Investing in farmland can be a lucrative option for investors seeking to diversify their portfolios using an alternative asset class. Farmland prices have steadily increased over the last two decades, due in part to the relatively low-interest rates that began after the financial crisis of 2008. When compared to other asset classes, cumulative farmland returns have outpaced the S&P 500, US Government bonds, commercial real estate, and gold over the past 20 years, making it an attractive alternative investment option and inflation hedge. However, farmland investing is not without risk and should be considered carefully before making any investment decisions.
How Farmland Earns Returns
Farmland investors can earn returns in three ways: capital appreciation, distributions, and partnerships. Capital appreciation is a rise in farmland prices due to the increase in demand for agricultural products. It can also be caused by a decrease in farmland supply. According to a report conducted by the American Farmland Trust, the supply of arable land in the US decreased by 31 million acres between 1992 to 2012. Similar supply trends have been seen across the world and are expected to continue as farmland is converted to other uses, such as residential and commercial developments.
Distributions are a cash tax liability that farmland owners receive from their farmland leasing tenants. These payments can come in the form of rent, sharecropping, or lease agreements. For farmland distributions to be classified as qualified dividends, they must meet certain requirements set forth by the IRS.
Farmland investments also offer opportunities for partnership through farm management funds or limited partnerships (LPs). The investor contributes money in exchange for a share of future distributions and/or appreciation. Partnerships can combine resources in the purchase of farmland or other farmland investment opportunities, allowing tenants to lease farmland while limiting risk exposure due to tenancies not fully funding land purchases.
Historical Performance of Farmland Investing
Over the past three decades, farmland prices have appreciated at an average annual rate of 5.4%, outpacing the Consumer Price Index (CPI) by 2%. With inflation rates in the US and many other parts of the world at or above their 30-year highs in 2021, investors have been turning their attention to farmland as a way of protecting or growing their capital. According to the TIAA Center for Farmland Research at the University of Illinois, farmland has a 70% positive correlation to inflation, making farmland a viable hedge against the rising cost of living.
The farmland market is relatively small compared to other categories, with approximately $260 billion in farmland assets under management. While this may seem like a significant amount of money, it's worth noting that this represents just 0.5% of total assets under management globally, according to the GIIN. This suggests that farmland investing is still in its early stages of development and has the potential to grow as investors become more aware of the investment opportunity.
Returns on farmland investing vary greatly depending on the location and quality of the farmland, as well as the current market conditions and proximity to metropolitan areas. For example, between 2020-2021, farm real estate average value per acre increased 2.7% in the Southeast compared to 9% in the Southern Plain states of Oklahoma and Texas. From 1991-2021, aggregate returns on farmland investments averaged 12.2% according to data collected from the National Council of Real Estate Investment Fiduciaries (NCREIF). Compare this to the returns of the S&P 500 (11.12%), commercial real estate (8.3%), US Government Bonds (6.1%), and Gold (5.4%) over the same time. Farmland's recent performance has been heavily influenced by low-interest rates, causing demand for farmland to increase as investors seek out assets with higher yields and less volatility than traditional investments. The income capitalization model for farmland valuation suggests an inverse relationship between farmland returns and interest rates. When risk-free interest rates rise, the value of farmland can be expected to decrease based on the principles of this model.
Several other factors have affected the recent increase in demand for farmland and its corresponding market value as well. The increased demand for ethanol and biofuels, especially during the early part of this decade, has driven up the price of corn and soybeans, which account for a significant portion of farmland value. Higher crop prices lead to higher land values which yield higher farmland returns. Another contributing factor is the growth in the global population, which is projected to reach 9.7 billion by 2050. This growing population will need to be fed, and farmland will be needed to meet this demand.
A Great Diversifier
Farmland investing can provide investors with a stable stream of passive income from rent, while also preserving their capital investment. In times of market volatility, farmland is often seen as a safe-haven investment due to its relatively low correlation to other major asset classes (Figure 1). For example, during the economic recession in 2008 when the S&P 500 lost 46% of its value, the NCREIF Farm index climbed 17%.
Figure 1 - Source: Spaventa, S. (2021, July 12). Farmland's lack of correlation to major asset classes. FarmTogether. Retrieved December 11, 2021, from https://farmtogether.com/learn/blog/farmlands-lack-of-correlation-to-major-asset-classes.
Before investing in farmland, it's critical to partner with a farm manager who understands the farmland investment landscape and has an established farmland management operation in place. While farmland investing has traditionally been reserved for accredited investors, non-accredited investors can now enjoy similar benefits through real estate investment trusts (REITs) and crowdfunding farmland platforms like AcreTrader and FarmFundr.