Value – The Fundamental Question
Previously the series discussed the different forms of agriculture investments and the mechanism options for investing in farmland. We will now go on to look at the various factors influencing the price of agricultural land.
The first and foremost question for a prospective investor in farmland is – what price should I pay? This question predominates regardless of the investment vehicle, ie, whether the purchase is to be direct, as part of some syndication, or via shares in a publicly-held land investment vehicle. The answer is of course, you should pay no more than the land is worth.
But how to know that the price is equal to the value? Applying the truism that a commodity is worth exactly what sellers are willing to sell for and buyers are willing to pay, ie the price at which seller and buyer meet, the best indicator of the value of any given farmland must surely be ‘the market’. But unlike with stocks or bonds or gold, it’s not possible with farmland to go to the financial section of a daily newspaper and find the current market value of any particular tract of land. This market-centric approach – the ‘comparable sales’ model –doesn’t work well with farmland, in that very often the market is weak and/or fragmented, with few sales over a given period or within a given region, making like for like comparisons difficult and unreliable.
And much more so than with equity and debt securities, and even with commercial and residential real estate, agricultural land lacks heterogeneity. Two seemingly similar tracts of farmland, in terms of size and location, may on closer inspection be found to have marked differences. For example, in soil fertility absent the use of artificial fertilisers, or in the presence or otherwise of a replenishable water supply and irrigation. Such factors may be responsible for large differences in the value of the land and thus in the price which the investor should pay.
Land valuation is more an art than a science and nowhere does that proposition hold than in relation to farmland. Here we take a look not at the technical aspects of land valuation processes but at the range of factors which, one way or another, will be taken into account in the application of whichever models are used in any given case.
External Factors (1) Government Intervention
A government may take action which measurably impacts on the value of the country’s farmland. At the extremity of this prospect would be an organised expropriation of land, typically by force of some diktat and sometimes backed up by physical force, as has occurred in recent history in Zimbabwe and Venezuela. Patently, farmland which comes under even the threat of expropriation will plunge in value, indeed any existing demand may simply vanish.
But government action need not be so extreme to have a negative impact on value. In New Zealand in the mid-1980s, so-called ‘Rogernomics’ (after the macro-economic measures introduced by then Minister of Finance Roger Douglas) saw the abrupt and wholesale withdrawal of farm subsidies as a key mechanism in kick-starting a moribund economy and averting a sovereign debt crisis. In response, the price of remote hill country sheep and beef farms fell by up to 60% in nominal terms and dairy farms, while less affected because historically not subsidised to the same degree, experienced a drop in value of some 45% between 1984 and 1987.
Attitudes to foreign ownership
A related factor is governmental attitude towards foreign ownership of farmland, a consideration which typically will be strongly influenced by the feelings of the local population. This attitude may change over time and from time to time. Indigenous fears of foreign ‘land grabs’ may be justified or fanciful but either way they can resound in governmental policy on the subject. Farmland purchased during a period of tolerance of, perhaps even assistance for, foreign investment may have its value seriously diminished if the shutters later go up and resale to foreign interests ceases to be an option.
Governments can also influence farmland values positively by interventionist measures designed to support or influence the direction of their domestic agri-sector. Here the most prominent examples must be the United States’ Farm Bill, which distributes a huge amount of farm support in five-yearly cycles, and the European Union’s ‘CAP’ – the common agricultural policy, a foundation-stone of the union and a mix of fiscal and non-monetary support mechanisms. The extent to which such policies influence farmland values is much debated, with the only truly reliable valuation mechanism being to remove them – as happened in New Zealand – and see what happens. That is not going to happen anytime soon in either the US or the EU, but the impact of such measures at the ‘grass-roots’ level – favouring this or that commodity, for example, or this or that ‘least favoured region’, can add a premium to the value of any given farmland which is not enjoyed by equivalent land elsewhere within the same country or (as with the EU) region.
Farm support, or broader support for agriculture, may also take the form of taxation relief – for example, farmland may be exempt from land taxes or there may be exemptions for farming expenditure not available to wider industry. A favourable taxation regime will impact on the value of land within its reach compared to equivalent land elsewhere.
(2) The Status and/or Performance of Other Investment Assets Having noted at the outset that farmland differs fundamentally from other investment assets, it needs also to be stressed that the value of farmland at any given point of time is not immune from fluctuations in the performance, value or liquidity of such alternatives.
Linkage to other investment products
It’s commonly thought that land in general, including and especially farmland, is a ‘flight to safety’ in times of volatility in mainstream investment markets. To the extent that this is true, falling prices in stocks and bonds should translate into rising values for farmland. But this linkage is by no means certain or universal. Whereas cashed-up investors are avidly seeking out farmland purchases in the United Kingdom, for example, even with yields from tenancies now barely above bank interest rates, the demand for farmland in the former communist countries of eastern Europe has plunged since the onset of the global financial crisis in 2007. The reason for this disparity is obvious enough – an historically strong belief in capital value growth in UK farmland which is simply absent in, say, Romania or Bulgaria, or Russia for that matter. Such perception of rising value developed quickly in the ‘bubble’ in those countries between 2004 and 2007 but proved incapable of sustaining itself as the crisis took hold and bank credit – and the market - largely dissipated.
Linkage to agri-commodities
In addition, farmland values cannot be decoupled from the value of food and food-related commodity investments. Ultimately, the reason anyone is interested and willing to invest in farmland is because of what can be produced on it, either as a direct human food input or as food for creatures we eat. The markets for those products are vastly more volatile than the market for farmland but over time the value of the latter will move in sympathy with longer-term trends in the price of food and animal feed commodities. And to this dynamic must now be added the impact of edible cropland conversion to the growth of maize and other biomass for biofuel production. This still-emerging market is impacting on farmland values in the United States and elsewhere in ways which remain unclear but which are likely to endure.
(3) National and International Events
In addition to long-term government intervention in farmland of the type outlined above, other domestic or international events may impact on farmland values in any given country or region. Typically, these will be unpredictable and unforeseen at any given moment and, invariably, their impact will be negative.
War and the Like
Sadly, much of Africa remains afflicted by the failure to overcome colonial anomalies. Even stable African states – as Mali hitherto appeared to be – remain under constant threat of internally or externally-induced unrest and conflict. This consideration affects not just the choice of Africa as a farmland investment destination but the value of that investment going forward.
And it was primarily African and other developing states which took drastic action to protect domestic food production when the global food price crisis struck in 2008. As the price of wheat, rice and other commodities started to soar, state after state imposed export bans and price controls on domestic production. By and large, this crisis was unheralded and its negative impact on investor returns and investor confidence is still being felt today.
To Be Continued..... The second part of this exploration of the factors to consider when assessing the value of a potential investment in agricultural land will look at those which are specific to the piece of land itself. What factors could lead to significantly variance in the market price of two seemingly similar tracts of agricultural land in relative proximity to each other?