Interest rates impact farmland in a few ways. Farms are operating businesses in addition to serving as investment properties, so they are particularly sensitive to changes in interest rates. The cost of farm credit not only depends on the credit of the individual farmer but also on the availability of capital.
Large national banks, for example, have occasionally been in the farm market. When they are active, there is more competition for the banks, and this can drive the cost of borrowing down, which is good for farm values.
We recently discussed the impact of interest rates on farmland with Howard Halderman, President of Halderman Land and Farm Management. Howard provides strategic direction for the firm, along with identifying new business lines and sourcing new clients. Our questions for Howard are in italics.
What are the areas that drive farmland value, and how do interest rates come into play?
The first variable affected is farm income. Farm income is a function of yield and price, along with the expenses of getting crops and livestock to the market place. For farmers who have to borrow capital for their operations, interest can be a large component of their overall expenses. Higher interest rates translate into higher costs of production and lower income.
Interest rates also affect farmland values insofar as more farm income creates the ability for farmers to be more competitive and bid up rents. Higher rent contracts increase the cap rates and internal rates of return (IRRs) for farmland owners.
Finally, the basic supply and demand equilibrium drives farmland prices. During certain business cycles there may be a lot of investors in the market to buy, and this naturally drives prices up. Interest rates of course play a factor in investor demand, but farmland values can remain relatively stable even in a higher rate environment.
Do high interest rates correlate with farmland values?
Actually farmland values are inversely correlated with interest rates. Not only do higher interest rates mean higher costs and lower profits for farmers, but alternative, low risk investment vehicles like CDs divert investors away from farmland. This in turn reduces demand for farmland and lowers prices.
Alternatively, in a low interest rate environment like the one we've been in for the past several years, bank-insured investment products have bee paying extremely low yields. Farmland generates cash returns of approximately three percent, which in this economy is very attractive, particularly when an investor can "walk" on their investment.
In an extreme case that has actually come to fruition, investors in Europe are fleeing a negative interest rate environment. They literally receive negative returns from their banks in some situations. For them, anything positive is an absolute home run.
Farmers and landowners need to be aware of the potential impact of interest rates when structuring agreements.
Halderman Real Estate & Farm Management has helped farm owners and farmers weather interest rate fluctuations through several generations. We look forward to discussing how you can mitigate the risk of changing interest rates and maintain profitable and healthy farm operations.