Looking for Value in Farmland Investing

By Tom Schenk, Director of Business Development for TerViva

Back in 2006, when people were trading the stock and the real estate markets like rock stars, few people cared about a quietly obscure asset class called farmland.  However, the economic collapse that began in 2008 changed all of that. At the same time, grain prices soared to a new plateau at 2x the prices seen in the 80’s and 90’s due to increased demand from middle class consumers in emerging markets and ethanol production, as well as supply shortages created by crop failures from violent extremes in weather patterns globally. On the demand side, the industrialization of emerging market countries has brought millions of people into the middle class in those countries who demanded – and could afford – better diets of meats, vegetables, and grains.

At the beginning of the farmland investment boom in the US, every $1 of farmland value only carried about 5¢ of debt.  Ownership was in strong hands. It was this obscure statistic relating to the low levels of farmland debt that was one of the greatest factors that contributed to the fact that this asset class being a wonderful placeholder for wealth during the financial hurricane that slashed stock and residential and commercial real estate in half in a period of months.  Asset classes that were highly-leveraged were the same ones that deflated the hardest.  When collateral for loans decline in value, lenders demand more collateral.  If that other collateral is falling, it creates fire sales in a rush for liquidity and thus a vicious feedback loop ensues.

Today, debt-to-asset ratios in some of the major farming states are back to 30% and higher.  These are levels not seen since 1979 which, along with sharply rising interest rates and falling commodity prices, led to the great farm crisis of the 1980’s.  Today, alarms are being sounded that we are in a similar setup and an imminent crash could be ahead.

However, few things in the financial world are that linear in reasoning.  There are many moving parts involved in calculating the future stability of this asset class if we enter a period of rough financial weather.  For example, while debt levels in dollar terms may have increased 2x, land values (on paper) have gone up 3x to 4x times in many instances.  Another major variable in this calculus is that production costs for farmers have come very close to doubling in this period also.  Additionally, farmland has historically had a very high inverse correlation to the 10-year US Treasury rate.  The enormous impact on farmland values from the Federal Reserve’s financial engineering of interest rates cannot be overstated.  Where investors could find 7% – 9% cap rates back in 2006, today those rates have dropped to a range of 2% – 4¾% depending on the quality, yields, and location in the US.

Nevertheless, traditional farmland investing is considerably more vulnerable to adverse shocks than it was in 2006.  Creighton University’s Farmland-Price Index is a monthly survey of 200 rural communities in major grain growing states.  The most recent survey show that the rate of farmland price appreciation is has been decelerating since late 2012.  Clearly land prices are flattening out.  Unfortunately, commodity prices and land values can drop by the speed of light compared to any declines in production costs , and this can put a farm’s balance sheet in a bind almost overnight.  A strong case can be made that interest rates may have hit a long-term (30+ years) cyclical low.  If rates begin to rise, there is little question that farmland prices can come under immediate pressure.  There has always been a historically strong inverse correlation between 10-year Treasuries and farmland prices.

US farmland prices were on the steady rise last year (above), but according to the recent Fed Reserve studies in KC and St. Louis, prices are plateauing (http://bit.ly/1b5Wzxe)

US farmland prices were on the steady rise last year (above), but according to the recent Fed Reserve studies in KC and St. Louis, prices are plateauing (http://bit.ly/1b5Wzxe)

The purpose of this article is not to sound alarms about the imminent demise of farmland asset values. In this past decade, we have seen “bluechip” stocks and “AAA-rated” bonds  go to zero, as well as commercial real estate like shopping centerss can become vacant or obsolete.  But what was unique about farmland is that it has an imbedded put option; if you lose a crop, you still have the land and you can try again.  In this crazy world of abstract derivatives with notional values priced at hundreds of trillions of dollars worldwide, there will always be a demand for an real asset like farmland; it cash flows and the demand for its output is relatively inelastic.  People have to eat.

However, it should give investors pause before they pay $12,000 for that next Illinois acre.

Large scale/institutional farmland investors have always diversified geographically and with different crops, but in cyclical commodity downturns, the income streams of these “diverse” yet traditional agricultural properties will have as much non-correlation as a squadron of Blue Angels at a summer air show.  In other words, that cotton property in Mississippi will go in the same direction as corn land in Iowa or the potato farm in Idaho.

So what’s a farmland investor to do in what appears to be a relatively deflationary economic climate?? One idea is to borrow a page out of what traditional money portfolio managers have done for decades which is to apply the principals of Modern Portfolio Management – namely, diversify into property types with diverse return profiles in order to reduce overall portfolio risk.  Over the years, I have seen small cap and micro cap managers rescue overall portfolio returns by exploiting those overlook and under-researched companies where fundamental analysis ran circles around index managers by finding those opportunities that returned comparatively out-sized returns from some overlooked niche. In the 80’s, Microsoft was one such company.  The underlying attraction in small cap stock investing is that few, if any, analysts are researching these companies.

TerViva pongamia trees thriving in Texas

TerViva pongamia trees thriving in Texas

To that end, there is a quiet little company out of Oakland, CA called TerViva that has been establishing plantations of a hardy tree crop called pongamia. Pongamia trees are native to Australia and India.  They produce a nut crop that is virtually a first cousin of soybeans – but grows on a footprint where soybeans generally cannot.  An annual harvest of the nuts can produce over 400 gallons of oil and a couple of tons of residual “seedcake” that can be used as a high-protein animal feed or as a high-nitrogen fertilizer.  In a given year, a producer has the ability to direct that oil to biodiesel, bio-jet-fuel, bio-chemical (it is high in oleic acid and other valuable long-chain carbon compounds), or even biopesticides markets, depending on what is determined to be the highest best use downstream markets. Pretty cool.  The oil has been tested by Dynamic Fuels, REG, and Shell as a great feedstock worth about $3.50/gal.  I recently spoke to an organic grower who has successfully used pongamia oil as an adjuvant in his pesticide sprays for the last 7 years.  His supply comes from India.  He proudly informed me that he had recently got the price of his oil “down” to $17/gallon!

