on the platforms themselves to ameliorate risk which itself elevates risk while at the same time adding an extra burden of cost to the process – the cost of remunerating the platform. In addition, real estate investment trusts have begun to amass farmland, and shares of these REITs trade on public markets.
This also comes with a downside typical of REIT investing no matter what the asset class; that of being closely tied to stock market volatility and the liquidity premium investors pay for something that is inherently not liquid. The rise of these two methods of investing in agricultural land has provided investors’ with access to farmland as an asset class, though investing directly with the farmer, as you can with us here at Bravante, provides a more efficient and lower risk option.
With markets no longer going straight up, investors are beginning to pay attention to diversification. A portfolio that holds a range of assets is better able to withstand such setbacks as a stock market correction. Farmland is one of the few counter-cyclical real estate asset classes. American agricultural returns generally come with fewer ups and downs than other asset classes. An additional benefit for investors is that farmland returns tend not to be tied to the stock market. Reflecting that low correlation, U.S. farmland routinely generates a positive return in years that the S&P 500 declines.
Current global market for grain and wheat
The USDA says the war in Ukraine – a major agricultural producer – is hurting global agricultural output. For instance, the USDA says global consumption of wheat is expected to hit 788 million tons in 2022-23. Yet global production is forecast to reach only 775 million tons, down 4 million tons from the previous year. The largest cut to production is in Ukraine, which is projected to have a crop one-third smaller than the previous year as war with Russia interrupts harvests. Production of corn and barley also are down slightly because of the war in Ukraine. The shortages are bad news for consumers, who face higher prices, but good news for owners of farmland that produces wheat, corn and barley.
Decreasing farmland supply + increasing investor demand = Higher land values
A growing population in the U.S. means agricultural land uses are pitted against housing and commercial uses. The American Farmland Trust says that from 2001 to 2016, some 11 million acres of farmland and ranchland were converted to other land uses. While farmers have learned how to squeeze more production from any given acre of land, the competition for arable land will continue to intensify. And any time supply shrinks while demand increases, a move in prices is certain to follow.
In the California Central Valley where we are targeting water abundant assets for acquisition, much land is going to be lost to new regulations restricting water use. As demand for food continues to climb as global populations grow, here in the Central Valley, the largest producing area for food in the United States (by far), land with good water access will see even higher demand and values will rise disproportionately to farmland assets in other locations.
Benefits of investing in farmland
Owners of agricultural land make money in two ways. The long-term play is appreciation – if the value of a ranch goes up while you own it, you can sell for a profit or refinance it to take out your equity while continuing to receive income from crop sales.
The other potential revenue streams are shorter-term – you can lease the land to a farmer while you own it, or you can produce crops yourself and hope that you sell your output for more than your costs of planting and harvesting the crop.
At Bravante we farm, pack, and ship produce ourselves which means we can ensure the highest quality produce goes to our customers at the right time so we can generate the best prices for our partners and investors.
The value of U.S. farmland has appreciated by nearly 6% a year during the past half-century, with only rare down years, according to USDA data. And that is not counting cash rent yields. Farmland has produced a positive return every year since 1991, according to the USDA, posting average returns of 11.5% a year. In other words, owners of American farmland have enjoyed returns similar to those experienced by stockholders, consistently and with the potential for greater asset appreciation in the years to come.
Farmland values tend not to rise and fall as sharply as other assets. That is partly because there is little leverage – little debt, in other words. Leverage boosts investor returns, but only in moderation. Too much debt – and this applies equally to any real estate asset class – can create swings in prices and makes investments inherently risker by increasing the chance that creditors can call a loan and foreclose on a property.
While a multifamily operator may borrow up to 70% or more to acquire an asset, here at Bravante we never take more than 50% leverage against a farm ranch and have never lost an asset to foreclosure to a bank.
If you are not managing the farm or working the land yourself, investing in farmland is a good way to create passive income. Owning farmland by partnering with us here at Bravante, you can benefit from our decades long experience in the industry and our institutional perspective to what is a highly fragmented and inefficient industry.
If you took Economics 101, you will remember the basic determinants of price – supply and demand. The supply and demand signals are forecasting an upward move for farmland values. On the demand side of the equation, global demand for food is growing. On the supply side, the inventory of farmland is stagnant or dwindling.
In a nutshell, 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 is not as simple as buying farmland in California and waiting for the value to increase. One crucial variable is access to water. Farms that have locked in a stable supply of 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. Meanwhile, the bear market of 2022 is encouraging a flight to safety – and it is hard to think of an asset that is safer than land that produces food.