In the February issue we looked at cash rents from the landowners’ perspective: what they want and the attributes they look for in a tenant. Often, landowners want a 4-5% return after real-estate taxes are paid on the current value of their investment. Then if you figure on a 4% appreciation factor that we spoke about in the December Profits column, they have about an 8% total return.
How about the perspective of the grower? What return can he expect over time?
A decade ago we used to be comfortable with a $50/acre return on investment and return on management. Since 2007 we look for a minimum of $100 and preferably more. Why the difference?
First, the investment per acre has nearly doubled in recent years. Secondly, the increased volatility we see in commodity prices needs to be compensated for, so $100/acre should be a minimum. Lastly, there is little safety net now as costs are far above farm-program payment loan rates. With increased risk, there needs to be increased reward.
Reality Hits: If it were only as easy as working the above numbers and paying the rent, things would be great. The problem is if the rent you pay on other farms is significantly below this example. That causes problems. As we discussed in last month’s column, landowners want transparency and to be treated equitably. In my experience, it’s worth the extra effort to make it right with other landowners rather than thinking no one needs to or will know about this deal.
Lastly, evaluating risk-to-reward balance is a balancing act. Take $1/bu. off the corn price in the above example and look at the margins go to about negative $60/acre.
That’s why the name of the game in the years ahead will be managing margins, being proactive with landowners and refining yourd relationship skills.
How does farming compare to other industries in terms of profit?
Is the 8% return to assets landowners look for realistic and how does that compare to returns in other industries?
First, if some leverage is used in purchasing land, returns can be 10-15%, especially with the low interest rates we have. Using someone else’s money can return more on your own money if returns are greater than the cost of debt.
Our clients’ return on equity averaged 14% in 2009, down from 18% in 2008. However, many have livestock and dairy, which brought those returns down. In comparing these to the Fortune 500 companies, their median return on equity was 10.5% for 2009. As I’ve indicated before, there is more opportunity to make money farming than most other industries.