Farmland investment returns have been running well above the norm. The trend may not continue.
There’s a new land rush going on in this country and abroad. Institutional investors have settled on agricultural land as a lucrative, relatively safe investment vehicle. But what kinds of returns do they seek and obtain?
A panel of deep-pocketed institutional investors shared their return expectations, and results, at the recent Farm Futures conference in San Francisco. While returns on U.S. farmland investments were astounding last year, in the 15%-range, according to one index, it would be a mistake to think they will stay that high.
“This is a 10 to 12% return business in row crop,” said Paul Pittman, who used to work on Wall Street and now owns Pittman Farms in Illinois, Nebraska and Colorado. He compared returns on farmland to those on inflation-adjusted bonds.
“You need to look at it as 5 to 6% cash flow, and 5 to 6% appreciation. You may get 8% in cash flow one year, but it’s not realistic to expect that over the long term.”
The USDA’s ERS database shows that between 1970 and 2009 agricultural land value grew by an average of 10.25%, a figure that includes both annual and permanent crops. During that period, farmland outperformed both domestic stocks (6.25% for the S&P 500) and government bonds (7.3% for 10-year Treasuries). Farmland investment stacks up well against the stock market.
Until recently, institutional investors had trouble gaining access to farmland investments, which tended to be private transactions, with limited reporting and research. TIAA-CREF, a pension fund with a $3 billion agricultural land portfolio, estimates that institutions still own only about 1% of U.S. farmland.
But in recent years, funds have popped up that provide access for outside investors.
Ceres Partners, for instance, oversees a portfolio of 104 farms totaling 25,000 acres in the Midwest for individuals and institutions. President Perry Vieth said the portfolio has produced a 16% annual return since January 2008, shortly after it formed. The fund looks for under-valued properties that can produce strong cash flow.
“We look for cash on cash unlevered return of 6.5 to 7%, and we get that. That’s our buy signal. We try to add value by making improvements. We might buy B-plus land. But then we could add irrigation or grow specialty crops to increase the value.”
Hancock Agricultural Investment Group said it’s the largest Hancock is the largest institutional farmland manager in the United States with a $1.7 billion portfolio that includes 275,000 acres of prime U.S. farmland; 6,000 in Australia; and 1,000 in Quebec, Canada. It deals mostly with pension funds.
Paul Joerger, director of asset management for Hancock, contributes the group’s results to the NCREIF Index. The index shows that institutional investors earned a 15.16% return last year, up from 8.81% in 2010, though results vary dramatically by region. Land values in the Corn Belt are up much more than the average, while in other regions they may be flat, NCREIF reported.
The NCREIF Farmland Index, which tracks 541 properties worth $3.3 billion, shows that income returns have cooled in 2012 due in part to the drought. Farmland in the index is primarily owned by pension funds and high-net-worth individuals. About 80% of the properties are leased to tenant farmers; the rest are operated by institutional owners.
Some farmland funds have been set up to leverage foreign opportunities. South American Soy, for instance, was established in 2004 to buy farms in Brazil. Owned by farmers and real estate investors, it has produced some phenomenal returns.
“The farms we bought in 2004 have gone up 5 times, and double that with currency valuation,” said General Manager Phillip Corzine. But lately, due to the difficult of buying land outright in Brazil, the fund has switched its focus to leasing land for anywhere from one to 10 years, using Brazilian labor and a full equipment line.
Even so, South American Soy has produced a 12% to 14% return for investors for the last three years, compared to the typical 6% or 7% return, said Corzine.
Who Does the Farming?
As the NCREIF data shows, most institutional investors prefer to let someone else do the actual farming. UBS Global Asset Management, for instance, used to have permanent farms, said James McCandless, head of global real estate farmland, with $900 million in farmland assets. Now they strictly lease. “Pension funds make poor farmers,” he said.
“We don’t believe our investor’s money should be exposed to farming risk,” added McCandless, who tries to structure deals that provide at least a minimum payment with a piece of the income upside. Based on its experience trying to farm, the fund works overtime to select high-quality operators, sometimes signing leases that may last seven years. The leases may even have evergreen provisions.
Pittman doesn’t think it makes sense for institutional investors to be farmers. “I would cash rent a farm if you can,” he told the investors in the audience. “You need to separate farm and land returns. I would also encourage people to make direct investments rather than in a fund. You have more flexibility with a fee-simple investment.”
Hancock traditionally has worked with tenant farmers. But Joerger said the fund may soon change directions. “We will probably be moving into direct farming within the next two years,” he said.
Is there a bubble in land values?
The rush to make farmland investments, coupled with recent reports of record prices paid for farms, has raised question about whether the market is in the midst of a bubble. Vieth of Ceres Partners agreed that lots of “people are pursuing deals,” and he sees some sales prices “that make no sense to us.”
“But you can’t generalize about the whole marketplace,” he said. Ceres, for instance, manages 25,000 acres. “Our average value is $52 an acre and we’re in the Corn Belt,” he said.
“We think the market is very rational at this point,” said Hancock’s Joerger, who has a fleet of acquisition people continually looking at deals. “There isn’t a dot.com mentality. We’re trying to observe and be cautious going forward.”
Jim Rickert, director of American Society of Farm Managers and Rural Appraisers, said that institutional investors are “rational buyers.” In cases where buyers appear to pay too much for farmland the reason is often that a farmer “absolutely needs to have the piece next to him. We don’t see some flipping or exceptional debt being applied to deals.”
Most of the panelists said they strive to find a tenant farmer as part of due diligence. When Hancock considers a deal, there may be a line of potential farmers out the door. The management group has a history of buying land from a father and leasing it to his son.