Costs are escalating everywhere: we see it at the gas pumps and the grocery store, and virtually each aspect of our life requires us to have more money. It becomes increasingly clear that we are a global economy and what happens in China and other parts of the world affect those of us in the Red River Valley of the North. It is a vicious cycle. Farmers tend to deal with it first – in buying the land they need to operate.
It costs a lot of money to run a farm, no matter the type. Land price is one of the major expenses and often prohibits younger people from starting a farming operation. Perley farmer Terry Guttormson explains: “I suppose there are several reasons (for escalating land costs). Over time, there is a certain amount of inflation that takes place. Recently that has been exasperated by higher commodity prices for crops we raise. Also, there is only so much land and we actually lose acres every year to urban sprawl, which adds to the competition for land. Another recent phenomenon is that investors have been looking to something more solid to invest in instead of volatile stocks and other indices where your money can literally disappear.”
“Add to that, the special tax treatment investors get called a 1031 exchange which allows investors to, for example, sell their apartment buildings and move their money, tax free, into farm land. This actually has been one of the things that has stacked the deck against farmers who have wanted to buy land, especially young farmers, and find they can not compete against someone who has built up huge [assets] and then move it, tax free, into farmland.”
Keith Ollie, a Fargo-based CPA, indicates one needs to be very careful about what type of real estate is used for this exchange as the IRS carefully distinguishes between personal and business real estate in the exchange.
An April 2011 NDSU news release, “N.D. Cropland Values Follow Grain Prices” best explains the upturn:
Buyers and renters should not be blinded by the many positives and ignore potential negative outcomes that could occur.
A strong uptrend in North Dakota cropland values and rents started in 2004 and accelerated with higher grain prices starting in 2007.
Grain prices peaked in 2008. Farm profit was the highest in a generation, and land values increased 20 percent that year. However, crop prices declined into 2009, and the increase in land values slowed substantially.
“Unfortunately, from 2003 to 2008, production costs rose to record highs,” says Andy Swenson, North Dakota State University Extension Service farm management specialist. “Costs nearly doubled for many crops, which necessitated higher prices to make a profit.”
At the beginning of 2010, expectations were modest and it looked like land values would be relatively flat. They were flat through the first half of the year, but then circumstances for grain producers took an abrupt positive turn. Prices rallied because of less world grain production than expected and, with strong yields, North Dakota producers were able to take advantage of it. Land values and rents were reignited, and annual increases of nearly 20 percent for land and 10 percent for rent were indicated in a January 2011 survey.
Swenson bases his calculations on surveys conducted by the North Dakota Agricultural Statistics Service.
What does the future hold?
Prices rallied because of less world grain production than expected and, with strong yields, North Dakota producers were able to take advantage of it. Land values and rents were reignited, and annual increases of nearly 20 percent for land and 10 percent for rent were indicated in a January 2011 survey.
“Many economists have been wondering whether we have been working toward a bubble in the farm real estate market,” Swenson says. “If that is the case, we certainly blew the bubble bigger in 2010.”
However, Swenson thinks that 2010 was a lesson in how difficult it is to predict land values. There are many factors involved, but the big three on the demand side are projected profitability, financial capacity of potential buyers and interest rates. All came back into alignment about midway through 2010 to fuel the land market. All remain aligned for 2011. However, it can change quickly, especially profitability, as grain prices demonstrated in a positive way during 2010.
“In these heady times, buyers and renters should not be blinded by the many positives and ignore potential negative outcomes that could occur from a bumper world crop and/or a downturn in the world economy, a poor production year in North Dakota or rising interest rates,” Swenson says. “Also, the cost of raising a crop in 2011 will be the highest ever.”
North Dakota land values have increased by an annual average rate of about 12 percent during the past eight years, according to the January surveys from 2004 through 2011.
“There have been two instances during the past 100 years that have had similar periods of continuous, strong increases in land values,” Swenson says. “There was an eight-year period (1942 through 1949) that had average annual increases of 10 percent and a nine-year period (1973 through 1981) that averaged a whopping 18 percent annual increase.”
The largest increase in cropland values (January 2010 to January 2011) was 25 percent (to $1,202 per acre) in the east-central region, followed by increases of 24 percent (to $883) in the south-central region and 23 percent (to $2,628) in the southern Red River Valley. Cropland values increased 22 percent (to $920) in the north-central region, 21 percent (to $724) in the southwestern region and 20 percent (to $1,062) in the northeastern region. The northern Red River Valley had a 16 percent (to $1,792) increase and the southeastern and northwestern regions had 12 percent increases to $1,660 and $590 per acre, respectively. (See the graphic: “Estimated average per-acre values of cropland in North Dakota from 2005-2011.”)
“Land rents, as typical, did not change as much in percentage as land values,” Swenson says. “On average, cropland rents increased about 10 percent. This was a strong increase from the prior year’s 2 percent upward move.”
As with land values, the strongest increase (15 percent) occurred in the east-central region. The average rent is $51.70 per acre. Land rent rates increased an average of 11 to 12 percent per acre in the north-central region to $44, southern Red River Valley to $94.70, southeastern region to $74.90, northern Red River Valley to $71.60 and south-central region to $42.
The northeastern region increased 7 percent to $45.20 per acre. The southwestern region increased 6 percent to $33.10 per acre and the northwestern region had the smallest increase at 5 percent to $32 per acre. (See graphic “Estimated average per-acre values of cropland in North Dakota from 2005-2011.”)
Swenson cautions that the values and rents are averages for large multicounty regions. Prices can vary considerably within a region because of soil types, drainage and location.
In an interview Monday, Swenson said that agricultural land values along the Red River on the Minnesota side would reflect the same or similar experience.
Crop input costs are expected to increase in 2011 for fertilizer, fuel and other petroleum products, and insurance.
Estimating a cash rental rate for cropland can be based on what others are charging/paying, average yields, a share of the crop value or equivalent, the tenant’s residual, and the corn suitability ratings (CSR index).
In the January 2011 article: Wealth Effect Ripples Through Farm Country, an AP dateline Austin, Texas reported, “Appraisers at Farm Credit Services of America found Iowa land values appreciated 20 percent in 2010, about 17 percent of that surge since harvest and one of the strongest rallies since the 1970s. Nebraska farmland accelerated 12 percent and South Dakota 9 percent, reflecting a higher mix of pasture and dryland in their state averages than Iowa.”
It is the law of supply and demand: Purdue University economist Chris Hurt reported in a recent study: “In the mid-2000s, China annually bought the equivalent of 8 million to 10 million acres of U.S. soybeans, but that demand has grown to 20 million acres for the 2010 crop, “ Hurt reported. “Biofuels from corn-based ethanol require another 21 million acres. Together that means an extra 25 million acres of corn and soybeans has been required to meet expanding demand just since 2005.”
Farmland prices in central Illinois are $11,500 an acre. What happens to local farmers and consumers should land prices escalate to that level? Swenson suggested that those land prices reflect land with value-added due to drain tiling as we see increasingly occurring in the Red River Valley (RRV) currently. Swampbuster regulations will prohibit tiling in areas already designated as wetlands. However, additional tiling of RRV acres certainly improves the ability for farmers to use the land to plant crops which the market would indicate more favorable during any particular crop market cycle, like now with the higher prices for corn or soybeans. If a farmer is able to get in the field sooner, planting corn would be more viable.
How much the market will bear will certainly depend on many factors and we see daily how even in our region it is a global marketplace — what happens in China affects us in the Red River Valley.