By special guest author Brad Hargreaves
From family offices to doomers to institutions, investing in farmland is back in vogue.
Of all the alternative real estate investment sectors, farmland is among least appreciated and understood. Loved by billionaires, inflation hawks, and doomsday preppers alike, farmland is in the midst of a renaissance as an investment category. Today, we’ll study farmland as an investment.
The USDA estimates that US farmland is a $3.4 trillion asset class—approximately the size of the US multifamily sector—yet it sees a tiny fraction of the transaction volume and institutional interest of other real estate food groups. A majority of US farmland is held by long-term family owners, many of whom have held the land for generations with very low (or zero) leverage. Over 60% of US farmland is held by owner-operators, and far less than 1% of it trades every year.
For a number of reasons—shrinking inventory, loose capital markets, and increasing investor interest—farmland prices have increased dramatically in recent years after decades of stability. According to the USDA, average farm prices have risen more than 20% over the past two years to $3,800 per acre, proving its worth as an inflation hedge and drawing further investor interest.
This article will cover:
- Macro trends drawing investor interest to the sector;
- Typical farmland investment profiles including target yields, IRRs, leverage, and deal sizes;
- Forward-looking analysis including potential headwinds.
Why Farmland?
Farmland is increasingly attractive to investors for a few reasons. One, the supply of it has been steadily declining for decades. Since 2000, the US has lost almost 50 million acres of farmland—5.3% of the nation’s total—an amount of land equivalent to the State of Nebraska in size. Greenfield development is a major driver of farmland loss; suburban housing developments, retail centers, and Amazon distribution facilities all occupy previously agricultural land. Marginal farmland has also been allowed to re-wild and return to forest, a trend that is seen most strongly in the northeastern US and even more dramatically in Europe.
Furthermore, the amount of farmland is practically limited. While farmland is easily lost to development, it is very expensive—and often environmentally discouraged if not prohibited—to convert non-farmland into net new farms. While some new farmland was created in the 2008-16 period in response to investment in biofuels and ethanol subsidies, it did little to reverse a multi-decade trend of farmland loss.
Farms have also benefitted from advances in technology—which have increased productivity and driven down operating costs—without facing existential, disruptive threats from new models. While we’ll discuss headwinds later in the letter, potentially disruptive innovations such as vertical farms, hydroponics, and lab-grown meat haven’t yet come close to competing against traditional farming methods in the largest product categories such as corn, soybeans, wheat, beef, and chicken.
Historically, farmland has shown high returns and low volatility. The net result of these trends over the past 50 years have been very positive for farmland owners; the asset class has seen solid returns without strong correlation to other investment categories or significant volatility. Since 1970, US farmland returns have exceeded the S&P 500 while exhibiting little correlation to other major sectors.
Segmenting Farmland
Not all farmland is the same, and farmland returns are driven by a variety of factors. At the highest level, farmland’s return profile is driven by two big things: (a) the productivity of the land and (b) the potential to turn the land into something else in the future; e.g., a housing development.
It’s impossible to divorce farmland returns from the underlying productivity and profitability of the land. The quality and fertility of the soil, availability of water resources, climate, and suitability for specific crops or livestock are primary determinants of productivity. The geography of the land, including its topography and size, also matter, as does its proximity to markets and infrastructure such as roads and utilities. And regulatory factors like environmental regulations and agricultural subsidies can play a big role in determining yield and profitability.
Like other real estate food groups, farmland is divided into classes that roughly correspond to the area’s productivity and reliability as a farming area. Prime corn-growing land in Iowa or Indiana, for example, would be considered Class A (or “core”) farmland. Cold, dry land suitable for wheat or grazing in Montana or the Dakotas, on the other hand, would be considered Class B (or “value-add”) land.
Farmland investment also varies based on the types of crops that are grown on a given piece of land. In general, there are two types of crops: row crops—which are planted anew every year—and permanent crops like trees and bushes that persist year-over-year. While row crops are fairly straightforward from an underwriting perspective, permanent crops add complexity as they take several years to mature and must be replaced on a regular basis, so they depreciate over time. This depreciation impacts the farm’s value but can also provide tax benefits.
Land prices—and the prospect for land price appreciation—also must take a farm’s future development potential into account. Buying farmland near growing cities or major distribution corridors (like interstate highways) can be viewed as a form of covered land investing. That is, the farmland is being used for agriculture now, but due to urban sprawl or changes in zoning laws, the land may be more valuable in the future for non-agricultural uses. In these scenarios, the land’s value is some combination of its current yield and its future value as a development site; these farms tend to trade at lower cap rates.
Approaching Farmland as an Investor
Historically, investors gained access to farmland as an investment category by simply buying farms. And many investors—particularly ultra high net worth individuals—still do. Bill Gates, for example, has purchased more than 270,000 acres of US farmland, making him the largest landowner in the United States and fueling no shortage of conspiracy theories.
But for most investors—institutional allocators as well as families and individuals without Gates’s resources—buying farms outright requires a tremendous amount of commitment and experience, especially given the scarcity of large, profitable farms sold through a public process. These investors are looking for a more accessible route to gain exposure to farmland.
