Farm Real Estate Economy Essay Research Paper

Farm Real Estate Economy Essay, Research Paper

Farm real estate values have increased continuously from 1987 to 1998, significantly improving the financial position of many farm businesses. But for the first time in over a decade farm real estate prices have begun to fall, due in part to record breaking yields for crops and extremely low commodity prices. I believe the value of farmland has increased at too fast a pace in relationship to value of farm production and is facing a major market adjustment. The farm real estate market saw it’s last major market adjustment in the mid 1980’s (see figure 1), many operations went out of business and the banking industry lost millions. In many cases the value of the note the bank was carrying was in excess of the value of the land securing that note. Although the market adjustment I anticipate will not be as drastic as the crisis of the 80’s, I do believe many lending institutions are in place to take some serious losses if the federal government suspends it’s payments to farmers.

Farmland currently accounts for slightly over 79 percent of all farm sector assets, which now exceed $900 billion. Some 52 percent of total farm sector debt, composed of either mortgages or short or intermediate term debt are secured by farmland. Consequently, the financial security of farm sector borrowers and their lenders is affected by changes in farm real estate values.

Agricultural land values are primarily determined by the income earning potential of the land, as measured by expected returns from crops and livestock. However in many areas, nonagricultural factors are playing a greater role. Where non-farm influences are involved, farmland is often drawn out of agriculture for residential, commercial, or recreational uses. Farmland values in rapidly urbanizing areas, like the outskirts of Lincoln for example or in areas popular as recreation destinations tend to be higher than would be predicted based on agricultural returns alone.

Research has found that 10 to 20 percent of the farmland in the United States is effected by population expansion. This may seem like a small percentage of the total farmland in this country but in many instances in urban areas land is valued at five times it’s production capability, or higher. This however is not taken into consideration when valuing the real estate in the farm sector as a whole. This problem is most prevalent in the Northeast United States.

Total U.S. farm debt rose from $32 billion at the start of the decade to $170 billion at the end of 1998. Who is holding this debt. The attached chart shows debt structure amongst major lenders until calendar year 1996, the trends have continued and now in 1998 commercial banks supply 45 percent of all farm debt, this up from 25 percent in the mid 1980’s.

Farm Credit Services is second holding approximately 1/3 of all farm debt.

Examination of bank farm loan portfolios should give some indication of the financial condition of farm operations. Bankers have reported that, using market prices prevailing in the late summer of 1999, current credit analysis of producers of many commodities suggests that a growing number of borrowers may have difficulty cash flowing loans in the absence of additional government assistance.

Aiming to prevent a repeat of the farm real estate disaster of the1980’s when lending institutions were holding debt that exceeded the value of the land that was securing that debt, commercial lending institutions developed a new method of appraising farming operations for credit. It no longer uses the appraised or potential sale value of the farmland, as mentioned earlier it uses a method that measures rates of return for productivity. Farm Credit Services was one of the first lenders to adopt a new credit scoring system,

Appraisal Practices of Farm Credit Services

(Omaha District)

- Used since 1988

- Estimate returns using both cash & crop share approaches

- Assume typical crop mix

- Plug in Helming prices (pessimistic)

- Income Costs

- Capitalization factor used (amortization factor of 35 year loan at 10% interest)

- PV = Est. LL. Net Income

.1036

- Production value typically 55 – 60% of market value

Commercial banks use a slightly different system to give them a valuation rate for farm real estate productivity. This rate is the annual expected per acre income return to the land owner (after property taxes and all other owner-related expenses are subtracted) divided by current average value per acre. In the vernacular of the financial world this is ROA (return on investment). In the terminology of agricultural real estate appraisal, this is referred to as the market-derived capitalization rate. Any capital gains (or losses) accruing to the real estate parcel are not included in this estimate. Survey reporters provide this estimate for the three general land classes: irrigated cropland, dryland cropland, and grassland. Estimated annual net rates of return for the current decade are presented in the following table:

Type of Land

and Year Agricultural Statistics District State Ave

Northwest North Northeast Central East Southwest South Southeast

Percent

Irrigated Land:

1990

1991

1992

1993

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