Land Prices and cash rents are expected to continue to rise — possibly at double-digit rates — across the Midwest into 2008.

And given the heightened demand for commodities — induced in part by the burgeoning ethanol market — healthy annual increases in land costs are likely to continue for years to come. The profits from raising a crop could shrink as earnings from higher commodity prices get bid into land prices and cash rents.

Earnings in 2007 will be decidedly higher than in 2006, perhaps adding fuel to an already hot market. According to a USDA report issued in late August, net farm income is expected to reach a record $87.1 billion in 2007, up 48% from 2006.

“Farmers have a tendency to bid excess profit into the land,” notes Mike Duffy, who tracks Iowa farmland prices at Iowa State University (ISU). “In the long run, the profit margin narrows as rents and land values rise.”

Indeed, farmers were the biggest players in the farmland market over the past year. They outpaced investors even in states such as Illinois, where investors have bought more land than operating farmers have in recent years.

“The investor group has a lot of money and is trying to compete, but farmers are the dominant force” in the Midwest land market today, says Murray Wise, chairman and chief executive officer of the Westchester Group, a farm management and real estate company based in Champaign, IL.

“There is more demand for farmland today than there has been for 40 years,” he says. “We are in a euphoric period.”

How high?

The fact that land prices are going up is hardly news in farm country. The question is: how high?

University and state agricultural land appraiser groups from across the Midwest reported increases in the 10 to 15% range from 2005 to 2006. That continued the trend of double-digit gains that began in 2004. Farmland prices in a large swath across the Midwest are up about 50% on average since then.

A new report released by USDA in mid-August summarizes where land values stood at the end of 2006. It reports that agricultural land values increased 16 to 18% in Iowa, Kansas, Minnesota and Wisconsin from the previous year and increased only a few percentage points lower than that across the rest of the Midwest.

Regional land values over the past decade for the Corn Belt, Lakes and Northern Plains regions are shown in the chart on page 50. They show that land prices have more than doubled in 10 years in all three regions. (To find the USDA report online, search for “USDA Agricultural Land Values 2007.”)

Much of the uptick reported for 2006 began in late summer and fall, as 2007 corn futures leapfrogged to $4/bu.

“When corn prices exploded in late summer is a large part of when our land prices took off,” says Duffy, who reported that the average price of farmland in Iowa topped $3,000 ($3,204 to be exact) for the first time in 2006. However, that's far below the inflation-adjusted peak of more than $5,000/acre established in the mid-1970s.

2007: Hotter than 2006?

That spark in the market has carried into 2007.

For example, a mid-year land value survey from the Illinois Society of Professional Farm Managers and Rural Appraisers reports that average farmland values in the state increased 5.9% in the first half of 2007.

“For the year, from what I am hearing, land prices are going up in the high single digits or low double digits, probably 9 to 12%,” says Gary Schnitkey of the University of Illinois, who worked with the farm manager group in compiling the survey. “This is the highest land prices have been. The increase in recent years has been huge.”

The Chicago Federal Reserve Bank reports that Iowa land values were up 7% for the first quarter of 2007 and 3% the second. Meanwhile, realtors across the state say values were up 7.1% from March 2007 to September 2007, Duffy notes.

“Preliminary indications are that increases may be as high as 15 to 20% for the year,” Duffy says. He attended a late summer auction where a farm sold for $6,100/acre, about $1,000 more than he had expected. In late summer, another parcel in northwestern Iowa reportedly sold for $8,400/acre.

In Illinois, an 80-acre tract near DeKalb reportedly sold for $10,000/acre at auction this spring.

Although $10,000 land is far above the norm, even in DeKalb County, the prospect of $4/bu. corn is continuing to have a big impact on the Midwest farmland market, says Jim Farrell, president and CEO of Farmers National Company, Omaha, NE.

“Once $4 corn hit, there was quite a bit of euphoria,” Farrell says. “Since October 2006 we have seen an 18% increase in some areas. There is just tremendous enthusiasm in the market right now. A lot of the land that we initially saw taking off was in the heavy ethanol production areas — the upper two-thirds of Iowa and southern Minnesota. Of course, the ethanol market has spread, so today it is a strong market pretty much everywhere.”

A high percentage of successful land auctions is one measure of market enthusiasm. “If this were 1986, we would be seeing very few land auctions taking place, and few getting sold the day of the sale,” Farrell says. “Of the 200 auctions we held over the past year, 97% were successfully sold the day of the sale. Oftentimes, farms are selling for more than we thought they would.”

Across the board, farmers have been the major buyers. Investors have taken a back seat, although their interest is growing with the recent sub-prime real estate and stock market meltdowns, Wise says. “The investor group has a lot of money and is trying to compete, but farmers are the dominant force,” he says.

He expects combined earnings from land appreciation and rent to average 12% annually over the next decade. “If you look at the stock market over a 50-year time period, this exceeds total returns to the stock market,” he says. “That's why land is a pretty attractive investment.”

Rent plays catch-up

The late uptick in commodity prices and land values in 2006, combined with the normal lag between changes in land values and rents, is expected to lead to dramatic changes in cash rents for 2008 in some areas.

