Flex LeasesLand Bubble and Profitability
Henderson CountyJanuary 12, 2011
Greg [email protected]://www.ca.uky.edu/agecon/index.php?p=169
Dept. Agricultural EconomicsUniversity of KentuckyDecember, 2010.
Agricultural Economics
Areas Covered Today1) Land Bubble2) Profitability by Soil Type3) Communication4) Leasing Game5) Flex Leases
Agricultural Economics
Hypothetical Story
Central Kentucky:• Profit• Knowledge• Competition• Greed
Agricultural Economics
True or False
Cropland Prices drive Cash Rents?
False!!!
Agricultural Economics
What Drives Cropland Prices?
Investor – Expected Land Rents
Farmer – Expected Profits
Agricultural Economics
What Is the Relationship Between Land Rents and
Profits?
Profits Drive Land Rents:• Higher the profit, the more that a farmer
can bid for land rent.• In long-run, most of profit will be bid into
land rents.
Agricultural Economics
What About Land Appreciation?
Yes, but…
Except for Development Potential→ Future land rents and/or profits determine appreciation.
Agricultural Economics
Formula to Estimate Max. Cropland Value
Investor Perspective:
Land Value = Land Rent – Costs Interest Rate
Agricultural Economics
Investor Perspective Example
$220/acre Expected Land Rent$20/acre Expected Costs5% Interest Rate
Land Value = $220 – $20 = $4000 .05
Agricultural Economics
Formula to Estimate Max. Cropland Value
Farmer Perspective:
Land Value = Profit per Acre Interest Rate
Agricultural Economics
Farmers Perspective Example
$300/acre Expected Profit5% Interest Rate
Land Value = $300 = $6000.05
Agricultural Economics
How is Interest Rate Determined?
If self-financed: → Required return on investment.
If Borrowing: → Rate of the loan.
Agricultural Economics
Effect of Interest Rate
As rate decreases: → Land value increases.
Interest Rate and Profitability/Land Rent Effect on Maximum Land Price
Interest Rate 1) Expected Profitability or 2) Land Rent minus Costs
$100 $200 $300 $400 $500
15.0% $667 $1,333 $2,000 $2,667 $3,333
10.0% $1,000 $2,000 $3,000 $4,000 $5,000
7.5% $1,333 $2,667 $4,000 $5,333 $6,667
5.0% $2,000 $4,000 $6,000 $8,000 $10,000
2.5% $4,000 $8,000 $12,000 $16,000 $20,000
Agricultural Economics
What Interest Rate to Use?
Returns on other investments→ Lot of risk out there.→ Farmland seems like safe investment.
Agricultural Economics
Land Rent vs. Profit ApproachShort-run: Farmers will have competitive
advantage over investors in areas with less then perfect bidding.
Long-run: Land rent and profit will be very close.
Agricultural Economics
Ohio Valley DynamicsMost Competitive Land Rents: • $200-$275 last year.• $300+ this fall.
What land prices will this support?
Interest Rate and Profitability/Land Rent Effect on Maximum Land Price
Interest Rate 1) Expected Profitability or 2) Land Rent minus Costs
$100 $200 $300 $400 $500
15.0% $667 $1,333 $2,000 $2,667 $3,333
10.0% $1,000 $2,000 $3,000 $4,000 $5,000
7.5% $1,333 $2,667 $4,000 $5,333 $6,667
5.0% $2,000 $4,000 $6,000 $8,000 $10,000
2.5% $4,000 $8,000 $12,000 $16,000 $20,000
Agricultural Economics
Projected Profitability 2012• Commodity prices down from late summer
high.• Determine if land rents can be supported
in 2012 at current commodity levels.• Evaluate range of commodity prices.
Agricultural Economics
Critical Budget Assumptions
20
1. Does not include land rent.2. Includes “non-cash” costs (e.g.
depreciation/overhead, unpaid labor). 3. P and K application at removal rate.4. Grain trucked directly to elevator.
Agricultural Economics
Corn and Soybean PricesNew Crop 2012
Price Scenario: Corn Soybeans Low $4.50 $9.50 Baseline $5.50 $11.75 High $6.50 $14.00
Agricultural Economics
Agronomic Assumptions
Corn Yield
Soybean Yield
Corn/Soybean Yield Ratio
125 bu 39.0 bu 3.2150 bu 45.5 bu 3.3175 bu 51.5 bu 3.4
Agricultural Economics
Budget Assumptions
Base ScenarioFertilizer: $/ton $/unit Anhydrous (N) $860 $.52 DAP (P2O5) $680 $.53 Potash (K2O) $640 $.53
Agricultural Economics
Projected 2012 Costs (per acre)Inputs: Corn (150 bu) Soybeans (45.5 bu) Seed $76 $45 Nitrogen $83 $0
P, K, and Lime $70 $53 Pesticides $35 $25Total Inputs $264 $123Machinery and Labor $121 $85Other: Drying Grain $23 $0 Crop Insurance $20 $20
Misc. $20 $20 Land Rent Variable Variable Operating Interest $7 $4 Total Other $70 $44Total Costs $455+ Land Rent $252+ Land Rent
Agricultural Economics
Summary Revenues/Costs (per acre)
Yield and Price: Corn SoybeansExpected Yield (rotation) 150 45.5Future's Price Fall 2011 $5.50 $11.75Grain Revenue $825 $535Direct Gov’t Payment $20 $20Total Revenue $845 $555Total Costs (Less Land Rent) $455 $252Gross Return (Less Land Rent) $390 $303
Agricultural Economics
Baseline Scenario (per acre)$ 11.75 Soybeans (elevator)
$ 5.50 Corn (elevator)$.52-N; $.53-P; $.53-K
Gross Return
CornGross Return
SoybeansGross Return
Rotation
125 bu corn $276 $234 $255
150 bu corn $390 $303 $346
175 bu corn $505 $366 $435Note: Subtract land rent to get Net Return.
