Wednesday, November 23, 2011

Private equity real estate or farmland?

Dr. Keith Black of the CAIA Association says for many investors, farmland falls somewhere between real estate and commodities.

"It’s basically private equity real estate,” he explains. “You have a farmland manager who acquires and manages the property for investors in a private partnership for maybe 10 years, owning and operating the farmland. But farmland responds differently to inflation than an office building does. Unlike the fixed leases and maintenance and depreciation costs on an office building that make it more like a 10-year bond for investors, with a value that declines with inflation, farmland is leased in one year cycles with income closely correlated to crop values. And you don’t have the depreciation and maintenance you see with real estate.”

World Agriculture Investment Conference October 4-5, 2011

There are significant differences between commercial real estate and farmland. It is simplest to start with supply and demand. Commercial real estate is sensitive to new construction. The supply will grow with construction and fall with depreciation and usage. There may a limited number of good properties but new supply can be be introduced to the market. That is not the case for farmland. There is limited number of acres of farmland and the supply is decreasing with urban sprawl. Farmland is also depreciating because of erosion and soil usage. The supply for new farmland will not get larger. Marginal land could be added but the size is limited. Switching of crops is also possible but again swithcing is limited.

Cash flows will have differences. Farmland will also be more sensitive to commodity prices because lease rates are reset every year. Farmland will also be affected by farm margins, so input costs are more important. This would be the equivalence of maintenance on a building. Farmland has higher risks in the short-run because weather will have a significant effect on the ability to pay leases. Prices can rise but if the quantity is reduced on your specific farmland, the value for income production is lower.
Real estate and farmland should be viewed as separate assets. Farmland is a commodity income and long-term price play and would be different than a commodity or commercial real estate venture. 

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