Farmland values are an important indicator of the health of the U.S. farm economy. Farmland accounts for the vast majority of the assets of the farm sector. As farm incomes have decreased, indicators of farmland values have been observed for clues to how well they are retaining value.
Purdue University's farmland-value survey is one such indicator. It measures respondent views of the value of different categories of Indiana farmland. The most recent survey shows that farmland values have continued to decline from their 2014 peak.
Farmland values decrease
Average-quality Indiana farmland declined only slightly from 2018 to 2019. But the values have been on a decreasing trend since 2014. After reaching almost $8,000 per acre in 2014, the value of average-quality Indiana farmland values has decreased by 12 percent to $7,011 per acre in 2019. During that same time better-quality land decreased by 15 percent.
Those declines are relatively large by recent standards. But they pale in comparison to the 1980s when land-average and better-quality land values decreased by 57 percent and 55 percent, respectively.
Figure 1 shows real -- inflation-adjusted to 2019 dollars -- average-quality Indiana-farmland values reported by the Purdue University survey. One can observe two clear peaks in the series. The previous period of decline saw farmland value decrease for six straight years from 1981 to 1987. The current streak of declines stands at five years. But to date it has seen more-modest declines than in the previous downturn.
Lesser capitalization rates persist
One of the reasons the current situation has resulted in more-modest declines is that interest rates have remained stable. In the previous downturn both income and interest rates were changing rapidly.
The capitalization rate implied by Indiana farmland values and cash rental rates is shown in Figure 2. That's calculated by dividing the cash rental rate by farmland values. The current capitalization rate has remained at about 3 percent for several years now. In the previous major downturn, capitalization rate started increasing as farmland values decreased faster than cash rental rates. The ratio peaked at slightly more than 8 percent in 1986 before starting the decreasing trend that it has been on. Since 2011 the capitalization rate has been 3.2 percent or less; it has corresponded to the interest rates seen in the broader U.S. economy.
Farmland price moderates relative to revenue
One of the reasons farmland values have softened is that cash rents have been decreasing. That decline has coincided with the reduced income that farmers can expect farmland to generate. Figure 3 shows the ratio of farmland value to the gross revenue that farmland is expected to generate. It's a type of price-to-sales ratio. It was calculated by dividing farmland value by the expected revenue associated with the land. Expected revenue was calculated by multiplying the expected corn yield in bushels per acre by the market-year average price for corn in Indiana.
The 2019 estimate of corn yield was 175 bushels per acre. The market year average price was $3.70 per bushel as estimated in the July World Agricultural Supply and Demand Estimates report.
The figure shows that currently the price-to-revenue ratio is 10.82. It has decreased since reaching a peak of 13.04 in 2014. But it remains elevated by historical standards. Even in the late 1970s and early 1980s the ratio didn't increase to more than 8. That's in large part likely due to the general decline in interest rates that occurred since the 1980s. With reduced interest rates, market participants don't discount future earnings as heavily as they would with greater interest rates.
Rates have remained relatively stable in recent years. It appears clear that farmland investors have begun to ratchet down expectations for the revenue and net returns that can be generated from a farmland investment.
Where we stand relative to past
The final graph in Figure 4 shows how rent, yield, revenue and farmland value have evolved since 1976. In that case everything is shown relative to 1976. The yields associated with average-quality Indiana farmland have increased steadily during the time period. They now stand at 171 percent of 1976 levels. That 71 percent increase during the time period amounts to a compound growth rate of 1.3 percent. We would suspect that many people would have guessed that the growth rate would have been larger. But that's what was calculated from the data.
Cash rents, shown in blue, have increased by 168 percent during that time period, for a compound growth rate of 2.3 percent. That rents have grown faster than yields isn't surprising because the growth rate was calculated on nominal values, which are subject to inflation. The green line represents the change in revenue. After increasing much faster than rents in the mid- to late-2000s, revenue has declined to come back to almost the same level of total increase as rents.
The final line to discuss is farmland values, which are shown in purple. Even after the declines of the past six years, they have increased 510 percent since 1976 -- again in nominal terms. That shows the power of the decreasing-interest-rate environment during the majority of the time period and the lesser-interest-rate environment of recent years.
Farmland is a critically important asset in the farm sector. According to the U.S. Department of Agriculture's Economic Research Service, it's projected to account for 83 percent of all farm-sector assets in 2019. Changes to farmland values can significantly impact the equity position of the sector. As the U.S. farm economy has struggled through a period of depressed incomes, farm debt has increased. Much of the increased debt load has come in the form of debt backed by farm real estate. As such, changes to those values impact the collateral position of many agricultural lenders and the equity positions of farmers.
The five-straight years of declines in Indiana-farmland values indicates how generally poor the agricultural economy has been in recent years. There has only been one time since 1976 when farmland values have decreased that many years in a row -- the 1980s. One key difference between then and now is that the declines were much greater in the 1980s.
When the more-extreme declines occurred both incomes and interest rates were moving unfavorably. At present it has been only incomes moving unfavorably for farmland owners. The declines in Indiana-farmland values have moderated a bit after decreasing more sharply in the first part of the downturn. That likely reflects the opinion that revenues may be stabilizing.
Whether or not revenues stabilize will likely be the deciding factor in determining immediate future movements in farmland values. On one side of the ledger are the recent Market Facilitation Program payments, which will provide a welcome shot of liquidity. A quick perusal of county-level Market Facilitation Program-payment rates found only one in Indiana with a payment rate less than $50 per acre, and many in the range of $60 to $70 per acre. Some counties in other states didn't fare as well.
On the other side of the ledger the trade war continues to exact a significant toll on the economic prospects of the farm sector. That USDA has earmarked $23 billion of trade-adjustment payments -- $8.59 billion in round one and $14.5 billion in round two -- says a lot about the magnitude of the problem in the short term. Whether that money has been distributed appropriately or equitably in the farm sector is another major question.
If the trade war isn't resolved by the next planting season, one can expect the revenue associated with farmland will likely decrease further -- barring another major weather scare or additional trade aid. As we've argued earlier, payments of that magnitude will likely be necessary to keep the farm economy and farmland values afloat if the trade war persists. One can hope that a resolution may come. But at present the finish line appears nowhere in sight.
In the longer term the damages of the trade war are likely much greater than even those suggested by the large Market Facilitation Program payments. The trade war is clearly sending signals to our competitors for the Chinese market, that they should expand production. Increased expansion in those areas, particularly in South America, will create a price that will be paid for by U.S. farmers and U.S. farmland investors for many years to come. Visit aei.ag for more information.