Unusual market forces drive farmland sales

Western Corn Belt farmers sometimes escape summer heat briefly in Colorado's mountains. The views and altitude there can take your breath away. An Iowa cornfield can accomplish the same goal in midsummer. However, it's not because of stifling heat and humidity. Instead, this heart-stopping feeling occurs from the price of the ground under a farmer's boots.

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The biggest increase was in those Iowa fields—up 36% from July 1, 2021, to July 1, 2022. "That's a stunning number," says Jim Knuth, the lender's senior vice president who is based in Iowa.

FCSAmerica bases this value on twice-yearly appraisals of "benchmark farms" in the four states. It uses that information to estimate collateral value of land. FCSAmerica also compares the appraisals to actual sales. FCS has 21 benchmarks in Iowa; values on eight of those farms exceeded $15,000 per acre.

These numbers follow the upslope march of land prices in other recent surveys. In March, the Iowa chapter of the Realtors Land Institute reported a statewide jump in land values of almost 33% in the previous year, with high-quality cropland in northwest counties averaging $16,576.

Iowa State University's most recent Land Value Survey, conducted in November, showed a 29% statewide annual increase in land values. It also found the highest average for top-quality land in the state's northwest corner, at almost $14,000 an acre.

Further east, a Purdue University survey released earlier this summer reported new land price records for Indiana. "Our year-over-year change is around 30%," says Todd Kuethe, a Purdue University agriculture economist, who conducts the survey.

In June, top-quality farmland statewide averaged $12,808 per acre. Medium-quality land was at $10,598. Meanwhile, poor-quality land brought $8,631. "Those are all new highs in nominal and real terms, the highest we've ever experienced," Kuethe says.

No Letup

About 70% of farmland sales tend to occur between September and March, says Steve Bruere, president of Peoples Co., which sells farmland in 30 states.

Drones and satellite technology have recently made it easier to sell land in summer when crops are still in the field, he says. However, the main reason the boom lasted into summer is "just because prices are so strong," Bruere says.

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"People who wouldn't otherwise be a seller are saying, 'With prices as they are, I'm bringing it to the market,'" he says.

On the buying side, "there was so much cash out there" from both investors and farmers, he says. With several unusual USDA payments and corn priced at $8 per bushel, farmers had money to buy land.

By summer, the economics of agriculture wasn't the only factor driving land sales; uncertainty about alternative investments, such as commercial real estate and the stock market, also contributed, Bruere says.

About that time, Bruere received a call from an industrial real estate investor in Los Angeles.

"Farmland is the best worst option of where I can put my money right now," he told Bruere.

With farmland, the investor didn't have to worry about property vacancy rates, Bruere says. A farmer would always be willing to rent it, which offers investors some return. The farmland capitalization rate he could expect in Iowa would be about 2.5%. The capitalization rate is the rate that income from farmland is expected to be capitalized into land values. It's often calculated by dividing expected cash rent — minus property taxes — by the land's price.

Unusual Market Forces

Those willing sellers and buyers are the crux of the boom. However, Kuethe has a list of 10 market drivers:

1. Current net farm income
2. Expected growth rate in farm returns
3. Crop price level and outlook
4. Livestock price level and outlook
5. Current and expected interest rates 6. Returns to alternative investments
6. Outlook for U.S. agricultural export sales
7. U.S. inflation rate
8. Cash liquidity of buyers
9. Current U.S. agricultural policy

Respondents rate each market force on a scale of –5 to +5, says Kuethe. Normally, a handful of those factors drive the market. All 10 factors ranked positive in 2021, the year before Purdue's most current survey. It was unique in the history of Purdue's tracking of land prices.

In the 2022 survey, all remain positive except interest rates, a negative factor this year.

"That's the only one that flipped," he says. "That's definitely the biggest change from last year."

Cash liquidity, at No. 9, remains strong.

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"Farmers with cash haven't had many options to spend," he says. Supply chain issues have made it harder to buy machinery.

"You can't buy machinery as easily so you're looking to add acreage," Kuethe says.

Other factors, such as expected growth in farm returns and crop prices, remained favorable in the survey, but weren't as strong in supporting land prices as the year before.

In addition to asking about interest rates the survey asks views on inflation. That remains a positive factor in land prices.

"There's sort of a belief that farmland is a hedge against inflation," Kuethe says.

Doug Hensley, president of Hertz Real Estate Services, also sees interest rates as the main headwind in today's farmland market. Hertz sells farms in a dozen states, mainly in the Corn Belt and Great Plains.

Hensley lists four forces driving farmland prices (which Kuethe agrees are the main ones). They are:

• Interest rates
• Commodity prices
• Demand for farms
• Supply of farmland for sale

Like Bruere, Hensley sees strong supply and demand for farmland. He expects interest in selling land to remain high among farmers who are considering retirement.

"When high prices come, sales volume comes with it," he says. "People want to sell into a strong market."