Interest Rate and Profitability/Land Rent Effect on Maximum Land Price
Interest Rate1) Expected Profitability or 2) Land Rent
minus Costs
$250 $300 $350 $400
7.0% $3,571 $4,286 $5,000 $5,714
6.0% $4,167 $5,000 $5,833 $6,667
5.0% $5,000 $6,000 $7,000 $8,000
4.0% $6,250 $7,500 $8,750 $10,000
Agricultural Economics
High Commodity Price Scenario$14.00 Soybeans (elevator)
$ 6.50 Corn (elevator)$.52-N; $.53-P; $.53-K
Gross Return
CornGross Return
SoybeansGross Return
Rotation
125 bu corn $401 $322 $361
150 bu corn $540 $404 $472
175 bu corn $680 $482 $581Note: Subtract land rent to get Net Return.
Interest Rate and Profitability/Land Rent Effect on Maximum Land Price
Interest Rate1) Expected Profitability or 2) Land Rent
minus Costs
$375 $425 $475 $525
7.0% $5,357 $6,071 $6,786 $7,500
6.0% $6,250 $7,083 $7,917 $8,750
5.0% $7,500 $8,500 $9,500 $10,500
4.0% $9,375 $10,625 $11,875 $13,125
Agricultural Economics
Low Commodity Price Scenario$ 9.50 Soybeans (elevator)
$ 4.50 Corn (elevator)$.52-N; $.53-P; $.53-K
Gross Return
CornGross Return
SoybeansGross Return
Rotation
125 bu corn $151 $146 $148
150 bu corn $240 $200 $220
175 bu corn $330 $250 $290Note: Subtract land rent to get Net Return.
Interest Rate and Profitability/Land Rent Effect on Maximum Land Price
Interest Rate1) Expected Profitability or 2) Land Rent
minus Costs
$150 $200 $250 $300
7.0% $2,143 $2,857 $3,571 $4,286
6.0% $2,500 $3,333 $4,167 $5,000
5.0% $3,000 $4,000 $5,000 $6,000
4.0% $3,750 $5,000 $6,250 $7,500
Agricultural Economics
Land Bubble?
• 1970’s vs. 2010’s→ What are differences?→ Let’s look at land values.
Agricultural Economics
Land Bubble?
Main difference today vs. 1970’s?
Politically imposed demand for grain.→ Ethanol used 40% of corn crop 2011.→ Political issue, not market issue.
Agricultural Economics
SummaryCurrent farmland values not unreasonable at
current profitability levels.However price levels will hinge on ethanol
policy.How will market react to: → 40% of corn crop dumped on market.
→ Market response to higher profitability.
Agricultural Economics
Land Rents by Soil ProductivityQuestion: If 150 bu ground rents for $200,
how much would you pay for 125 bu corn ground?
We will look at partial budgets to help answer this.
Note: Base rents are purely hypothetical.
Agricultural Economics
Land Rents by Soil Productivity
If productivity increases 20% → Land Rent increases by 20%.Does this seem fair?
38
Corn - Partial Budget for Increased YieldYield Increase (bu/acre) 25 Elevator Price ($/bu) $5.50 Increase in Revenue $138 Increased Costs: Seed ($/bag) $200 1000 $2.50Nitrogen $0.52 15 $7.80Phosphorous (P2O5) $0.53 10 $5.30Potassium (K2O) $0.53 9 $4.64Harvesting ($/bu) $0.08 $2.00Trucking (miles) 15 $2.93Drying ($/gal LP) $2.00 $3.13Other ($/acre) $0.00 $0.00Total Increased Costs $28.30 Net Increase Revenue $109
39
Soybeans - Partial Budget for Increased YieldYield Increase (bu/acre) 6.0 Elevator Price ($/bu) $11.75 Increase in Revenue $71 Increased Costs: Seed ($/bag) $45 0 $0.00Nitrogen $0.52 0 $0.00Phosphorous (P2O5) $0.53 4 $2.23Potassium (K2O) $0.53 7 $3.50Harvesting ($/bu) $0.08 $0.48Trucking (miles) 15 $0.70Drying ($/gal LP) $0.00Other ($/acre) $0.00 $0.00Total Increased Costs $6.91 Net Increase Revenue $64
Agricultural Economics
Land Rents by Soil Productivity
Productivity Change of 25 bu corn:• $109/acre net corn.• $64/acre net soybeans.• $86/acre net 50-50 rotation.
Note: Based on assumptions previous two slides.
Agricultural Economics
150 bu Base Rent
Yield (bu corn)
Equivalent Land Rents
Equivalent Land Rents
200 $373 $348175 $286 $261150 $200 $175125 $114 $89
Note: Base Rents examples only.
Agricultural Economics
175 bu Base RentYield
(bu corn)Equivalent Land Rents
Equivalent Land Rents
200 $336 $311175 $250 $225150 $164 $139125 $77 $52
Note: Base Rents examples only.
Agricultural Economics
Land Rents by Soil Productivity
Summary:• 17% dec. yield → 43-50% dec. rent.• Not linear relationship.• Better ground may be underpriced. • Poorer ground may be overpriced.