Land inflation is no cushion; paper wealth can vanish

Feb 15, 2013
by DTN

U.S. agriculture is underestimating its vulnerability to another adjustment in land prices, Purdue University economist Mike Boehlje told 150 farmers attending the annual AAPEX meeting in Cabo San Lucas, Mexico, this week.

With Iowa land auctions bringing more than $20,000 an acre in some cases this winter, “the question isn’t whether we’re in a boom, it’s how long the boom will last and what the bust will look like,” he said.

Optimists have contended that the surge in farm net worth will cushion any blow should land values correct any time soon. Some economists believe farmland owners may feel the fall, but they won’t take farm banks down with them like they did in the 1980s.

Those who believe that paper wealth will buffer any correction in the farm economy forget that land and farm machinery are likely to depreciate in tandem—and that adjustment could be swift when it happens, Boehlje warned.

What’s more, nearly 85 percent of farmers’ net worth consists of farmland today—a far more concentrated investment than before the land crash of the 1980s.

Boehlje’s comments come on the heels of a new USDA Economic Research Service report that estimates 2013 net farm incomes as the second highest ever in U.S. history, only trailing 1973 when adjusted for inflation. But he believes agriculture “has a false sense of security” to the debt capacity it’s built over the past decade.

“I don’t want you to be road kill,” he told the crowd. “A lot of people don’t realize how vulnerable they are.” In 2009, national average net worths tumbled on a temporary drop in commodity prices, so a return to $4 corn this fall poses a serious risk.

Over the last 100 years, the norm for world agriculture is to be producing surpluses, so commodity prices have trended down when inflation is taken in account. Adding pressure to the potential price bust is that the world added 123 million new acres of farmland to production in the last five years, Boehlje said, the equivalent of adding another producer with about half the area of total U.S. crop production. This did not count 20 million acres that the U.S. shifted to corn from other crops.

Expect less mercy from farm lenders when economic conditions deteriorate compared to the 1980s, Boehlje also cautioned. International banking regulations recently reclassified agriculture as the highest-risk-category industry, so lenders will need to set aside more capital reserves and raise their loan margins if they choose to finance the industry in the future. Dodd-Frank also mandates stiffer loan oversight of commercial lenders.

Farm lenders wrote off $72 billion in bad debts during the 1980s, a practice they are unlikely to repeat any time soon, Boehlje said. Most commercial loan covenants contain a “materially adverse event” clause allowing the bank to call longterm fixed-rate loans if collateral values fall precipitously or you experience a series of losses.

“If you have the urge to buy more land today, try to do it with seller financing rather than commercial credit,” he said.

A stress test based on actual 2010 farm records by Allen Featherstone of Kansas State University found a mere 15 percent reduction in gross farm revenues would trim debt repayment capacity from a comfortable 154 percent to a subpar 62 percent. If higher interest rates occurred at the same time, they would compound the financial damage, Boehlje added.

U.S. agriculture is vulnerable when paper wealth vanishes, Boehlje said. “And it’s the guy in the middle who will be affected, not just the high fliers.”

Marcia Zarley Taylor, DTN