The strong financial position of most farmers offsets higher interest rates, he says.

"There was a ton of money made last year in agriculture," he adds.

He agrees with Kuethe that if farmers have money to spend, land is attractive, even though buying machinery offers expensing options for taxes. Buying land doesn't.

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"Farmers want to be farmland owners more than they want to be owners of a different tractor," Hensley says. Adding another 80 acres is more appealing "because that's an expansion of their business," he adds.

He knows from contacts in the farm machinery industry that the supply of new equipment remains tight, and he expects that to continue into 2023.

Another of Hensley's four factors — commodity prices — is less strong than in 2021.

Strong commodity prices were driven in part by the war in Ukraine that began in February.

"We really saw another leg up in the commodity markets. We've kind of given that up now," he says.

Headwinds for 2023?

Higher interest rates on farmland mortgages seem to be an obvious negative factor for farmland sales. However, they haven't yet had an effect.

"I would say that so far, what we've seen is that the amount of cash and liquidity has really offset the interest rates," says Knuth. In Iowa, 80% of farmland has no debt. When a relatively small parcel of land is purchased, the added cost of interest on the loan is small when spread out over the entire operation's acreage, he says.

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"There is a lot of capacity, a lot of collateral, a lot of powder," Knuth adds. Other experts have doubted that interest rates will substantially impact farmland values in the near future.

Agricultural economist Wendong Zhang, formerly of Iowa State University and now at Cornell University, coauthored a study last winter that suggested a delayed effect of interest rate hikes.

"The current projected interest rate hikes will exert downward pressures on the land market; however, it probably is not sufficient to offset the supporting role of the 2020 rate cut this year. The net effects of all interest rate changes since 2015 will become negative for farmland values in late 2023 and onward," Zhang and grad student Abulena Basha wrote.

Hensley cited that study in his summer "Hertz Outlook" newsletter. However, he pointed out the study was done when the Federal Reserve System wasn't expected to boost rates as fast as it has.

"You're going to see weakness show up before the end of 2023," Hensley says. "When the Fed is being more aggressive, the potential for weakness [in land prices] is greater."

Although the Fed doesn't set longterm rates, the yield curve in the bond market tends to follow its direction. Mortgage rates are tied to bonds, usually 10-year treasury notes for banks. The Farm Credit System lends from sale of its own bonds.

"When guys were buying land a year ago, they were paying closer to 4%. They're going to be paying 6% or above today," Hensley says. "When you run the numbers with a 4% interest rate vs. a 6½% interest rate, they look very different. It's just giving people a little bit more pause. They're thinking more about it." Investors also could be put off from buying farmland if interest rates rise enough, says Bruere.

That's partly because bank certificates of deposit are also tied to interest rates. By summer, five-year CDs were paying about 3%, according to the St. Louis Fed.

"If bank CD rates end up at 4% to5%, investors may like that better than farmland," Bruere says. So far, though, investors see farmland as an inflation hedge, he says.

"The market is robust as I sit here today," Bruere says.

Cooldown Coming

While the market remained strong this summer, observers are nearly unanimous in expecting the boom to moderate.

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"I think we'll still see some growth, but I don't think we'll see another year of record-high growth," says Purdue economist Kuethe. "If the Federal Reserve continues to increase the cost of borrowing, it will slow growth in land values."

At FCSAmerica, Knuth points to the table of land value changes in Iowa, Nebraska, South Dakota, and Wyoming. In Iowa, in contrast to its 36% annual increase, values have risen 9% in the past six months.

"That curve is starting to flatten a little bit," he says.

Sales of top-quality land sold through Hertz are still strong, says Hensley.

"We're starting to see a little less aggressiveness with the B and C quality farms," he says. "We've seen some weakness in those sales compared to 90 days ago.

"Last year and in early 2022, every new sale was a record. The bar just kept being raised from one sale to the next," Hensley says.

That's not happening in late summer of 2022.

"I think we're plateauing," he says.

Bruere sees the recent boom in corn and soybean prices as a major factor in the rise in land values in the Midwest.

In other states with different crops, "the markets have not heated up as much as in the Midwest," he adds.

When asked if nonfarm investors are looking outside of the Midwest to buy farmland, Bruere says, "We're already seeing that."

Knuth points out that nearly all the farmland in Midwest states like Iowa is purchased by farmers or local investors. Those farmers don't look at nearby farm parcels the same way as investors do and tend to be "very patient" with expected returns, he says.

There's agreement that demand for the highest-quality land will remain strong among farmers. Production risks are lower and if it has to be sold, more liquidity exists.

"They will always be willing to stretch themselves for a really good-quality farm," Hensley says.

Bruere sees challenges for any leveraged buyers of farmland if crop prices return to a more historical range. However, strong farmer demand for Midwestern top-notch ground will remain.

"I think it's probably steady as she goes," he says. "I don't see land continuing to appreciate, but I don't think it's going to fall out of bed, either."