The rapid rise of land prices has a lot of people crying “bubble,” with some sales hitting astronomical amounts for typical Iowa farmland. Higher crop prices, along with solid yields, bolstered buyers’ efforts to expand their operations, but could things be changing in 2014?

“There are three main factors that have impacted land values: commodity prices, low interest rates and availability of land,” says Sterling Liddell, senior analyst, Rabobank Food and Agribusiness Research and Advisory. Interestingly for 2014, there are changes in at least two of these factors.

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The biggest change is that commodity price increases the last five or six years have bolstered the market. But Liddell says for the first time in a few years, crop stocks may rise. If that happens, prices will soften, which will cease commodity prices as the main driver going into next year. It’s not a bad thing that prices are softer, yet land buyers from outside agriculture may reduce their demand.

Changing the demand picture

For Kyle Hansen, Hertz Farm Management, based in Nevada, Iowa, the guide for land values is commodity prices, and he notes that since the beginning of 2013, the market has dropped corn prices $2. Yet one factor may not change immediately. “High-value farmland is very much in demand,” he says.

Realtors like Hansen are still seeing solid sales of top-quality land. However, marginal and lower-value land may see the biggest impact. “We’re seeing timberland and low- to medium-quality land start to slide,” he says.

He adds that when you look at the U.S., USDA reports that 78% of land is paid for, free and clear. “When you start talking about the buying power for individuals and debt paid down in the last few years, and if the land is good quality and fits their operation, they’ll bid for it,” Hansen says.

One factor driving some land purchases is the need to expand for the next generation. For the past 20 years there has been a youth exodus from the farm, but lately farm families are finding sons and daughters who want to return. That pushes farmers to find new income sources, and farming more ground can boost returns.

Interest rates are another hot topic. Low for so long, they started creeping up in 2013. “The Fed continues its chess match to control interest rates,” says Liddell about the Federal Reserve. “As we’ve seen increasing economic activity, we’ve seen an increase in interest rates, which from our perspective is the largest risk to land values.”

Landowners expect a specific return that is directly tied to that interest rate. As rates rise, that can crimp returns, making land less of a bargain, Liddell says.

If you look at historic land values and factor for a corn price of about $4.50, Liddell adds that the average price of farmland is about where it should be. “Our expectation is of a slowing, plateauing effect to land prices,” he adds.

About that bubble

The last farmland bubble in the mid-1980s was something experts saw coming, and mortgage payments outpaced rental rates. The mortgage on land is a reflection of two things, Liddell explains: the value of the land and interest rate. A look at interest rates, rental rates and land values, combined with underlying debt on land, doesn’t indicate a bubble, he says.

“That doesn’t mean that we won’t have a land value adjustment downward,” he says. “If interest rates increase and we don’t see values increase, and you start to see a separation between payments and rent, then you could start to fear a bubble in the market.”

Rental rates are likely to remain stable in 2014, but if commodity prices slide further, there will be pressure by renters to have landlords adjust rates.

Brent Gloy, an agricultural economist at Purdue University, is looking at interest rates. This is a critical variable for land values going forward. So far the Federal Reserve has affirmed its current low interest rate approach to pump up the economy.

“There’s pressure eventually, largely depending upon how well the economy rebounds, and it’s not certain that interest would take right off [in a recovery],” Gloy says. He notes that the latest Federal Reserve Open Market Committee report was clear that interest rates would stay low for some time.

In the long run, what will matter, Gloy says, is the earnings and the present value of future earnings off that land. “No one in 10 years will care what you paid for that farm,” he says. “Just because you buy it for cash today doesn’t mean it won’t go down in value. Land purchases at prices above what earnings will support are a consumption decision as much as an investment decision.”

Going into 2014, a sharper pencil will be needed to evaluate land purchases. Such an opportunity may be right if you’re growing your farm business.