However, the most compelling aspect of this tree crop is that these trees can thrive in marginal soils such as south Texas or the challenging sandy fallow soils southern Florida where citrus trees used to grow before HLB disease marched through the state.  Instead of passively collecting x in revenue like typical farmland investors, you can proactively generate 5x-10x on these lower grade properties. And as a result, you will obviously get a sharp appreciation in the underlying land value in addition to the improved income stream that is arguably on par with the richest Iowa or Illinois farms.

Is this too far-fetched of an idea?  Not for three major citrus growers in Florida (plus a fourth grower planting this month) who conducted extensive research on the tree and this concept before planting on their own properties.  So far, they are more than pleased with what they are observing. The trees are growing almost twice as fast as citrus and require a fraction of the inputs.  Moreover, for investors who want to grow this tree crop, these citrus companies will act as the operators for planting, maintenance and harvesting.

Sometimes is you cannot find any gems in the rough, you just have to make your own.

Tom is TerViva’s Director of US Business Development, and works every day with agriculture growers to explore opportunities with new crops.

Where Can Investors Hide Today?

Author:  Tom Schenk

If the political and financial landscape seems to be getting a little crazier to you, you are not alone.  What happened in Cyprus a few weeks ago set a new bar for what the governments and central banks can – and will – do.  It also demonstrates how powerless the citizens can be.

ScrewedToday’s investors are extremely challenged to find some “place holder” for the wealth they have spent their life accumulating.  After Cyprus, I think we can scratch “cash in the bank” off of that list. Government bonds? Who wants to buy a 30-year Treasury at a 2.95% yield?  Any guess what would happen to the principal if rates rose?  Stocks are not cheap.  And adjusted for inflation, they really haven’t gone anywhere in the last decade plus companies can always issue more shares.  Buying at the highs may not end well. And after 2009, when we saw stocks drop by half or more, how do you quantify your risk-adjusted returns in this asset class?  And let’s not forget about the hundreds of trillions of esoteric derivatives that are collateralized by this stock and bond markets where volumes are dominated by elaborate algorithms and high frequency trading systems.

Gold and silver? Those are a classic store of wealth (even though they do not cash flow), but we have also seen the US government (in the 1930’s) make it illegal to own.  Could they confiscate it today?  They don’t have to; all they have to do is declare, say, a 50% tax on any sale. Would they do that?  I have no idea. But until last week, I sure didn’t think they would talk about taxing our retirement savings, either.

Hardly a day goes by when I’m reading about some guru advising investors to move their assets abroad.  Really?  Would you really feel better with storing your wealth thousands of miles away in Europe or some developing economy country? There were no classes in business school that taught us how to cope with today’s investment climate.

That green paint could be worth more than we all think.

That green paint could be worth more than we all think.

By process of elimination, I believe the last thing a government would do is jeopardize its domestic food supply.  For that reason, I believe that good US farmland may be one of the last, best places for investors to preserve their wealth.  It’s not a place for a get rich quick home run, but it may be perhaps the best oasis in a landscape increasingly filled with risk that is almost impossible to define anymore by conventional analysis.

In the last 10 years we have observed how fast money can move in a panic.  None of the problems that caused that panic have been solved; they have only gotten bigger.  Now is a better time to trust your own gut feeling, or common sense, or what else you want to call it.  Don’t split hairs over a 4.5% cap rate or a 4.38 % or whatever.  If farmland feels like a good place to invest, get out and look at the property, meet the farmer, look over the operation and make your decision and get a good night’s sleep.  Time may be shorter than you think.

Tom Schenk is the Director of Business Development for TerViva, working with landowners to develop new strategies for new agriculture crops.  Tom has worked for over 20 years in trading agriculture commodities and acquiring farmland for investment purposes.

International Land Grab

On February 5, the New York Times published an op-ed called, “The Global Farmland Rush” (http://nyti.ms/XQqFfG), which discusses the intense land grab in emerging economies.  An example cited in the article:  a Saudi-led group’s recent attempt to acquired 4,600 square miles of land in Indonesia.

The rationale for this land grab?  Well, as Mark Twain said:  “Buy land — they’re not making it anymore”.  With increasing pressure on our global agriculture system to feed the world’s growing population, there’s a rush to find arable land — whether for production today or as an investment for the future.  On that note, we’ve been amazed by the sophistication with which certain investment groups are analyzing this space.  As an example, look no further than the treatise on African agriculture put forth by Renaissance Capital  (http://bit.ly/YWOQ10).

Perhaps because of my background in energy, there’s something familiar about this story.  A few decades ago, it was popular for established US and European oil companies to go into Asia, the Middle East and Africa to secure land for drilling.  Over time, those countries’ governments slowly clawed back on those deals, effectively knocking down the project returns.

We’ve already seen governments do this with land (think Zimbabwe).  As the value of arable land goes up in the coming decades, we believe there will be populist pressure to “re-negotiate” these current land deals.  Of course, I’m sure that investors have “priced” this possibility into their land purchase calculations, and they’ve still concluded that it’s worth it.

And that, to me, says a lot about how valuable land is becoming.