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February 12, 2024
Lately, the news has been full of talk about interest rates. The Federal Reserve’s recent decision to hold interest rates steady at 5.25% to 5.5% comes as a beacon of stability. It signals that perhaps we are approaching the corner on inflation.
But now that we’re sitting on high interest rates, what does that mean for the farmland market? Since the onset of rate hikes in March 2022, we’ve seen the landscape of borrowing and investing undergo significant shifts, with the Fed’s actions rippling across various sectors, including agriculture.
According to Ty Kreitman of the Federal Reserve Bank of Kansas City, there’s a growing concern that higher interest rates, coupled with a moderation in agricultural commodity prices, could lead to a dampening of demand for farmland, and consequently, a potential decrease in farmland values.
This scenario unfolds in a context where, for the first time since 2001, interest costs on new farmland loans have surpassed the recent average annual appreciation in land values. This shift marks a significant departure from the trend observed from 2002 to 2022, where growth in agricultural real estate values consistently outpaced the cost of financing, thereby supporting robust demand for farmland — essentially, bankers paying you to buy farmland.
While interest rates are a concern for farmland values, my observation is that they are not as impactful as you might think. Here are some reasons I believe this to be so:
High inflation and farm income. The Federal Reserve increases interest rates to stave off inflation. But during periods of high inflation, commodity prices often increase, which can lead to higher farm incomes. This phenomenon is especially pronounced in agriculture, where the prices of crops and livestock can rise significantly in response to inflationary pressures. This increase in farm income can provide a financial cushion for farmers, helping them to absorb some of the shocks of rising interest rates.
Surplus cash as a mitigating factor. The surplus cash generated from higher farm incomes can offset the increased costs of borrowing due to higher interest rates. Farmers may use this surplus to cover higher interest payments without needing to liquidate assets or reduce operational investments. This ability to manage increased costs without compromising the financial stability of the farm operation helps in sustaining the value of farmland.
Long-term perspective in farmland investment. Investors in farmland typically take a long-term view of their investments. The short-term fluctuations in interest rates, while important, are often weighed against the long-term potential for income generation and capital appreciation. High farm incomes during inflationary periods reinforce the long-term profitability and viability of farmland investments, thus supporting land values even in the face of rising interest rates.
According to a recent University of Illinois Farmdoc daily article, 2023 was a year of contrasts in the Illinois farmland market. Cash rents climbed 6.6% over 2022, reflecting strong returns to farmland. Concurrently, Illinois farmland prices were up by 4.5% from the previous year — all during a period of skyrocketing interest rates. These figures, while indicative of growth, also hint at the underlying complexities of the farmland market.
The current return on farmland (calculated as farm income divided by land value) is akin to the interest payment on a debt instrument. Current return and interest rates are correlated over time. That means if interest rates go up, then income also has to go up in order for farmland to hold its value.
And income is the 800-pound gorilla.
If income increases at a rate faster than interest rates, then farmland values likely rise or remain the same. If income remains the same or declines when interest rates rise, then there is pressure for farmland values to go down. Income for 2024 is projected to decline from previous years. Does that mean land values will also decline in 2024?
Looking ahead, the crystal ball remains cloudy. If recent cash surpluses from the good years hold, maybe we can weather the storm. If not, then we’re looking at a scenario where land values dip from current levels for a bit of a correction. Downward pressures may be on the horizon, but price declines might still be a season or two away — or, maybe not at all, if grain markets recover.
As with all things in farming, the only certainty is uncertainty.
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