The following is a question on land purchases that I received earlier this spring, while I was out doing my Road Warrior talks around the country. I am tardy on my response, but “better late than never” is the next best alternative. Let’s put some thought to this question.
Question: My son and I have attended some of your seminars. My question to you is regarding the purchase of farmland. I am in a position to purchase land and have purchased about 500 acres in the past four years. Just today, a local landowner offered me 80 acres approximately 10 miles away from home, not great land, but probably a 6 out of 10 score. It loses a point because of location. I agreed to help the owner find a buyer and have done so, but I wonder if I am doing the right thing. The land is probably priced at about $500-600 below what would bring. I do not need the land for a sustainable future for my son’s farm, but an additional quarter would be better. Whether land goes down is not my concern (I think it likely will, but will any be for sale?), but I wonder if I am being less than aggressive at the wrong time? I appreciate your opinion given the information I have provided.
Response:My first assignment for the producer and his son would be to establish their business, family and personal goals. How would this incremental land purchase fit their goals and objectives? “Being less than aggressive at the wrong time” may be a sign that this investment is inconsistent with their overall goals. To be sure, it is critical that each partner conduct a goal assessment in writing, separately, and then determine how high land investment is in their overall priorities.
Next, I would ask the family to analyze the last three years of financials. What are your debt levels, working capital, and financial liquidity, and have you been profitable?
- Would the purchase of this land increase your debt to asset level to above 50%?
- Would your net working capital to revenue ratio be below 20% after the purchase?
- Has your return on assets been above 5-10%?
If the answers to the first two questions are “yes,” be careful on the purchase because you are pushing the maximum debt and minimum working capital thresholds, which could possibly create stress when the commodity super cycle ends.
If your profitability, measured by return on assets, is above 10% and has been between 5% and 10% over the years, this would be a good sign that you have the financial engines to manage a land investment.
The next part of the analysis would indicate that the land is being purchased below market value, which is good sign. You then could compare this investment to other types of investments. In today's marketplace, there are few investments that will generate a higher return compared to farmland investments.
Many agricultural producers throughout the country have been asking this same question. I wish you and your son well. I hope to see you at another seminar very soon!
Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at [email protected]