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Consider the cash rent equivalent

Andrii Yalanskyi Hand holding bag of money with farm field in background
As cropland rental rates climb higher, weigh your options before purchasing land.

The USDA recently released cropland rental rates for 2021. Iowa, like many other states, is showing an increase from 2020. Iowa’s increase for average land rental was $3 (1.3%) to $233 an acre.

When land rents go up, the option to buy becomes more enticing, even with the increase in land prices. Working with your lender to purchase land will most likely lead into a discussion on cash rent equivalent.

Cash rent equivalent is a calculation for owned land that does what is says. It equates the payments of your owned land to rental land rates. The calculation is:

Bob Krogmeier083121 cash rent calculation.PNG

As an example, you own 320 acres outright and are currently paying the mortgage on 160 acres you purchased a few years ago. There are 80 acres that just came up that you’re interested in which has a current asking price of $11,500 per acre.

Here are some figures for us to use as for examples:

Bob KrogmeierCash rent example price table

One thing I want to point out is that the purchase price for our owned acres (the 320 and 160 plots) is irrelevant for this calculation. We are only interested in the annual cashflows to carry the land, loan payments and property taxes.

In order to get this land purchase to work, you would have to:

  • have a down-payment to decrease the annual loan costs;
  • subsidize the loan with off-farm income; or
  • have owned land that you have in production to help carry the burden of the loan.

The last point above is the $178 cash rent equivalent.

There is a huge competitive advantage for owned land when you calculate your cost of production. When you look at your cost of production from a commodity perspective, you aggregate your cash rent equivalent and rental costs. A young farmer or rent-heavy operation would most likely be better off renting at $233 (or $250, $350, or even $450) as opposed to trying to cash flow the purchase of the land.

There are a lot of factors that come into play when purchasing land, so make sure you take the time to consider all your options and make sure your operation can handle it. It’s hard to pass up that field that’s right next to the home farm, but it’s not worth losing the home farm over.

The opinions of the author are not necessarily those of Farm Futures or Farm Progress. 

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