Over the past few years, Wall Street investors have grown increasingly bullish on farmland and many now want to own their 40 acres. Farmland focused private equity and hedge funds have been springing-up and individuals and institutions are pouring in capital.
Investing in farmland was one of the big ideas coming out of this summer's Benchmark Lunches seminar, a 50-person invite only conference for "ultrarich" investors organized by Blackstone's Byron Wien. The play has also been touted by Michael Burry, the former hedge fund upstart who pioneered the bet against subprime mortgages, Traxis Partner’s Barton Biggs, Jim Rogers and other high profile investors[i]. This recent attention marks a change of pace for the asset class, which, for much of the last century was largely ignored by Wall Street.
Today, institutional investors represent slightly less than 1% of investments in US farmland, a $1.4 trillion market, however, their share is growing rapidly[ii]. Hancock Agricultural Investment Group, one of the largest institutional farmland investors, saw assets under management increase 200% over the past five years to $1.3 billion, although not all of the firm’s investments are in the US[iii]. Pensions and endowments are also starting to earmark funds for investing; TIAA-CREF recently doubled its exposure to farmland, to $2 billion[iv]. And this month, endowment pioneer Harvard Management Company acquired a New Zealand dairy farm for $28 million.
Interest in farmland comes from investors looking for alternatives to traditional asset classes in a time of wavering sentiments about the domestic economy and poor returns. Real estate is still frightening; residential may be decades away from a recovery and commercial won’t improve until unemployment drops significantly. US equity returns were flat over the last decade and investors including Warren Buffet see a bubble in bonds. Farmland, meanwhile, has enjoyed 8% annualized appreciation over the past 10 years, outperforming both bonds and US equities. Farmland also has an income component from crop production, providing an average return of 5% over the past 10 years, bringing total returns to 13% for the period.
Market Outlook
Recent increases in farmland values can be attributed to short-term agricultural commodity price shocks. Several years of poor harvests in key regions around the world and a rebounding global economy are driving crop prices. Cotton recently hit an all-time high as increased demand from garment factories in China met a global shortage; heavy rains drowned the local Chinese crop and flooding in Pakistan, the fourth largest cotton producer, ruined much of the crop there this year. Recent drought in Eastern Europe caused wheat and corn prices to spike, both are up nearly 50% since June. Between 2006 and 2008 prices for corn, wheat and soybeans doubled and rice more than tripled, largely due to financial market speculation, causing widespread panic in many developing nations in what became known as the world food price crisis.
While these short-term shocks, which are not expected to persist in the long-run, have largely driven commodity and farmland prices over the past several years, it is the long-term macroeconomic trends that are most attractive.
From a demand perspective, the planet is expected to add another 2 to 3 billion people over the next 40 years[v]. With the current population of 6.8 billion, we already consume all of the grain that is produced and reserve stocks have been declining for years[vi]. Adding 2 to 3 billion people will cause a proportionate increase in demand for food. Increasing standards of living around the world, especially in China and India, will boost calorie intake and meat consumption and further increase demand for food. Converting crops to meat is an inefficient process that requires at least 4 to 6 pounds of feed per pound of meat. If China’s current population trends toward the protein consumption patterns of the US, and all indications are that it will, an additional 58 million acres of cropland will be needed. When including India and Africa, where much of the growth in population over the next 40 years will come from, the required increase in farmland from meat consumption alone could easily top 100 million acres[vii].
From a global land use perspective, most available fertile land is already in production and growth will come largely at the expense of rainforests in Africa and South America. In the US, farmland acreage is shrinking as commercial and residential developments expand into agricultural areas, particularly in California and throughout the Corn Belt region. This trend has slowed since the 2008 economic downturn, however, since 1950 total US farmland declined by 282 million acres, an area greater than the size of Texas[viii]. Globally, farmland is increasing, especially in Africa, which holds 60% of the world’s uncultivated arable land[ix]. Yet, in both Africa and South America inefficient farming methods and weak property rights have led to widespread erosion and soil degradation. Ongoing unsustainable farming methods in the developing world will limit the net increase in global farmland acreage and pressure from global warming advocates will slow the rate of deforestation.
