PAM (Private Asset Management)

May 12th @ 3:09 pm

Learn about the unique challenges and advantages of investing in farmland.

Growing Appetite

Experts outline some of the unique challenges and advantages of farmland investing, which is showing higher than usual returns recently.

Sophisticated investors have long been looking ahead at allocations to the newest and latest technology, but some affluent individuals may be ignoring one of the most traditional businesses in this country: farmland investing. Even for investors whose familiarity with agriculture ends and begins with viewing Grant Wood’s “American Gothic,” overlooking this asset class may be a mistake, as growing demand and science advancements have made investing in farmland more attractive than ever.

Experts agreed that increased food consumption due to a rapidly growing global population has also created a growing demand for crops.

Matthew Jehn, CFP at Royal Oak Financial Group, says: “Globally [demand] is continuing to go up each year and that’s what’s going to make this class always good to be in.”

John Taylor, national farm and ranch executive at U.S. Trust, echoed that sentiment, stating the US is in a dominant role both in the production and in the export [side] of the grain crops. “As the world continues to grow in population and emerging markets continue to grow their country GDP and per capita GDP, we see a higher demand for grains and other types of protein,” he says.

Not only are populations growing, but according to Philippe de Lapérouse, managing director HighQuest Partners, the makeup of these groups is changing.

He notes that an increasingly urbanized world has created a greater demand for food. Populations which have migrated from rural to urban area were previously able to grow their own food, but now can no longer do so in cities. Additionally, these urban populations are producing a growing middle class with increasing disposable income that they can spend on more protein and higher quality foods.

He says: “Historically, a lot of high-net-worth individuals and family offices, have been investing in farmland, or developed their fortunes on the basis of agriculture…While on the one hand, this is nothing new, on the other hand, what is changing is that investors recognize, whether they are HNWIs or family offices, or for that matter, pension funds, is that there is a reason for them to want exposure in the sector. There’s an attraction and there’s a justification for holding some of one’s assets in farmland, [which is] a real asset, which preserves capital value [over] the long term.”

Additionally, de Lapérouse says part of the reason that farmland is considered an attractive investment is not only the opportunity it provides to benefit from appreciation over the long-term, but that it also provides a cash return on an annual basis.

Jehn agreed, saying: “[Farmland investing] has been lucrative for many clients. Yields have been good and profits have been good, and the folks that are in the farm business love the farm business, so they come into it for the longevity.”

He says because this asset class is cash producing, it also is attractive to many investors. “It’s like owning a great stock that yields a dividend.”

Taylor points out that this is considered a conservative part of a portfolio, adding that “the asset class has an asymmetric risk curve” with limited downside volatility.

“Unlike a stock or a bond, you never see the value of land going to zero and becoming worthless,” he says, with the same principle applying on the return side.

Taylor notes that there is a “no vacancy factor on good US farmland,” with all superior US land being farmed every year because of the world demand for these crops.

Once an investor decides to make an allocation to this asset class, there are various options for exposure.

Geoffrey Lutz, senior vice president, Mesirow Financial Agriculture Management, says the firm focuses on acquiring and managing farmland for high-net-worth individuals and institutional investors either through funds or through separately managed portfolios.
The funds are comingled investments with typically a minimum $100,000 investment or more, he noted. He added that separately managed accounts oftentimes require a minimum $25m investment, some require $50m.

“The difference is really predicated on a minimum investment size,” he says. “A fund makes sense for the high-net-worth marketplace much more than a separately managed portfolio unless they have family wealth somewhere in excess of $250m dollars or so.”

He pointed out that for most investors, when investing in this asset class are generally more comfortable with a 1-3% allocation in their portfolio. He added that most high-net-worth investors would find it far easier and would prefer to invest in a fund, especially if there was a fund that offered some liquidity.

A separately managed account can take several different forms.

One choice is a standard cash lease, with an operating farmer renting the land and absorbing the risk. This provides muted volatility with a current yield that Taylor says is “very attractive to our high-net-worth and ultra-high-net-worth” investors. “Typically, cash leases have continued year over year and gently gone up,” he said. “[These investors] want current income and also would like their assets to appreciate over time and for those income streams to go up over time. These are characteristics of good farmland.”

Taylor says that most standard leases will not discuss the specific crops that can be grown on the land, and is left to the farmer’s discretion. The lease will, however, outline the timing of payments and protocol for how to remove a tenant if payments are missed, as well as maintenance and good agricultural practices, such as maintaining the health of the soil.

