ST JEAN BAPTISTE, Man. — There’s a basic question that farmers need to answer before they agree to high-priced land purchases or rental deals.
“Why are you doing it?”
That’s something Roy Arnott of Manitoba Agriculture’s Farm Management branch says farmers need to grapple with if they want to farm with any reasonable hope for profits.
“Knowing and understanding risk in this land racket is huge. Just because you can (finance a land purchase) doesn’t mean you should.”
Land prices escalated around 2010 and continued to increase, although more slowly, after the commodity boom ended in 2014. Those increases have taken land prices far above the levels of the mid-2000s and put much more pressure on profitability, on both purchased and rented land.
Arnott said farmers need to judge land prices against the cost needed to pay off the debt and how much of the returns of their equity base each purchase will consume. With land often taking 20 years to be paid off, farmers must understand the true costs involved.
That means not just looking at the land cost and debt payments versus operating costs or hopeful yields and prices, but against reasonable expectations for production results and interest rates.
If total costs, including labour, machinery payments and other significant factors, aren’t included, or debt payments are not assessed when looking at the impact of possible interest rate increases, farmers aren’t getting an accurate sense of the risk they are taking on and the costs they are paying.
One cost often ignored is the need to produce some income from farming. Life on a farm has costs and those have to be covered, however the crops turn out.
You can’t always trust your lender to advise you well on whether or not to make a land purchase.
“Just because the banker says you can afford it, do you want to risk it?” said Arnott.
“What is your comfort level?”
Another way of looking at the opportunity cost of buying land is to compare its carrying cost against the profits produced by owned acres. Are you willing to see the returns from three acres owned completely consumed in paying for an acre purchased? Or are you only willing to have two acres funding (and being put at risk for) the purchase of an acre?
That will greatly affect how much you should be willing to pay.
“What are you putting at risk to do this?” said Arnott.
Once some land is purchased, future land purchases become more risky as the farm’s equity base is diluted.
“Pay attention to your equity in a big way, because that’s going to have a huge impact on whether or not you’re going to break even,” said Arnott.
“Equity is great in terms of competitiveness and resiliency, but careful what you do with it.”
The intense competition among farmers for rental land also creates dangerous financial dynamics.
“Everyone either wants more (for the rental land they own) or is trying to figure out how to pay more,” said Arnott.
Rental rates aren’t transparent. There are general listing services, and each quarter’s value is based on specific productive capabilities.
Arnott has been developing and customizing land rental calculators for Manitoba conditions, which Manitoba Agriculture has published in a RentPlan guide.
It is available online at manitoba.ca/agriculture.
The calculations look at the cost of rent compared to operating costs and against gross revenues, plus a host of other factors, compared to expected production and returns.
The results can be sobering, raising the question of why a farmer would be willing to pay more for land than can be likely covered by expected returns.
To protect renters and reward landowners, Arnott recommends farmers consider “flexible land rental” agreements, which connect farming results to rent. The base rent can be set on a farmer getting expected returns, but can be discounted if he only gets a reduced result, such as 80 percent, or increased if he achieves something like 120 percent of expectations.
“If the landlord wants to get the big bucks for the land, I think he needs to take on some of that risk,” said Arnott.
Many farmers are willing to pay more than Arnott considers reasonable for both purchases and rent situations, and often farmers tell him his views aren’t realistic.
But as an analyst, he has a question for them: “Show me where I’m wrong.”