Farrell expects 2008 cash rents, which often are benchmarked at 4 to 5% of land value, to climb 25 to 30% in Iowa, Illinois, Minnesota and the eastern Corn Belt. He expects 20 to 25% increases across the Plains and along the Missouri River corridor.

Others expect lower, though still substantial, rent increases. For example, the Illinois land appraiser group's mid-year survey anticipates average cash rent increases of 11% for 2008.

In Iowa, Duffy notes that land rent prognosticators are of two minds. In a recent informal survey, most respondents expected increases for 2008 to be in the 20 to 25% range, although a smaller group said rents will be up 9 to 10%.

Future rent increases will probably be higher on land for which rent was negotiated before the commodity markets took off last October, Farrell says.

“If the 2007 rent was set in August 2006, the general market was flat or a small increase,” he says. “When we hit the November-December 2006 time frame, those farms that were not leased yet saw a tremendous premium. If you were one of the landowners who leased your farm out in January [2007], you aren't going to see the increases compared to those who leased in August [2006].”

Overheated, or new paradigm?

With farmland increasing an average 50% in value since 2004, with seemingly no end it sight, there's plenty of questioning about whether land values — and rents — are getting out of line. Schnitkey of the University of Illinois says that hasn't occurred so far, given the improved outlook for commodity prices since 2006.

“The answer to the question about whether land is overpriced depends on where you think commodity prices will be for the next few years,” he says. “Prior to 2006, the long-term projections were for corn prices at $2.40. There was real concern that land prices were overvalued versus the rent they could generate. Now, at $3.50 corn, the land value is not out of line, but it is close. You can make the case for $5,000/acre land in central Illinois, but if we have another double-digit increase, it will be out of line compared to the historical.”

“As long as land is priced for what it will earn, we won't have problems,” adds Duffy of ISU. “But I think there is always that danger that land prices will get out of line. We have had three golden eras in agriculture. One was the 1910 to 1920 period, and it was followed by a collapse. The next was the early 1970s, followed by a collapse in the 1980s. Now we are in the third era.”

Wise, of the Westchester Group, agrees that land values and rents need to be based on earning power over the long term. He sees huge upward potential for commodity prices and, consequently, for land values.

“I think from the American farmer's point of view, there will never be a more optimistic time,” he says. “American farmers should tighten their seat belts for a very good period. We are going through a once-in-a-lifetime experience.”

Wise argues that contrary to most periods of high commodity prices, which have been caused by supply shortages, the current market is dictated by burgeoning world demand for many agricultural commodities. “Ethanol is a secondary factor,” he says. “Global demand for commodities is the number-one driving force.

“I am not just talking about corn and wheat; it is most commodities,” he continues. “All it would take is one little downturn for the American or Brazilian crop and this thing would be explosive.”

Wise says that this continued upward momentum for commodity prices will easily fuel agricultural land price increases averaging in the 8% range annually for the next three years and 5 to 8% annually for the following seven or eight years.

Farrell at Farmers National agrees that there is plenty of momentum in the farmland market. “At this point, things are pretty exciting,” he says. “The euphoria about biofuels has permeated throughout the industry. We don't see the land market making huge increases in value, but a steady increase.”

Long-term strategies

Duffy advises approaching the current hot land market with caution. He notes that the number of parcels for sale is relatively small compared to demand, which is bound to inflate prices under current market conditions.

“This is a pretty thin market, largely driven by retirements and estate sales,” Schnitkey adds.

“There is a lot of exuberance right now; I am not arguing against that,” Duffy says. “But I am saying, let's be a little cautious.”

As farmers cope with the hot land market, in general they are on solid ground financially. “The agricultural sector has accumulated a bit of debt, but overall it is in pretty good financial shape,” Schnitkey says.

A recent USDA report notes that the average debt-to-equity ratio of U.S. farmers — 10.7% at the end of 2006 — is at a record low since 1970. That's about 20 percentage points lower than its peak in the troubled mid-1980s. Meanwhile, the average farmer has about twice as much capacity to repay debt as is being used. By comparison, in the early 1980s, the average farmer had virtually no ability to pay additional debt.

Farmers will face challenging decisions in the coming months and years as they adjust to higher land values. Duffy suggests that growers devise a long-term strategy to help guide their decisions. He advises using farm financial planning services such as those offered by the extension service in Iowa in plotting the future.

“Now is not a bad time to totally reevaluate your strategies,” he says. “The fundamentals have changed, so just tweaking around the edges may not be enough. It is going to be a high-risk environment. Ask yourself how you fit into this new world. You need to do more than just year-to-year planning.”

AGRICULTURAL LAND VALUE ESCALATION
  1998 2000 2002 2004 2006 2007 CHANGE
Corn Belt (IL,IN, IA, MO, OH) $1,730 $1,930 $2,180 $2,300 $3,050 $3,450 +199%
Lake States (MI, MN, WI) $1,280 $1,570 $1,870 $2,220 $2,840 $3,300 +258%
N. Plains (KS,NE, ND, SD) $499 $526 $571 $632 $840 $961 +193%
SOURCE: USDA Economic Research Service