Indexes designed to reduce risk of falling farmland value

It isn’t a big risk in any one year of farming, but farmland value is the biggest risk to a farmer’s overall lifetime wealth.

An American financial risk management developer is looking for a way to hedge that risk by creating farmland price indexes that can serve as the basis for farmland derivatives.

“I just don’t see anything that’s as strategically important as farmland,” said Paul Kanitra, founder of PeakSoil Indexes, which offers farmland sales indexes for a number of U.S. states including Iowa, as well as a Saskatchewan farmland index.

Kanitra’s indexes aren’t designed primarily for farmers, but I can see them acting as the basis for land value protections that many farmers might want to use.

Often the only things a farmer has left after a lifetime of farming is farmland and some worn-out machinery. As a result, anything that could substantially reduce the value of the land is a huge risk to a farmer’s retirement.

However, until now it has been hard for farmers to reduce that risk.

The value at risk has become astronomical as land prices escalate.

For example, a farmer who is approaching retirement with $10 million worth of land that drops in value by 25 percent will potentially be out $2.5 million. When land makes up 90 percent of a farmer’s net value, that kind of a reduction could mean a big difference in the farmer’s retirement lifestyle.

For younger farmers, a drastic decline in farmland value could destroy the financial basis of the farm and make it hard to expand.

Kanitra’s farmland value indexes aren’t based on surveys of what people say farmland is selling for — it’s actual sales prices.

He wouldn’t tell me exactly how he gets those hard numbers, but assured me they are actual dollar values of real sales.

With enough data points and representative farming areas, such as Iowa and Saskatchewan, Kanitra thinks his indexes can become the underpinning mechanism on which financial instruments could be designed.

Kanitra said over-the-counter products are the most likely first users of the indexes, but even farmland futures contracts could eventually be designed with the indexes as bases.

Kanitra sees institutions such as banks and investment funds will want to use farmland value derivatives because they often have significant exposure to swings in farmland values but no good way to hedge the risk.

He also sees the indexes as foundations for instruments that will allow investment funds and other speculators to invest in farmland values without actually having to buy the land. Most of those funds don’t want to own land, but it’s now the only good way to directly invest in farmland values.

This is an interesting subject for me because in 2006 I asked famed commodity investor and guru Jim Rogers about the possibility of creating farmland derivatives when I met him in New York. He explained to me the daunting challenges of finding a way to do it with common derivative instruments.

He launched his farmland investment fund a few years later, and various other farmland investment funds have been launched around the world. However, almost all are based on buying and holding real farmland.

Kanitra hopes his indexes can help develop farmland derivatives that investors could use to invest in farmland values without becoming landlords.

I imagine farmers will most likely see these indexes, if they work well, indirectly. They will probably be operating in the background, behind various contracts or forms of insurance offered by their bankers or other financial institutions.

In whatever way they end up working, if they begin offering a way for farmers to hedge their massive exposure to farmland values, they will be a big step closer to being able to reduce a massive risk that now hardly gets noticed.

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