by Ron Beach, Peoples Company
During the past five years productive Midwest farmland has emerged as an institutional asset class. As investment portfolio managers have been faced with greater uncertainty, increased volatility and persistently low returns in the traditional investment markets many have recognized farmland as an attractive addition to their investment portfolios.
As an alternative investment, farmland has attracted these institutional investors by: (1) being an attractive portfolio diversifier, (2) performing as an historical inflation protector, (3) providing a stable and sustainable annual cash income and (4) being an opportunity to participate in the rising global demand for food, fuel and fiber. In addition to these financial rewards, there are social rewards that come from contributing to the preservation, stewardship and conservation of this vital natural resource.
While these attractive investment features have recently been “discovered” by many in the institutional investment world, here in Iowa we have intimate first-hand experience of how farmland can enhance an investment portfolio.
Portfolio Diversification – Farmland occupies a relatively unique space on the investment continuum with high total returns (income and appreciation) and moderately low volatility (as measured by standard deviation). Farmland returns have a low or negative correlation with traditional asset classes of stocks and bonds. Chart 1 shows a statistical summary of the return performance and volatility of farmland, equities and bonds over a 53 year period. Overall, farmland generated both a higher return and a lower volatility than the other two classes. These features alone make farmland a nice method for diversifying an investment portfolio.
Inflation Hedge – While inflation has not been a significant issue for quite some time, current monetary and fiscal policies world-wide create a climate of uncertainty about the future of inflation. The present state of low inflation is not indefinite and at some point will turn and trend higher. Farmland has historically been an asset providing a good hedge against inflation, thus protecting the investor from value erosion. Chart 2 shows how farmland returns have performed during periods of high, medium and low inflation. Again, an investor benefits from the inclusion of farmland in their investment portfolio.
Annual Income – Farmland has been referred to as “gold with a dividend”. The crucial difference between these two assets is that productive farmland has demand for its tangible real production while gold relies on intrinsic value. During the holding period of a farmland investment the investor realizes positive annual cash income which is not the case with gold. Farmland is also distinctly different from other real estate investments because the demand for the production from farmland creates an environment in which farmland has a zero vacancy rate. There has always been demand from farmers for access to farmland and it has always generated a positive cash return. This is a feature that significantly reduces the volatility of the investment.
World Demand for Food, Fuel and Fiber – The United Nations forecasts that world population will increase from 6 billion to 9 billion over the next 40 years. That equates to an additional 205,000 mouths to feed daily. And thanks to a growing world-wide middle class, especially in the two most populous nations of India and China, the demand for higher level meat proteins multiplies the demand impact on grain-producing farmland. While demand will always ebb and flow, the demand trend is higher. And unlike a bond investment, the yield (cash rent) can rise over time and keep pace with inflation. This rising demand is favorable for both land values and land rents. Also, investors can more directly take part in this demand via crop share leases or custom farming.
Finally, another factor favorable to investors is the disruptive demographics within the farmland market place. The average age of the American farmer is 57 years and rising. That’s 17 years older than the average American worker. The only age group of farmers with significantly increasing numbers are those 70 years and older. On the other hand the number of farmers 25 years and younger continues to decline. In the state of Iowa, 30 percent of the farmland is owned by people 75 years and older and another 26 percent by people 65-74 years old. That means in the next 20 years nearly 56 percent of Iowa’s farmland, or $150 billion in farmland assets, will generationally change hands. In the past 20 years the turnover was 43 percent. This acceleration of turnover and declining number of farmers result in a set of disruptive demographics within the farmland marketplace that creates favorable circumstances for investors.
Natural resources don’t get any more basic than farmland. Combined with water and sunlight this investment literally feeds and clothes the world. So while there are various methods for investing in the increasing worldwide demand for food, productive farmland is arguably the most fundamental, tangible real asset in this class.
Ron Beach works in the Land Investment Programs division of Peoples Company based in Des Moines, Iowa, where he assists farmland investors in analyzing and executing their buy, sell or hold strategies and sources farmland transactions between investors wanting to buy farmland and farmers wanting to add leased land to their base of acres.