Casualties of Trade War? Farmland Real Estate Is Holding Fast—for Now
With President Donald Trump having marched merrily into a trade war with China, one of the more neglected questions is a real estate one:
What will this mean for the millions of acres of U.S. farmland?
“Agriculture prices have gone sideways for the last four to five years, but they’re holding up reasonably well despite the trade war,” said Mark Zandi, the chief economist at Moody’s Analytics. “And so far, land values seem to be holding their own. I think the trade war effects will likely take a while to play out. The general thinking is that this is temporary and isn’t something that will be around a year from now.”
But can struggling farmers—mainly cropland farmers and those who harvest soybeans—maintain positive cash flow in the face of unpredictable headwinds and without taking on too much risk?
China’s 25 percent tariff on soybeans hit prices particularly hard heading into the fall harvest; the U.S. exports nearly half of its soybeans to China, the world’s number one buyer of the commodity. Other grains such as corn haven’t experienced the same troubles caused by the trade dispute, and many farmers are already indicating that they’ll cut their soybean seeding by 2 million acres come next spring, a 2.3 percent drop, and instead plant more corn and wheat, according to Farm Futures’ first survey of 2019 planting intentions released on Aug. 28.
“It’s easy to be gloomy, but a lot of farms are resilient and are more keen to adapt,” said Jennifer Ifft, an assistant professor in the Charles H. Dyson School of Applied Economics and Management at Cornell University. “There are a lot of people who are hurting. In the medium term they’ll have to be ready to adapt to a trade-related slump.”
The highest concentrations of soybean production in the U.S. mostly comes from the Federal Reserve’s seventh district, which covers Iowa, northern and central Illinois and Indiana, Michigan and southern Wisconsin. In 2017, production was especially strong along the Mississippi River, down to Louisiana and also all the way up into areas of North Dakota.
“Global food demand and food scarcity and the elasticity for food doesn’t change much,” said Paul Pittman, the CEO of Farmland Partners, a publicly traded real estate investment trust. “You wouldn’t stop eating. That imposes a level of stability on a hard asset that really doesn’t exist in other types of real estate.”
In the second quarter, there was a 1 percent increase in seventh district farmland real estate values from a year ago and a 2 percent increase from the first quarter.
The United States Department of Agriculture (USDA) measures farmland real estate values per acre by accounting for all land and buildings on farms. Real estate values reached a record high of $3,140 per acre in the USDA’s latest report in early August. In today’s agricultural climate of low interest rates, higher farmland real estate values and sliding income levels, taking on additional debt becomes more attractive for farmers. But, how sustainable are land values currently when the sector is expecting slight debt increases and sustained revenue dips?
Past reports from the Federal Reserve Bank of Kansas City indicate that considerable increases in profits and investment are normal characteristics of the end of an agrarian boom cycle, which was last experienced around 2011 to 2014 when profits and productivity were soaring.
Adjusted for inflation, farm sector debt is expected to fall almost $3 billion, or 0.8 percent, while farm sector assets are also projected to drop almost $6 billion (0.2 percent), according to the USDA. Prior to these shifts, farm sector real estate debt had been increasing every year since 2009; and the USDA expected it to reach $239 billion in 2018, a 1.2 annual increase nominally.
Now, with net income and net cash income sliding a bit and interest rates expected to move higher, parallel to that of the Federal Reserve’s plans to raise rates in September 2018 and three times in 2019, a possible campaign of deleveraging could be on the horizon.
“Farm lenders are being very cautious, I would say,” Ifft said. “You would have to have a big down payment and have to show a good business plan.”
Still, the USDA expects inflation-adjusted farm sector equity and debt to remain flat in 2018. At the same time, the number of Chapter 12 bankruptcy filings from family farmers and fisherman from January to June 2018 fell 9 percent from the same period in 2017, according to a report from the American Farm Bureau Federation; but the main drivers in the decrease in filings was the Southeast, West and New England regions. The Midwest—from where most soybean production came—saw 2 to 5 percent climbs in bankruptcy rates, led by Wisconsin, which registered the country’s highest volume of filings over the period at 26.