Since 1960, arable land per capita has fallen from 12 acres to six as the global population expanded by 3.8 billion[x]. Food production over this period increased to meet demand largely through land productivity gains. Genetically modified crops, advanced fertilizers and increased investment in irrigation and farm equipment have doubled grain yields in the US since the 1960s. The Food and Agricultural Organization of the UN estimates that 90% of the increase in food production over the next 40 years will come from increased productivity and only 10% from increased farm area[xi].
In the US, where farms already employ large amounts of irrigation, equipment, fertilizer and genetically modified seeds, future productivity gains will come mainly from advances in genetic engineering[xii]. But there are limits to the amount yields can be increased through science and the ability of the biotech industry to continue to drive productivity is unproven. Recent advances by Monsanto (NYSE:MON), the largest producer of genetically modified seeds, have largely failed to meet expectations[xiii]. However, at 31 times earnings the market clearly expects further innovation from the company. Landowners will benefit both from future innovation and from expiring patents on existing technologies like Monsanto’s Roundup Ready 1, which is set to leave patent protection in 2014[xiv]. As this happens, much of the profit from increased yield will shift from patent holders to farmers who no longer have to pay royalties.
Asset Fundamentals
Over the last decade, buyers of farmland for non-agricultural purposes represented 25 to 50% of the market and paid a premium of 50 to 100% over other buyers[xvi]. Most of these transactions were for land near urban areas for development purposes. While demand from developers has subsided with the economic downturn, in the long term, farmland values will be propelled by demands from higher value added uses like housing.
Farmland can be segmented into land with permanent crops like fruit trees and land with row crops like corn and wheat. Most permanent cropland in the US is irrigated and sells at a significant premium to row cropland. Row cropland has the advantage of flexibility as farmers can choose which crops to plant each season given the economic outlook. A well diversified portfolio of farmland should include row crops and permanent crops as the correlation in prices between row crops is high. Diversification will also protect against increasing crop price volatility and geographic specific risks like adverse weather and pests.
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| Correlation between crop prices |
While farmland prices have been increasing globally, land in the developing world, particularly in Africa, trades at a significant discount to land in US. Developing markets don’t have the same export opportunities, infrastructure or access to water that farms in the US enjoy. Farms in the US have strong representation in congress, ensuring farmers access to subsidies, water rights and favorable export treaties. Political risk is another major factor contributing to lower farmland prices in the developing world.
Farmland offers returns from land appreciation and crop income and is a natural hedge against inflation. Depending on the direction of the biofuels market it may also act as a hedge against rising energy prices. But liquidity is a significant risk as there is no centralized exchange and price and correlation data may also be unreliable as this data is based on appraised values. For these reasons, institutional investors may not be willing to add the asset to their portfolios, at least not in significant quantities. Investors will incur significant transaction expenses from real estate commissions, taxes and legal fees. US investors will also face currency risk and as the dollar rises US commodity exports will become less attractive to foreign buyers.
Farmland has low correlation with major stock indices and the US bond market. In a portfolio context, it may help increase risk-adjusted returns, however, there are conflicting studies on the implications of adding farmland to a well diversified portfolio[xvii].
Investment Vehicles
Gaining exposure to farmland can be complicated and expensive but is possible in several ways. Investors can directly purchase land and personally manage it, outsource management or rent. Renting transfers crop risk and return to the renter and reduces operational risk for the investor. Direct investment can have tax advantages and allows for maximum investor control. However, direct investment requires active management and specific industry knowledge. Achieving a geographically and agriculturally diversified portfolio will also be beyond the means of most individual investors as farmland trades in large blocks, often of $1 million or more.
Farmland ownership is also possible through an institutional investor. Hancock Agricultural Investment Group, the Westchester Group, UBS AgriVest, American Farmland Co., Chess Ag Full Harvest Partners, Emergent Asset Management and a few dozen other asset managers, private equity and hedge funds specialize in acquiring farmland in the US, Australia, Africa and elsewhere. Investing with a fund buys access to professional expertise and increased diversification. However, funds often require large minimum investments, Hancock’s is $50 million, and charge significant fees.
