New world view affects farmland value

by Morton Sosland
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Considering the urgency that characterizes warnings about shortfalls in global food production in the next several decades, it seems nigh on to ridiculous to be worrying at the same time about agricultural prosperity in America along with the likelihood of a farmland “bubble” bursting. Yet, these very issues exist today and ought to receive careful attention from food manufacturers who would be negatively affected by a sudden downturn in the U.S. farm economy. Past boom and bust cycles in agriculture, largely reflected in gyrations in farmland values as well as in agricultural prices, have caused severe supply chain difficulties. These have involved a broad range of problems like crop shortages and reduced attention to quality that make more recent concerns about soaring ingredient costs less significant.

Concerns about a farmland “bubble” are an almost expected response to soaring farmland values, which have reached record highs in every region. Hardly anything better describes the current situation than the value-to-cash-rent ratios. In major producing states like Illinois, Iowa and Indiana, farmland has sold at prices as high as 30 times current annual cash rent. The prior peak for this ratio, barely above 20, was attained in the 1970s. Along with double-digit annual gains that have exceeded farm income increases, the performance of farmland values has raised questions about what really is prompting such gains.

At a conference on agriculture sponsored several months ago by the Kansas City Federal Reserve Bank, the point emerged that the soaring value-to-rent ratio may be due more to the integration of agriculture into international financial markets and lower capitalization costs than reflecting farm income. In other words, as was sometimes claimed about individual crop prices, sharp farmland gains stemmed from investor demand more than could be credited to actual demand for farming. If that’s the case, then farmland, like other investment assets, is subject to falling in the case of a rise in interest rates. Saying it another way, current low interest rates impart rationality to what seems like sky-high value-to-rent ratios.

Having the value of land, the most basic input essential to food manufacturing, no longer tied to prices for wheat, corn and soybeans presents a huge problem for the industry. It is especially telling when the situation in a number of developing nations may be exactly opposite, with farmland values extremely low in relation to crop prices, at least those ruling in global markets. Along with looming shortfalls in global food production as population gains are accentuated by urbanization and rising incomes, this situation helps explain the moves to accumulate large blocks of current and potential farmland.

Most telling is the rapidly expanding effort by major international food manufacturers to seek to establish relations with agricultural producers, especially in developing areas. It is not unusual these days to observe a major world-circling food company cite with pride the number of farmers with which it has established direct relations, primarily aimed at helping to increase yields and improve quality and marketing. These same companies also often point to their efforts to be close to consumers, which along with the farmer relationship, emphasizes a strategy of producing food preferred in specific areas and made from locally produced raw materials. That is very different from a worldwide food industry that moves massive quantities of raw materials as well as finished products in international trade. Local presence is what apparently drives much of the expansion of these corporations into new markets.

If “local presence,” which has reached into retailing in America, is gaining this foothold around the world, it signals a very different approach to globalization. Expanding global food needs certainly have played a role in boosting farmland values to their present heights. Along with a rise in interest rates or a marked lowering of investor appreciation, a fundamental shift in how the world is going to produce enough food for the future could have an equally powerful effect.

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