A laundry list of factors can support or sink farmland values. In the past few years, values have been surprisingly resilient. Looking forward, however, prices may lean lower, according to a recent report from the Federal Reserve Bank of Kansas City.
In 2018, the spread between returns to farmland owners and benchmark interest rates narrowed to its lowest level in more than a decade in the Tenth Federal Reserve District. At the same time, farmland sales increased in some states for the first time in several years.
“Together, the reduced spread and indications of increased sales in some regions suggest the potential for lower farmland values moving forward,” write Cortney Cowley, economist and Nathan Kauffman, vice president and Omaha branch executive, for the Federal Reserve Bank of Kansas City.
How did farmland values arrive at this crossroad?
Over the last four years, low commodity prices have pressured farm real estate markets. From 2013 to 2018, U.S. farm income declined more than 50%, and working capital declined 65%. Despite these developments, the Federal Reserve Bank of Kansas City’s Survey of Agricultural Credit Conditions shows farmland values were stable or modestly lower. From 2013 to 2018, cropland values in the Tenth District declined only 16%.
Strong farmland values have helped farmers survive the tightening of farm financials. A majority of Tenth District ag lenders reported using increased debt restructuring or increased use of real estate collateral during the current economic downturn. In the last three years, 20% to 30% of agricultural loans have involved restructured debt.
Even with stable farmland values, risks of declining values are increasing. For instance, the chart below shows that capitalization rates, which can be calculated as the ratio of cash rents to farmland values, have decreased continuously over the past decade. The cap rate has fallen from 5.4% in 2009 to 3.3% by the end of 2018. Cap rates show the annual rate of return a buyer or investor expects to receive on farm real estate, according to the economists. Therefore, lower cap rates imply, from an investment perspective, land owners are receiving lower returns on capital invested in farmland.
The decline in capitalization rates coincided with a rise in interest rates. The gaps between the blue line and the green and orange lines in Chart 2 show that in 2018, the spread between cap rates on farmland and risk-free returns narrowed to its lowest level in 10 years.
Another factor tugging farmland values lower is a recent increase in farmland sales in some states. A majority of ag banks in Kansas and Nebraska reported an increase in the volume of farmland sales in 2018 relative to the previous year. Although the volume of farmland sales declined in other parts of the District, the overall pace of the decline slowed considerably.
Combined, the uptick in farmland sales in some states, higher interest rates, persistently low commodity prices and the lower spread between returns to farmland and benchmark interest rates suggest farmland values could decline further, Cowley and Kauffman note.