The basic law of supply and demand suggests that farm rents and values should react to changes in commodity prices. However, looking at trends in farmland value, it is apparent that prices are “sticky down,” to use an economics term. In terms of volatility, commodity prices have the most, rents are moderate and land values are the least volatile.
Values that are “sticky” are slow to react in response to underlying commodity price changes, driven by supply and demand factors. There are a number of reasons why changing commodity prices may not impact farm rents and values as much as you would expect in the short run.
Commodity supply and demand
Commodity prices certainly do affect values, but since they are susceptible to short-term effects like weather and trade disruptions, their impact may not be great unless the market interprets these factors as long term, covering multiple years. The price of a commodity is set at the point where the supply and demand curves intersect. Low commodity prices tend to drive demand up, in turn raising prices again. However, the relationship between lower (or higher) commodity prices, farm rents and farmland values is not so simple.
If weather or trade agreements change either the supply or demand curves, a shift can occur up (higher prices in the long run) or down (lower prices) depending on current trends. Big yields or decreasing demand create excess supply and lower prices near term.
This would be the case if an industry like ethanol began to use less corn or substituted another commodity, creating less demand (and lower prices) and shifting the curve downward. Similarly, if the trade war with China remains unresolved, producers will be left filling the void and taking less per bushel for soy due to losing a very large customer for their product.
Land economists point to three factors that increase land value. Robust product yields, low interest rates and a limited supply of available farmland will generally push farm rents and values higher. These factors will even tend to raise the values of poor-quality farmland. When good yields combine with average to above-average prices, rents and values may increase quickly.
Occasionally, there is a discrepancy in terms of how quickly cash rents and farm values increase. Cash rents may be trending up due to strong yields, but farm values may be outpacing these gains. In some cases, prevailing low interest rates may induce investors to shift out of alternative investments, in turn driving up the price of farmland.
When the yield curve flattens for long-term treasuries, investors are inclined to accept lower yields for their investments, and these include farmland. Also, if interest rates are low, this tends to drive the dollar lower, in turn boosting demand for U.S. exports. With increased demand, commodity prices start to climb, driving up profits and cash rents.
The counterbalancing effect of commodity prices tends to push farmland values toward equilibrium, excluding exogenous shocks like trade wars and weather disruptions. As the price of commodities increases, farmers tend to increase production, which, absent other major impacts, leads to a supply imbalance and a reversion to lower prices.
The reality though, is that markets are not that simple. Commodity prices, government subsidies, crazy weather patterns and trade wars are becoming the new normal. If you need guidance through turbulent times, know that Halderman Real Estate and Farm Management has been there for its clients for several generations and stands ready to serve your farm management needs.