“Some of the underlying issues are the profitability of agriculture, if we think about the stream of income that’s being generated by a farm in the Midwest. It’s down from where it would have been from a few months ago as the crop prices have come down,” said Federal Reserve Bank of Chicago Senior Business Economist David Oppedahl in August when he detailed his district’s second-quarter performance newsletter. “There’s been an increase in amount of loans having trouble with repayment. It’s beginning to be a bit of a challenge… Repayment problems come down to profitability. It’s not as profitable as it had been five years ago; and interest rates are starting to rise.”
Farmland Partners has acquired more farmland over the last couple of years, now owning 320 different farms across 162,000 acres of farmland in 17 states, Pittman highlighted. The company has 110 tenants, producing 25 different crop types. It merged with American Farmland Company in February 2017, opening up the door for the REIT to enter California and benefit from the state’s production of nuts and berries, among other crops.
Its stock was trading at $7.04 at the market’s close on Aug. 29, up over 33 percent from July 11, when it tumbled to $5.28 from $8.65 after a questionably negative news story written under an anonymous byline was published on Seeking Alpha.
“Farmland as compared to other assets is fundamentally scarce. If it were an office tower, farmland would have zero vacancy; the amount of land available to feed every individual has been in decline,” Pittman said.
The percentage of U.S. land that’s arable—usable for plowing and growing, not including livestock production and forests—declined to 16.6 percent in 2015, the most recent number provided by The World Bank. That’s a 4 percent drop since the early 1980s.
“[Arable] land is truly scarce,” Pittman said. “John Deere is not going to run out of tractors; Bayer won’t run out of seed; there’s no fundamental scarcity for commodities and equipment. With the fact that you can’t make more land and also that food demand keeps growing, the most stable place to be is the farmland itself. It’s the underlying asset that matters, the asset that will be the long-term value, but it’s not a rocket ship.”
But, there is no doomsday scenario currently for U.S. farmland real estate; the country is the number one exporter of food in the world, ahead of the Netherlands and Germany, and demand is insatiable—the world’s population is exploding and people have to eat.
Still, the escalating trade war with China has undoubtedly hampered farmers’ bottom lines.
“[The trade disputes] created disappointment on the part of farmers because they expected the year to be more profitable,” Oppedahl said, detailing the bank’s August newsletter. “Farmland values [in the seventh district] have been fairly stable the last couple of years in part because real interest rates have been flat, but even though we’ve had rising rates the last couple years, with inflation picking up, it keeps a bit of that from affecting long-term prospects for farmland at this stage. You’re discounting future earnings, and so far the pickup in rates hasn’t affected the real side of valuation.”
To take the overall temperature in regards to lending: In the second quarter, demand for agricultural loans overall decreased for the 11th consecutive quarter, according to a 2018 second quarter agricultural credit survey from the Federal Reserve Bank of Dallas, which covers the country’s 11th Fed district of Texas, northern Louisiana and southern New Mexico.
In the Fed’s 11th district, loan renewals and extensions rose, while the rate of loan repayment continued to decline, suggesting that farmers have had issues servicing their debt, according to the Fed survey.
“From an insurance, risk management perspective, it’s taken heat off of credit use,” said University of Illinois professor of agriculture Todd Kuethe. “Year-to-year fluctuations aren’t a big deal in terms of borrowing capacity. The next growing season—next summer—we’ll have higher interest rates, and farmers tend to pay above prime as a function of financing conditions in the agricultural sector. With lower returns, it won’t be easy for farmers to get credit at levels they’d like, but we’re still not in a case where farm solvency is an issue.”
Farm profitability is certainly one of the sector’s largest concerns, with falling net cash incomes and futures prices and also with rising interest rates expected to continue into next year’s growing season.
