US farmland faces asset bubble test

May 21, 2013 5:23 pm

US farmland faces asset bubble test

By Gregory Meyer in New York

A century ago, US farmland real estate enjoyed a huge boom. Interest rates were low. Grain prices were high. The world’s appetite for agricultural exports seemed endless. Now, as a strikingly similar story unfolds, land investors are hoping for a different ending. From 1900-19 US farmland gained 70 per cent. Then the farming economy was hit by a rise in interest rates and a slowdown in food imports after the first world war. Land prices collapsed back to turn-of-the-century levels by 1940. Over the past decade, US farmland prices have doubled as the Federal Reserve has held interest rates at historic lows and demand has stayed strong. The big question is what will happen when monetary policy is tightened and the supply of grain grows. The question is important not only for farmers bidding at country auctions, but also for big investors that have poured billions of dollars into farmland as a “real asset”. After embracing timber land and commodity futures, some are touting acreage planted with corn, cotton, almond or soya as a wager on rising population and incomes. “It’s a long-term belief in an upward trend,” says Linda Assante of investment firm Jasper Ridge Partners.

That belief is about to undergo a stiff test. First, most US crop prices are falling – CBOT corn delivered after the harvest is about $5 a bushel, the lowest in almost a year, as US, Brazilian and Argentine farmers eye record crops. Second, interest rates have nowhere to go but upwards. “When we get a combination of those two things – declining grain prices and rising interest rates – we’re going to see an adjustment in farmland values in the Midwest,” says Stephen Gabriel, chief economist at the Farm Credit Administration, which oversees government-sponsored agricultural lenders. “A 20 per cent decline would not be out of the question.”Third, the ratio of rents paid to land prices has fallen about 1 percentage point in the past decade to 3.5 per cent. Put another way, the price-to-rent multiple has expanded, a similar signal to a high price-to-earnings multiple in stocks.

Finally, the best US farmland is expensive relative to tracts elsewhere in the world. VTB Capital, a Moscow-based investment bank which is developing irrigated farms, says land in Russia’s central black earth region costs one-fifth of land in central Illinois, measured in dollars per tonne of corn output.

A reversal in land prices could have repercussions beyond farming.

The real estate mortgage loan portfolio at agricultural lenders that belong to the US Farm Credit System has risen by 9 per cent on the year to $88.7bn as of March. The system is a government-sponsored enterprise, implying federal backing if its loans sour.

Fitch Ratings has raised concerns that the system’s credit quality could suffer if land values fall. “The unprecedented spike in farm land values over the past several years is primarily being driven by the confluence of two factors: historic low interest rates and historic high commodity prices. Should these two factors rapidly reverse from their current levels, Fitch would expect a large correction in farm land values,” the rating agency warned last year.

The FCS says members have in some instances taken steps to reduce risks from farmland loans, including limiting loan sizes to 65 per cent of land values. Mr Gabriel says the system is “well positioned to withstand” a price correction.

Indeed, investors argue this time is different to previous booms, starting with the fact that the world population is set to hit 9bn by 2050. Farmland has been an excellent bet so far, returning investors 20.5 per cent in the past year, according to the National Council of Real Estate Investment Fiduciaries. This compares with a 9 per cent return for timber land and a 5 per cent loss for commodity investors tracking the S&P GSCI commodity total return index.

Unlike the last bust of the 1980s, farmers’ debts are also low relative to their assets. Fertile land is not a crowded trade. Managers say they believe that less than 1 per cent is held by institutional investors, with cash-rich farmers bidding for the rest. In some states such as Iowa, institutional ownership is banned.

Jose Minaya, head of natural resources and infrastructure at TIAA-CREF, which owns and manages more than $3.5bn worth of farmland, says: “What’s driving farmland prices is profitability. When a farmer has money in his pocket, he buys dirt or steel.”

Farmland investors also say that while rents have declined as a share of land values, they have steadied in the past few years and are still almost twice the dividend yield of the S&P 500 stock index.

Finally, unlike other world breadbaskets, the US has strong land rights and an unrivalled transport system. When extreme drought gripped Russia in 2010 thegovernment banned grain exports. When the US suffered it worst drought since the 1930s last year, Washington let trade flow freely.

Investors say that while prime parcels in corn belt states may have overheated, land in lesser areas can be found on the cheap.

“I would argue that the US is an incredibly fragmented market,” says Charlie McNairy, chief executive of International Farming Corporation, an investment manager. “There’s lots of opportunity for improvement.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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