There?s also another dynamic at play. You may remember that prior to the housing crisis, developers and other investors were buying up agricultural land for residential developments, but not anymore. Instead, investors and other nontraditional buyers have turned to farmland as an investment because rental rates are producing returns that are higher than other investment returns available on the market. So demand is high, the supply of farmland is limited, and folks believe that land values can only go up.
Other forces at play in today?s high commodity price environment is that farmers may be willing and able to pay more than they normally would for land, because they have excess cash and they can purchase the land with a significant down payment and short-term financing, say five to seven years. Getting a loan is usually no problem, as banks typically look at a three- to five-year average of an operation?s ability to service debt, and many farmers and ranchers have been able to demonstrate strong debt service coverage for the past three to five years.
But not all Idaho farmers are buying more land. Some are using their extra cash to reduce debt or replace old equipment, and older farmers who will retire soon aren?t interested in expansion or incurring more debt. There are also farmers looking down the road to the inevitable decline in commodity prices. They remember the lean years and aren?t willing to make that type of investment if they have to rely on commodity prices remaining high. They recognize that prices are cyclical, so they manage to that end. The more conservative farmers first calculate how a decline in commodity prices will affect their ability to make payments over time on the land they?re considering purchasing today.
Whether farmers are using cash or borrowing money to purchase agricultural land, a well-researched financial plan and due diligence are a must. Here are some questions that should be considered before making a purchase:
? What is the financial condition of your business? Consider needed investments, expected expenditures and crop conditions. Is it the best use of your cash, or are there other opportunities that can provide a better return?
? Have you created a pro-forma cash flow? Research sales trends and expected revenue of a potential plot of land to determine how well the purchase fits within your plans. Does the potential return meet your objectives?
? Given your revenue forecast, are you overpaying? If you pay a premium, how long will it take you to recoup? How much should you prudently spend on a land purchase to ensure that the revenue justifies the purchase?
? Have you thought long and hard about it? Never be rushed by a broker, and never confide your best price or financial goals with a party working for the seller. Don?t buy impulsively. Visit the property numerous times. Rework the standard broker?s purchase contract, delete what you don?t like and add what you want before presenting the offer.
? Does it make more financial sense to rent the land rather than owning it? Rental rates are high, but renting frees your cash for other activities. What will be your total land payment per tillable acre owned, and how does this compare to cash rents in your area?
? Should you go ?all in? with your cash? Think about alternatives to an all-cash transaction. Land is an illiquid asset, and purchasing it will affect your farm?s liquidity.
? How much land are you acquiring? Sounds simple, but there can be confusion. Know exactly what you?re getting before making a bid. Is the land surveyed? If not, determine the acreage based on the legal description or consider a survey. Are there special easements? If so, understand them.
? What does the land appraise for? Are there comparables in the area? Even if you don?t get a full appraisal, attempt to find some comparable sales to determine if the purchase price is reasonable.
? What is the condition of the soil? What is the capability of the soil, and how does it affect your revenue forecast? Know the type of soil and the history of annual crop rotation.
? What is the water source? Is the property irrigated? Do the water rights convey with the property? Account for water cost in your financial plan. Make sure all water wells are registered with the appropriate authorities.
? What do you know about the gas, mineral and wind rights for the property? Do these rights convey to the purchaser? Have they been surveyed or severed from the surface rights? Are they currently under lease?
? How is the property zoned? Will your plans conflict with existing zoning restrictions? Are there conservation easements? Make sure you understand the assured leases that may go with the property.
? How will you hold deed in the property? Will you own it individually, jointly with a spouse, in a family-owned entity or in a trust? The pros and cons of each will depend on your long-term goals.
? Are there any environmental problems? Paying for an onsite environmental audit before you buy the land may be worth the cost and will ensure you?re not buying into an expensive cleanup.
? How long will you actively farm? Make sure your financing plan matches the rest of your intended career. Will you fully retire all debt from the purchase before you retire? Do you have sufficient life and disability insurance?
These are tough questions to take the time to consider in the middle of a market that is breeding a sense of urgency. But it makes sense to carefully evaluate a purchase to ensure decisions made today position your business to prosper and obtain credit in the future.
Dawn Justice is the president and CEO of the Idaho Bankers Association. She worked with the IBA Agricultural Bankers Committee and the American Bankers Association Agricultural and Rural Bankers Committee for this column.
Source: http://idahobusinessreview.com/2013/07/22/agriculture-land-values-are-on-the-rise/
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