Examining the source of farm equity
During the past few years, farmers also have seen a dramatic change in net worth. The average net worth went from $600,000 in 2007 to just more than $1.3 million in 2012.
The question becomes: Is that change in net worth driven by changes in asset values or retained earnings? In 2007, the average net farm income was $192,200. In 2012, the average was $367,317. With this increase in farm income, have farmers been putting those earnings back in the farm or has the change in net worth been driven by appreciating farmland values?
My colleague Frayne Olson and I have analyzed data from 1998 through 2012 to help find the answers. We divided the data into two time periods: 1998 through 2006 and 2007 through 2012. The shift that occurred in agriculture in 2007 would provide a reference point.
Based on our results, farmers during the most recent time period (2007 through 2012) are relying more on retained earnings to build net worth than asset revaluation. In other words, most farmers have been using their earnings wisely.
Perhaps a partial explanation for this change could be lenders shifting focus to earnings-based decisions vs. asset-based decisions. The 1980s farm crisis illustrated the dangers of asset-based lending decisions. Although proper assets must be in place to justify a credit decision, lenders also are requiring sufficient earnings/cash flow to secure credit.
So what does this mean for the future? What happens if land prices fall? What happens if prices do not rebound? I wish I had a crystal ball and could forecast the future accurately. Although I am unable to forecast the future, I believe that we can agree that commodity and input prices will continue to be volatile, which highlights the need for sound financial management.
The hope is that farmers, lenders and researchers can use the lessons from the 1980s financial crisis and the recent agricultural boom to help avoid any future crises.
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