Interest rates remain low | FCC offers outlook
Falling commodity prices could put downward pressure on land rental rates, but it will take a while before they adjust, according to a Farm Credit Canada analyst.
Crop receipts are the biggest influence on rental rates. A bumper crop in Western Canada could offset slumping prices this year, but the outlook is for tighter margins over the next decade.
The U.S. Department of Agriculture’s long-term outlook to 2022 calls for crop prices that will be better than they were before the bull market but well off the lofty levels they have been at over the past three years.
“The average price of corn for the next 10 years is (forecast at) $4.60 (per bushel),” said FCC agricultural economist James Bryan in a recent webcast.
Prices at that level would squeeze crop receipts, reducing the rates landlords can charge renters.
“It’s possible to see some pullback in rental rates,” he said in an interview following the webcast.
“Depending on the area and depending on how competitive the rental market was, you might see some fallback, but not necessarily dramatically.”
He said it would likely take several years for rates to fully adjust because they tend to lag well behind commodity price changes.
“Rental rates seem to be sticky on both ends,” Bryan said.
“They don’t go up as fast as you might expect, but they also don’t come down as fast as (you) might expect.”
Growers often sign multi-year agreements, so it takes a while to adjust to the new reality in grain markets. Rates also tend to be set at the beginning of the year, well in advance of that year’s commodity price movements.
Rental rates have been climbing during the recent bull market but not nearly as dramatically as the increase in crop prices. One reason for the muted response is low interest rates, which is the other major factor that influences rental rates.
The Bank of Canada hasn’t changed its overnight rate of one percent since September 2012.
Low interest rates bolster land values because it makes debt more affordable, but it has the opposite effect on rental rates.
Landlords are willing to accept a smaller percentage of their land value as a rate of return when interest rates drop because they have to remain competitive with alternative safe investments such as savings accounts and bonds.
Interest rates are forecast to remain low for much of next year, but they will eventually rise from today’s rock bottom levels. This would increase pressure on rental rates, helping offset the downward pressure of falling crop prices.
“Right now we have two factors working in different directions,” said Bryan.
Statistics Canada says that 39 percent of Canadian farmland is rented with 22 percent in cash rental agreements, 13 percent leased from government, three percent in crop sharing arrangements and one percent in other types of agreements.
Bryan said 76 to 80 percent of the rental agreements in Alberta and Saskatchewan in the last three years have been cash rental.
“Definitely cash rental is the way it seems to be going,” he said.
“It’s simple and it’s easy to understand.”
He suspects another reason is that landowners are becoming increasingly removed from the farm and less comfortable and informed about grain markets, so they’re leery of crop sharing arrangements.
The most common contract is still a one-year lease, which gives both parties the flexibility to respond to changing market conditions each year.
Farmers might have the mistaken impression that the rental rate is the most important factor for a landlord. That is not the case, according to a U.S. survey showing that factors such as trustworthiness, reputation and paying on time take precedence over the rate.
Rental rates can vary widely. Saskatchewan Agriculture data from last year found that rental rates for non-family members in the province were $6.25 to $140 an acre. The average that year was $35.65 an acre.
Bryan said determining a fair rental rate starts with the quality of the land. Is it tile drained? Are there wet spots? Will fence lines get in the way? What is the soil type? What chemicals have been used on the land recently? Does the landlord insist on a particular rotation?
“That really can impact what your profit is,” he said.
However, he said one factor is more important than all others when it comes to establishing a fair price.
“Knowing your cost of production is absolutely, 100 percent, the most important thing that you can know to know how much you can pay for land,” said Bryan.