Structuring Farm Operations
Financially, farmland operations tend to follow a few structures:
Direct Farming
In the direct farming model, the farm is owned and operated by one entity. While this is how the majority of farms operate in the US today—with one farming family or organization both owning the land and operating the fam—it is relatively rare in the world of farmland investing in which the real estate and the operator are separate entities. Unlike (say) the hospitality industry, agriculture hasn’t yet gone through the widespread disaggregation of operations and ownership, so direct farming models are still commonplace.
Net Leases
Net leases are the simplest type of structure out there. In this model, the farmland owner will sign a net lease with the farm operator, ensuring a steady cash flow for real estate investors while giving the farmer the upside (and downside) of variations in productivity and yield.
This structure is not as risky for the farmer as it may seem; the Federal Crop Insurance Program has protected farmers from losses since the 1930s and currently covers 74% of all potential output liabilities of US farmers.US farmers. So even a particularly bad harvest would be unlikely to cause a farmer to default on their lease obligations.
Federal crop insurance now protects a significant majority of all planted acres in the US.
Operating Agreements
Other farmers prefer to sign operating agreement structures similar to management agreements in the commercial real estate market. In this model, the farm manager charges a percentage management fee usually between 5 and 10% usually between 5 and 10% of total net crop proceeds. In this model, the farm owner takes all of the productivity risk—federal crop insurance aside—but outsources operations to a third party.
Blended Models
Often, the owner and farmer choose to combine the net lease and operating agreement models into a blended structure in which the farmer pays a lower base rent plus a share of upside to the farm owner. This helps the farmer offset risk while giving [the investor] some upside.”
Risks and Future Outlook
Farmland has a number of structural tailwinds: there is a dwindling supply of viable farmland, the category is not particularly sensitive to economic cycles, and farmland has historically produced strong investment returns. But trends change, and it’s worth taking a look at the threats facing farmland investments on the horizon.
As we mentioned earlier, farmland investments have two primary return drivers: the operating cash flow produced by farm operations and appreciation of the underlying land. Each driver its own opportunities and threats.
On the surface, the cash flow coming from farm operations seems like as sure of a bet as any: the amount of farmland is decreasing, human population is increasing, and humans require food. But a Malthusian future in which these forces push food prices ever-higher seems increasingly unlikely: while technology continues to improve the efficiency and quality of food production per acre, global populations are widely expected to peak in the next 50 to 75 years before beginning to decline as more countries go through demographic transition. Many large countries have already turned this corner; China’s birth rate fell below replacement rate in 1991 and India passed that threshold in 2020.
Climate change represents another risk for farmland owners. While changes in weather patterns may radically shift the number and location of farmable acres over the remainder of the 21st century, the United States is relatively well-positioned among global food producers to handle climate threats with robust government programs.
Land appreciation has also been a major driver of farmland returns over the past 50 years. Suburban sprawl has created the opportunity for thousands of farm owners to cash out, driving overall returns in the category higher.
But it may be tougher for farmland investors to rely on this tailwind going forward. In a sense, many farm buyers are making real estate bets in places that are rapidly depopulating and have few economic drivers beyond the farmland itself. And land within an obvious path of urban development comes with a significant price premium and is best viewed as covered land—not farmland—investing.
This is not to say that land price appreciation won’t be a factor; rather, it will impact owners differently depending on where they own. Remote work may bring more relatively well-off people to certain rural areas, reversing negative population trends in specific areas. Colorado, Washington, Vermont, parts of Montana, and southern Appalachia all benefitted from these trends over the past 10 years and saw their populations grow and diversify. But farmland investors that are betting on land appreciation as a return driver must be intentional about the underlying demand that will drive any price appreciation.
In aggregate, it’s tough to argue with advocates who believe that farmland is one of the better bets in real estate today. Strong historical returns and a lack of correlation with the broader market have made it a favorite of billionaires and wealthy families for good reason.
There’s also something buried deep in our lizard brains that makes it compelling to own farmland; even when the farmland investment is through the purchase of shares in a company that will purchase the farmland and not the direct purchase of acreage.
Brad is the editor of Thesis Driven, a publication covering innovation in the built world. Over the past decade he has co-founded General Assembly, a pioneer in education and career transformation specializing in today’s most on-demand skills, as well as Common, a multifamily operating company focused on innovative housing typologies like coliving.In addition, Brad sits on the boards of Playcrafting and StageGlass and is an advisor to a number of companies including Breef, Stacklist, and Arrange.
This article is for informational purposes only, and is not a recommendation or offer to buy or sell securities. This content is intended for accredited investors only. Information herein may include forward looking statements and is for informational purposes only. Forward-looking statements, hypothetical information, or calculations, financial estimates and targeted returns are inherently uncertain. Past performance is never indicative of future performance. None of the opinions expressed are the opinions of RealtyMogul. Advice from a securities professional is strongly advised, and we recommend that you consult with a financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks and tax consequences associated with any real estate investment. All real estate investments are speculative and involve substantial risk and there can be no assurance that any investor will not suffer significant losses. A loss of part or all of the principal value of a real estate investment may occur. All prospective investors should not invest unless such prospective investor can readily bear the consequences of such loss. In addition, additional risks are faced by farmland investments, including, without limitation, damage to crops resulting from weather, drought or disease and volatility in commodity prices.