Real estate, alternative real assets and other diversions

Volatility to Explain High Historical Farmland Returns A look back over 30 years of increased farmland returns

The Farmer

Introduction – the danger of being a farmer at MBA school (or at a dinner party)

MBA schools characterise farming as a commodity industry, subject to negative weather events and low returns. Farmers are often told at dinner parties that farming:

  • is a low return asset class
  • which produces commodity products, which cannot easily be differentiated
  • making it a puzzle why land is so expensive
  • with the prices being paid for farmland recently being particularly crazy!

A case study of one of these “expensive” assets: South Island New Zealand sheep and beef land

Over the years these views made sense to me also. Twenty years ago $3,000 per hectare for land in our valley seemed high. By the time my father died in 2004 they had risen to $6,000. Now they have again doubled to $12,000. At each stage of this process the farm was generating only 4% operating returns on assets*.

*This must have been true in the 1970s also as I can remember my father telling me then that “NZ sheep and beef farms will always yield only 3% to 5%”. With the benefit of hindsight I believe he was suggesting that as soon as they start to yield more farm prices will rise to bring the yield back down to their equilibrium range.

This commentary attempts to unpick the puzzle of an asset class that often looks very ordinary (or in a bad year downright unattractive) when looking at the current year’s financial accounts, yet so often looks good when looking in the rear view mirror.

Historic US Farmland returns

The graphs below summarise separate decades of data on the total returns** to US farmers and also looks at returns in a couple of other countries.

**these are returns on assets, including both operational returns and capital gains.

The 1970s

In the 1970s US farmland had a remarkable decade with annual total returns of 18.2% per annum in a period of stagflation when both equities and bonds had negative real returns. Farmland, gold, and other real assets benefited from the “flight to quality” in the face of high inflation and low growth.

Compounded Return of Selected US Assets Classes 1970-1979

Source: Map of Agriculture analysis

The 1980s

The 1980s is the one decade in our sample when US farmland under-performed both US Treasury bonds and equities.  In this decade US farmland, with 7% annualised returns, “normalised” – giving back some of the relative returns from the 1970s (when farmland valuations like gold, may have become over-extended).

Compounded Return of Selected US Assets Classes 1980-1989

Source: Map of Agriculture analysis

The 1990s

The 1990s was an infamous period for agricultural over-production caused, primarily, by excessive subsidies (remember butter mountains and wine lakes). However US farmers still did ok with an annual growth of 12 % vs. equities at 17% and US Treasuries at 7%.

Compounded Return of Selected US Assets Classes 1990-1999

Source: Map of Agriculture analysis

The 2000s

Finally, in the decade to 2010 US farmland generated a compound return of 13% per annum vs equities -1 %.

Compounded Return of Selected US Assets Classes 2000-2009

Source: Map of Agriculture analysis

Other Countries

A 2008 study by Eves and Painter (table below) for the period 1990 to 2005 suggests that in New Zealand (at 14% per annum) and Australia (at 10%) farmland total returns were slightly ahead of those in the US, with Canadian returns not far behind at 6% (Canada, by the way, has since picked up nicely).

Income, Capital Gain and Total Farmland Investment Yields (1990 – 2005)

Source: Eves and Painter 2008

The above data was gathered by the US Department of Agriculture and other national agriculture departments. The data is from operational farmers and includes both trading and capital returns to farmers (who for the most part own the land they farm).

Earnings growth as the key driver of farmland returns

In my view, and this is a view I think many farmers would share, the key to creating value in a farming investment is growing the production of our farms over time. Farmers do this within existing crop types (old fashioned “productivity gains”) and we also create gains by undertaking land-use change (“development”).

Considering the same-crop type; farmers routinely increase their annual production per hectare via technological, management and genetic gains (some costless, others involving investment).  During the green revolution (most of which occurred in the 1950s and ’60s in developed countries; and in the ’60s and ’70s in less developed countries) these productivity gains ran along by as much as 5% per year.  More recently same crop gains have fallen to 1% to 2% per year in most farming systems.

Annual productivity increases and development gains (net of expected deflation of food commodity prices, and adding expected inflation) are typically capitalised into farmland values.  Since these gains are expected to continue into the future a simple equilibrium “valuation model” should add these sources of gain to the % operating return. E.g. if a NZ dairy farmer budgets 6.5% operating (i.e. cash-flow) returns, 2.5% gains from productivity and development (net of investment) and 2.5% inflation gains then he may reasonably expect 11.5% total returns on assets.

Farmers will typically then (moderately) leverage these assets. E.g. our typical NZ dairy farmer might  budget a gross 15% total return to equity after leverage. After corporate overheads and taxes net NZ dairy total returns might then average 12% for the more highly leveraged operators, and 10% for the more conservative.

10% or 12% p.a. is quite an attractive return for a defensive, low depreciation real asset with a negative correlation with equities*** so the question arises why does the market not further “bid up” the price of farmland, to bring expected returns in line with other assets?

*** Professor Bruce Sherrick of the University of Illinois estimates a low/negative correlation between farmland and equities

The Farmer

About Forbes Elworthy

Forbes Elworthy

Forbes was brought up on Craigmore Station in the South Island of New Zealand and worked as a shepherd in the early part of his career. He then trained in Agricultural Economics at Lincoln University in New Zealand where he was student president in 1984. He went to Oxford as a Rhodes Scholar in 1985. After some time at Goldman Sachs he completed an MBA at Harvard Business School in 1992. Forbes worked as a credit trader at Merrill Lynch from 1992 to 1999 where he headed a convertibles trading desk. He then led financial information publisher Credit Market Analysis which was acquired by Chicago Mercantile Exchange. Forbes returned full time to farming in 2005 to live on and manage Craigmore Station – a sheep, beef and deer property farmed by the Elworthy family since 1864.   From 2009 Forbes partnered with his brother-in-law Mark Cox to create Craigmore Sustainables, a specialist manager of farms and forests in New Zealand. Since 2014 he has been leading a Craigmore sponsored farm information management company called Map Of Agriculture. It provides software and farm data integration systems to help over 80 AgBusinesses including Centre for Dairy Excellence in New Zealand and McDonalds Restaurants in the UK connect to and assist their networks of farms. 

Articles by Forbes Elworthy

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