Profits have taken steep dives since 2013. The USDA Economic Research Service (ERS) has forecasted a 6.7 percent drop year-on-year in net income to $59.5 billion in 2018, the lowest level since 2006 and down from a record high of $123.7 billion in 2013. Net cash income, which accounts for all cash flow and expenses, such as feed, seed, fertilizer, taxes, interest payments, wages and rent, is expected to dip 5.2 percent year-over-year to $91.9 billion, the lowest mark in nearly a decade and down from a 2013 high of $135.6 billion. This all is despite robust production levels that continue to climb despite the decrease in arable acres.
“What matters to a farmer is not price per bushel. What matters is revenue per acre, or profit per acre,” Pittman said. “The volume of production has been high the last couple of years, so the number that matters is revenue per acre.”
Tenant farmers can utilize many different strategies to cut input costs should the trade war go on for an extended period of time. Still, the long-term resiliency of farmland real estate is holding up, as many owners, operators and academics expect.
“The trade war is certainly not good for production agriculture in the short term,” Pittman added. “If [Trump] happened to win that war, it would be incredibly good for agriculture, but while it’s still going on, it’s not a good thing. It’s actually hurting agriculture this season.”
From Washington’s point of view, the battle is far from over. On May 21, Trump tweeted, “China has agreed to buy massive amounts of additional farm/agricultural products—would be one of the best things to happen to our farmers in many years!”
Not long after, on June 4, he tweeted, “Farmers have not been doing well for 15 years. Mexico, Canada, China and others have treated them unfairly. By the time I finish trade talks, that will change. Big trade barriers against U.S. farmers, and other businesses, will finally be broken. Massive trade deficits no longer!”
More geopolitical jockeying followed and more tariffs were levied in the weeks following those social media jabs.
The White House’s $12 billion emergency aid package to farmers, which the USDA will begin deploying this week, is weighted heavily to offset losses from soybean production. The package will include direct payments to farmers as well as commodities purchases that will be used for food-aid programs, among other strategies. This package comes in addition to the already forecasted $9.3 billion in government subsidies tapped for the industry this year, according to the USDA. (Officials from the USDA declined to comment for this story.)
Meanwhile, China has been proactive in finding alternatives to U.S. exports, setting up ports and access points in South American countries that are producers of needed grains. Brazil, which has seen its amount of arable land increase over the last few years, has assumed a much larger share of China’s soybean imports from the U.S.
Ifft, the Cornell agriculture assitant professor, said in order to have sustained growth in commodities, farmers must have export markets. “It’s reasonable to be alarmed because things could go in a lot of different ways, but they could make it work as people innovate and adapt,” she said. “But, it would be painful.”
U.S. farmers are the world’s most active food producers and have many levers they can pull to cut costs and maintain cash flow, including increasing yields, using cheaper fertilizers and cutting third-party labor.
Farms touch a wide range of income levels, and the USDA recognizes any enterprise that makes at least $1,000 a year. Many farms are operated by families who have owned the ground they work for generations, so steady declines in profitability—if they’re unable to regain cash flow through other cost-cutting avenues—can be detrimental.
“Farm ground is the most reliable asset on the farmer’s balance sheet,” said Michael Swanson, a senior vice president and agricultural economist and consultant with Wells Fargo, one of the country’s largest commercial agricultural lenders. “It makes for great collateral even with all the current issues of crop prices, interest rates and rental rates.
“[Farmland] is also the most emotionally charged asset,” Swanson added. “Asking someone to sell a multigenerational piece of ground might be good lending and business for both parties, but it’s a very unpleasant experience most of the time. We have seen a significant amount of land be releveraged or sold to help with the recapitalization of working capital, but it is very stressful.”
The pressures of price and income dips can easily mount, creating an issue for many borrowers. Kansas City Federal Reserve president Esther George, speaking at the Federal Reserve Bank of Kansas City’s annual agricultural symposium in July, said, “This does not help when you have marginal borrowers or borrowers that are struggling,” she told the attendees. “It doesn’t help with, perhaps, young farmers that incurred a lot of debt for the purchase of land or equipment. And so, there are pockets of stress as we look around. I don’t think anything is at the point that we think is alarming at this stage, but the question is: How much longer will we experience this continuation of low commodity prices [and] low farm incomes?”