—Lancaster Farming. Saturday, Jul:
14
Editor’s Note: The following article is based on a speech
given by William Crowley, Natural Resource Economics
Division of USDA. He made the presentation earlier this year
at Michigan State University.
EAST LANSING, Mich. - To buy or not buy farmland - that
is the question. And if to buy, is now the time? More than
rhetoric, this problem is often a difficult one as farmers (and
would be farmers) weight the merits of buying or leasing
farmland.
The optimists on the one hand say that land just has to be a
good buy since there’s only so much to go around for so many
people - an increasing population at that. And to back up
their position, they point to the nearly continuous rise in farm
real estate values since 1933.
The more cauious investors contend that farmland is
overpriced in relation to its earnings potential. They argue
that land should not be bought until either its price drops or
its money-making potential improves. Moreover, they
rightly point out that there’s no guarantee that land values
will keep rising.
Although both viewpoints have merit, they overlook the
fact that trends in land prices and price-earning ratios are
based on national averages. Therefore, regional or local
deviances are hidden. Also, the individual farmer’s situation
is not taken into account.
As can be imagined, the prospective buyer’s cir
cumstances - such as his financial resources - figure heavily
in any buying decision. In addition to money on hand or
capital assets, other big factors are: producer and
managerial abilities, debt repayment capabilities, levels of
aversion to risk, short- and long-term land ownership goals,
and alternative uses for available funds.
Assuming however, that the buyer is adequately financed
and is or will be a reasonably efficient fanner or landlord,
the present time appears to be reasonably favorable for
buying farmland. Still, though, a little cautious figuring
before the deal is closed is definitely wise.
The first maxim to keep m mind is that farmland has value
primarily because it is capable of generating income. Of
course, land offers other benefits such as a sense of in
dependence and security in owning a chunk of the earth, but
the prune consideration should be financial.
And financial consideration goes far beyond the price tag.
It involves projecting into the future expected annual net
income from the land - a not so easy chore, particularly m
light of environmental controls on agriculture.
Also, a discount rate must be figured into the projected
income over the years, as the longer you have to wait to get
that income the less it is worth to you today. For example,
compare the worth - purchasing power - of today’s dollar
against one in 1950.
There’s a mathematical equation the income
capitalization formula that is based on this shrinking'
phenomenon of a constant dollar The formula is simply
v=a/r where “a” is annual net land income, “r” is the
discount or interest rate, and “v” is the resulting implied
value of the land
Use of the formula can help you determine a tract of land’s
breakeven price Assume you have your eye on a tract with a
projected constant annual net earning power of $lOO per acre.
Figuring to keep the land indefinitely and that the discount
READ LANCASTER FARMING
FOR FULL MARKET REPORTS
10. 1976
rate should be eight percent a year, the breakeven price
would be $1,250 per acre.
If this is more than the going market price, don’t despair.
Most land - regardless of the location - appears to be selling
at a premium these days. That is, the asking price exceeds
the present value of the anticipated income stream.
One angle the formula doesn’t take into account is the price
appreciation potential - a big factor in recent years with
zooming farm real estate values. Particularly if the land is in
an area where there is a strong demand for add-on tracts or
where there are urban or other nonagricultural pressures,
land holding can be a good investment in itself.
The lure of land appreciation can turn into a pitfall, though,
if the situation is not realistically appraised. For example, if
the land’s earning power is too low - even if anticipated ap
preciation is high - the inbetween years can be financially
lean ones.
Another factor to consider is that land appreciation is not
certain, even though the near future looks optimistic. A
possible cloud on the horizon could be land use controls such
as measures to keep prime land in agricultural production.
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These controls would preclude or at least complicate the sale
of farmland to urban, industrial, or recreational buyers -
those usually most willing and financially able to pay
premium prices.
If all these “ifs,” “ands,” and “buts” about buying far
mland are just too much for you or if you’re short on initial
capital, don’t give up - you might want to consider leasing.
Leasing has its drawbacks in that you don’t share in land
appreciation and you might run into a nonrenewable con
tract, but it also has its good points.
The main advantage is that the cash flow from a leased
tract may be more than that from an owned tract. Reason is
that a tenant doesn’t have to make mortgage or property tax
payments.