“We need to monitor [the lessee’s] agriculture practices to ensure they are farming it in a professional manner and adding value to the farm,” he says.

Taylor explains that the firm does “tremendous due diligence” before agreeing to rent property to a person, including observing agriculture practices on other farms, ensuring that the renter has the equipment and capacity to man the new land, as well as looking at finances to ensure that he can make future lease payments.

For those investors that want more of an exposure to commodity risk, Taylor says, there are sharecropping agreements that allow for more volatility, depending on crop pricing and external factors such as weather.

Taylor notes that it’s important to have a trusted contact or advisor that can oversee the land at close range, especially for those investors that are not located near the investment.

He says: “You have to have an organization like ours that has the time and the seat that can actually be on the ground…When we look for investments, we have to ask if there enough good quality farmers in this area? To use a sports term, we need to make sure that there’s an adequate bench. For [an investor] in a high rise in New York, if you don’t have the contact or the Rolodex, it’s going to be difficult to find the right [lessee]. And also, how are you going to monitor that farmer to make sure he is working within that lease term and taking care of the land to help increase the value of that land over time?”

de Lapérouse says the question of who will manage and oversee the land is one of the biggest obstacles in the industry.

“That’s one of the big challenges—the major challenge—in the sector, is to find farm managers or operators whom [investors] can really trust and rely on,” he says.

This is hardly the only challenge in the industry.

Jehn emphasizes that agriculture is a year-round business and for an investor that opts to operate the farm, as opposed to lease it, the off season is just as important as the planting and harvesting season.

“People do have a misconception of all the work that goes into it and all of the moving parts,” including weather, irrigation, moisture, soil nutrient levels and storage concerns if a farm owner opts to hold crops until prices go up, he says.

Insurance can give an investor peace of mind when it comes to these challenges, Lutz says.

“Typically, we will obtain insurance when we operate to cover production. This protects us if the crop is damaged by disease, storm or drought. Or you can get crop price insurance, so if commodity prices of drop precipitously,you can protect yourself against price risk,” he says.

So-called ‘acts of God’ aren’t the only concern for investors—there are also those of changing governmental policy and shifting attitudes to the types of food the public consumes.

Jehn points out that current events and “geopolitical disruptions,” such as the unrest in the Ukraine, could have an effect on the agricultural market.

de Lapérouse notes that the “output from the farmland is very much determined by policy and geopolitics,” pointing out that political unrest, like that occurring in the Ukraine, “could have a bullish impact on the wheat markets,” adding that if a blockade was imposed on wheat exports from Russia, it would have an impact on the value of the product elsewhere.

Meanwhile, one of the things he says will affect the industry is how the US government is going to enforce the Renewable Fuel Standard, which mandates that certain amounts of biofuels be blended with transportation fuels like gasoline. The rule was created with an expectation of growing demand for transportation fuel, which has not materialized. Therefore, he says, the U.S. ethanol industry has hit a “blend wall,” as the legislation requires more ethanol to be produced than can be blended into transportation fuel.

“If [the US government] were to get rid of that mandate, that could have an impact on the value of farmland to the extent that it would take off pressure to produce sufficient quantities of corn for ethanol,” de Lapérouse says, adding that it would create pressure to increase exports and find other markets in the US for corn.

Additionally, in spite of increasing discussion about the place of organic products and genetically modified organisms (GMOs) in popular culture, the major agricultural industry does not seem to be making any major shifts, Taylor says.

“Many key crops, like corn and soybeans, grown in the US are GMO-type crops and it will continue to go that way,” he notes, stating that GMOs will “hopefully mean that you will farm in more efficient manners using less fertilizer and potentially less water.

“[In the US], we haven’t seen thesame level of GMO concerns as opposed to those abroad, and those are really subsiding,” he says, adding that there is not really a focus on organic in the major grain crops produced in the agricultural space.

All told, in spite of the numerous challenges in the space, agriculture has provided impressive returns. Farmland has produced returns in the mid-to-high teens for the past five or six years, Lutz said, due to a combination of land appreciation and income production.

“It’s a great diversifying asset,” Lutz said. “It provides very good investment returns and can be looked at as an inflation hedge.”

Jehn says that there is an “instrinsic value” in farmland. “Here’s an asset that’s going to produce forever, as long as there’s a human need for food.”

He adds that a more emotional side of things has also explained the draw to this asset class. “I do also think the love of farming and a love for the land creates an emotional attachment to the business. But I also do think it’s an asset that, if managed correctly, can [allow someone to] make a good living.”

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