Farmland is a good candidate for a REIT vehicle but a product of this nature has yet to be developed. Until one is, retail investors can participate in agricultural industry profits through the stocks of publically traded suppliers of chemicals, fertilizers and seeds. Monsanto, Potash (NYSE:POT), Syngentra (NYSE: SYT) and other agricultural suppliers tend to benefit from rising crop prices, however, correlation with farmland values is not particularly strong. Agricultural commodity futures contracts and commodity exchange traded funds are another option. Several ETFs are available including Elements Rogers International Commodity Agriculture ETN (NYSE:RJA), PowerShares DB Agriculture ETF (NYSE:DBA) and Path Dow Jones - AIG Grains ETN (NYSE:JJA). These funds offer more flexibility on position size, liquidity, diversification and better control over leverage than direct or institutional investing. However, commodities are more volatile than farmland, prices are not perfectly correlated with land values and there is no cash component to returns. Recently, large capital inflows have caused many commodity ETFs to significantly underperform the commodities they track, exposing what some market observers see as a fundamental flaw in ETFs constructed with futures contracts[xviii].
[i] “Burry, Predictor of Mortgage Collapse, Bets on Farmland, Gold,” Bloomberg, 9 September 2010, http://www.bloomberg.com/news/2010-09-07/michael-burry-predictor-of-mortgage-collapse-bets-on-farmland-and-gold.html
[ii] “2007 Census of Agriculture,” USDA, http://www.agcensus.usda.gov/Publications/2007/index.asp
[iii] Hancock Agricultural Investment Group website, http://www.haig.jhancock.com/about.htm, and author’s own calculations
[iv] “TIAA-CREF Bets the Farm,” Barron’s, 18 October 2010, http://online.barrons.com/article/SB60001424052970204352204575550203580453146.html
[v] “World Population to 2300,” United Nations Dept. of Economic and Social Affairs, 2004, http://www.un.org/esa/population/publications/longrange2/WorldPop2300final.pdf
[vi] “Grain Stocks Historical Track Records,” USDA, April 2010, http://usda.mannlib.cornell.edu/usda/current/htrgs/htrgs-04-30-2010.pdf
[vii] “China’s Protein Gap Will Stoke Global Inflation: Andy Mukherjee,” Bloomberg, 25 April 2007, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a_QDvulQffOE&refer=home and author’s own calculations based on USDA statistics
[viii] USDA National Agricultural Statistics Service Quick Stats database 1950 – 2009, http://quickstats.nass.usda.gov/
[ix] “How food and water are driving a 21st-century African land grab,” Guardian, 7 March 2010, http://www.guardian.co.uk/environment/2010/mar/07/food-water-africa-land-grab
[x] World Bank arable land data table, 1960 – 2007, http://data.worldbank.org/indicator/AG.LND.ARBL.HA.PC
[xi] “Agriculture, Food and Water,” Natural Resources Management and Environment Department of the United Nations, 2003, http://www.fao.org/docrep/006/y4683e/y4683e00.htm#P-1_0
[xii] “Agricultural Productivity Strategies for the Future: Addressing U.S. and Global Challenges,” Council for Agricultural Science and Technology, January 2010, http://www.cast-science.org/websiteUploads/publicationPDFs/CAST%20Ag%20Policy%20IP45%20FINAL168.pdf
[xiii] “Monsanto shares fall, SmartStax may disappoint,” MarketWatch, 28 September 2010, http://www.marketwatch.com/story/monsanto-shares-fall-smartstax-may-disappoint-2010-09-28
[xiv] “As Patent Ends, a Seed’s Use Will Survive,” New York Times, 17 December 2009, http://www.nytimes.com/2009/12/18/business/18seed.html
[xv] “Will Farmland Values Keep Booming?,” Federal Reserve Bank of Kansas City, 2008, http://www.kansascityfed.org/Publicat/ECONREV/PDF/2q08henderson.pdf
[xvi] “Will Farmland Values Keep Booming?,” Federal Reserve Bank of Kansas City, 2008, http://www.kansascityfed.org/Publicat/ECONREV/PDF/2q08henderson.pdf
[xvii] “Portfolio Diversification Using Farmland Investments,” Hennings, Sherrick and Berry, 2005, http://ageconsearch.umn.edu/bitstream/19273/1/sp05he05.pdf
[xviii] “Amber Waves of Pain,” Businessweek, 22 July 2010, http://www.businessweek.com/magazine/content/10_31/b4189050970461.htm