Farmland values have increased just over 9 percent per year from 1998 to 2007, according to the USDA Land Values and Cash Rents 2007 Summary, making farmland investment an attractive alternative to traditional real estate. To increase cash flow, many investors keep their farmland in production through cash rent lease arrangements. Cash rent leasing is simple, potentially lucrative and free of self-employment taxes.
Cash rent leasing arrangements, in which the tenant pays the property owner a lump sum per year for use of the farmland and any other resources the landowner supplies, are increasingly common. Cash rent returns have averaged between 5 and 6 percent annually —slightly lower than returns on some other leasing arrangements—since 1999, according to Iowa State University’s Agricultural Extension.
These arrangements were equally popular in 1982, each accounting for 22 percent of farm acres in Iowa, according to Iowa State University’s Agricultural Extension. By 2002, 42 percent of farm acres in Iowa were leased using a cash rent arrangement.
In Iowa, 54 percent of farmland was leased in 2004, with 68.5 percent of leased land cash rented according to an Iowa State University Extension survey of cropland leasing practices. The number of cash rental arrangements for farmland leasing is rising, according to Timothy Eggers, a field agriculture economist at Iowa State University.
Cash agreements are simple, straightforward and require little management| alt=|A tractor harvesting a green field of alfalfa|]Minnesota has also seen an increase in cash rental agreements relative to the number of crop share leasing agreements. “In our part of the world, cash rental agreements are dominant,” Jim Stordahl, assistant extension professor at the University of Minnesota, said in an e-mail interview. “As farm size increases, so does the number of landlords. Keeping crop share [leasing] agreements straight adds another level of complexity that many large producers wish to avoid. Cash agreements are simple, straightforward and require little management.”
There are many factors investors should consider when determining the amount of rent to charge, such as what others in the area are charging, average crop yields on the land, farmland productivity indexes and how cash rent arrangements compare to crop share leases, according to Iowa State University’s Extension program.
Additionally, investors may want to offer discounts to high quality tenants and operators, particularly on farms with permanent crops such as fruit trees, as opposed to row crops such as corn and soybeans. Mistakes made with permanent crops may be difficult to overcome and could last for years, while mistakes with row crops could be corrected in the following growing cycle.
Investors should perform their own due diligence on farmland leasing, including speaking with a professional farm manager, a farm management company such as Farmers National or the Westchester Group, or other landowners in the area.
Flexible Cash Rents
Flexible cash rents can help investors reap some of the rewards of both cash rent and crop share leases. This kind of rental agreement has been gaining popularity with farmland owners since a period of high grain prices in the mid 1990s, according to The Land.
“The major disadvantage with a cash rent is that the payment does not vary with economic conditions,” Gary Schnitkey, farm management extension specialist at the University of Illinois, said in an e-mail interview. “Flexible cash rents have a mechanism that changes the cash rent based on revenue (or yields or prices). This allows cash rents to vary with economic conditions. Of course, this adds rental risk for the landlord.”
Essentially, flexible cash rental agreements have floating values based on price and crop yield. Typically, this floating amount has upper and lower limits that are equally spaced above or below the normal value. For example, if the normal cash rent is $50 per acre, a flexible cash agreement could be as high as $70 per acre or as low as $30 per acre, depending on conditions. The limits are agreed upon by the owner and the tenant, and should depend on the risk and reward desired.
Flexible cash rents bring landowners bigger profits in a good growing year| alt=|Sunset over a barn and silo|]“The greatest benefits of flexible cash rental agreements may be the shift in risk and reward and [that they] may have the greatest appeal to those willing to accept the additional risk without the burden and additional management required with traditional crop share rental agreements,” Stordahl said. “The beauty is that each agreement can be set within the risk-reward parameters agreed upon by both parties.”
For investors, flexible cash rents offer the opportunity to realize more of the profits during a particularly good growing year. For tenants, they lower the financial risk because rents are reduced when revenues are low. The cutback in joint decision-making and communication, as compared with crop share leasing agreements, may assist investors with tax considerations. Additionally, because the rental agreement is flexible, the need to renegotiate can be reduced.
“Flexible cash rental agreements offer a safer financial alternative to both parties but without the management and logistical baggage of traditional crop share agreements,” Stordahl said. “These agreements may only have appeal to [investors] that can afford the additional risk.”
A disadvantage of flexible cash rent arrangements is similar to that of crop share leases: the trust factor. Investors must trust that their tenants are accurately measuring production. Another disadvantage is that the initial lease agreement can take longer to negotiate than traditional cash rent leases. Also, because flexible cash rent arrangements are fairly new, those negotiating may be less familiar with them.
Depending on how it is structured, a flexible cash lease may be viewed as a share lease by the USDA and the Federal Farm Service Agency, which could affect federal farm program payments that subsidize some farming expenses. Investors using a flexible cash rental arrangement should consult with their local Farm Service Agency to determine how a particular leasing arrangement will be viewed by these organizations and whether it will affect any payments.
Production can shift over a given time period, so deciding on appropriate timing for payment could be difficult, and calculating an adjustment price can be more complex on farms with multiple crops. But, for investors who can accept these few complexities, the results could be a potentially greater return on investment.