The Farmland Price Bubble

I recently heard of Iowa farm prices soaring to new record highs, some even as high as $20,000/acre.  The Realtors Land Institute reported in September 2012, that tillable land prices in Iowa increased by an average of 7.7% compared to the preceding 6 months.  In the 3rd quarter of 2011, the seventy Federal Reserve District reported land values increased 25% on a year-to-year basis.

We have all seen farmland increase in price substantially since food prices began to climb in 2007.  Here in the Dakotas, the increase has grown exponentially in some areas with the discovery of oil or natural gas.  But an overriding question is, “Will the inflated bubble of land prices pop and if so what will be the effect?”  Will we have another disaster like we had in the 1970s in agriculture, or another crisis like the recent housing crisis?

In the farm crisis of the 70s and 80s, total farm debt to net farm income was as high as 14:1, that is $14 of debt for every $1 in income.  Currently, the debt to income ratio has been closer to 2:1.  Data from the USDA shows the debt repayment capacity of utilization (DRCU) ratio is falling.  DRCU shows the ability of the farm sector to repay its debt over time using just farm income is still under 40%.  At the height of the farm crisis in the 80s, the DRCU was near 110%.  Debt-to-equity values are at 11.7%, showing a strong reliance on equity instead of debt to fund farms.

Part of the reduction in the ratios is from farm asset values increasing, but a lot comes from a more conservative approach to farm debt with producers and investors applying more cash equity into the project and lenders applying lower LTV limits than what they did in previous times.  Entities like Farmer Mac have recently reduced their top LTVs they will look at in areas with steep land price increases.

Clearly, the leverage applied to farms is not near what was used in the housing crisis.  A 2010 survey by the Federal Reserve Bank of Kansas City showed an average LTV of 70% of the land value.  At the peak of the housing bubble, the National Association of Realtors reported in 2006 that more than 40% of borrowers bought a house with absolutely no money down, giving a LTV of 100%.

Even though the farm economy is rather healthy now, caution should be applied.  Some strong growth-oriented producers and young farmers may be leveraged highly or are using long-term, high-priced contracts for leased farmland.  Any correction in commodity prices will compress their operating margins to the point of making the credit a problem loan. 

The lending landscape in agriculture has changed.  In the 70s, farm debt was spread out over a large number of farms and ranches.  Now, it is more concentrated with 10% of the farms generating 80% of the agricultural revenue and carrying 60% of the U.S. farm debt.  The risk today is any third party risk and how US farm debt is interconnected.  Today, if a large producer has a down year, contracts, farm alliance obligations, and ownership interests can make the complex loan a risky portfolio concentration. 

Long term cycles tend to repeat themselves every 30 to 50 years and today we sit nearly 30 years since the last dip.  Some will argue that we are due for a correction, but how severe is yet to be seen and the lack of high leverage in the Ag community points to a softer landing.