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Cut land rent costs

Creative deals with current landlords, and farmers seeking retirement, could deliver more acres at less cost to you.

Farmland rental rates, which have been skyrocketing for more than a decade, have finally skidded to a halt. With a second year of poor commodity prices here, midwestern farmers are seeing a tug at the booming cash rents that marked the mid to late 1990s and are hoping to take advantage of it.

"Rents in Iowa were down a few dollars this year from last year," reports William Edwards, Iowa State University extension economist. "The size of decline wasn't so significant as the fact that it was a decline."

Indiana is seeing a similar trend. Cash rent for the top land dropped slightly from $140/acre last year to $138/acre this year. "Last year was a new all-time high in cash rent," notes Craig Dobbins, Purdue University extension economist.

While good yields and poor prices spell economic problems for many farmers, these conditions should help some renegotiate better rents and rental agreements this winter. Staying in business for the next decade means taking advantage of any rental opportunities opening up now, experts agree.

Rents in 2000. "If you are good [at farming], get ready to take on more land and expect to get it at lower rental prices," reports Howard Doster, Purdue University extension economist. Doster firmly believes that high rental rates must come down. "In 1996, I said farm rent will go up and now I say rent has got to go down."

High rental rates have not penciled out for many farmers in the last two years, he explains. After paying rent and the variable costs of production, they have had no income left for labor and family costs. Doster worries that these farm operations can't continue much longer.

"When people lose money and don't replace machinery, it takes awhile before they get out of farming," Doster says. "I believe there will be 5 to 10% of tenants this winter who will not get their loans renewed because of cash flow and will be forced to give up farms."

Cash rents that do not pencil out are a common problem for many corn and soybean farmers in the Midwest, including Minnesota. "Most of the average farm cash rents are $95 to $106/acre," reports Gary Hachfeld, Nicollet County extension educator. "If you work through a worksheet and put in real numbers for input costs, the rent should be about $80/acre."

Hachfeld obtains farmland rental information from an extensive survey conducted in a six-county area in south-central Minnesota. More than 2,000 farm operators and landowners responded to the last survey completed a year ago. Rents varied in the area from $30 to $175/acre. The survey showed a slight decline in average rents from 1998 to 1999.

Top rents drop. Northern and central Illinois where land rents hit $185 to $195/acre may see some relief. These rents should be the first to be renegotiated this winter.

"There are some really high rents that I think will come down," suggests Tom Chamberlain, vice president of First Mid-Illinois Bank, Tuscola, IL. "But the medium cash rents may stay the same."

Chamberlain works with many farm customers who rent top Illinois farmland. He helps bank customers run a budget analysis to determine a breakeven on cash rents. Figures from actual cost of production are entered, along with long-term yield averages of 155 bu./acre corn at $2/bu. and 45 bu./acre soybeans at $5.50/bu. The results aren't always positive.

"Some guys are losing money at $140/acre cash rent, not accounting for any disaster payments," he says. "I also have some farmers not borrowing money who pay $175/acre cash rent. They feel they continue to make a profit. If you take borrowed money out of the equation, it will be a little easier."

Farmers earning premiums on specialty crops also pay cash more easily for a high rent, he notes.

Chamberlain says that, although his farm customers are positioned pretty well for the next year, across the industry it could be a different story. He, too, expects more operating loans than usual to be declined this winter.

Modified crop share. Crop share, once the most common farm rental agreement, has dropped in popularity. Most Midwestern states report that the number of crop-share agreements has declined while the number of cash rent arrangements has increased.

In Iowa, half of the rented farmland was on a crop-share basis in 1982, according to Iowa State University economist Edwards. By 1997, crop share accounted for only 39% of rental agreements and cash rent increased to 57%.

"We've gotten to the point where cash rent earns more for landlords than crop share," Edwards says. Plus, many landlords do not want the hassle or expense of paying crop inputs and then marketing the crop, especially when they have inherited the land and don't intend to be involved in farming.

However, crop share still is desirable for farm tenants, especially in low-commodity-price situations. Illinois banker Chamberlain urges farmers who have these agreements to keep them and modify them if needed.

One new twist to the traditional crop-share agreement is the "privilege" payment. The farm tenant and landlord split the crop and inputs on a 50-50 basis as usual, but the tenant also pays the landlord a rent. A typical privilege rent runs $20 to $25/acre.

"We are just now seeing some of these modified 50-50 agreements," Chamberlain says. "These make the returns closer to a cash rent for landowners. It is a way farmers can develop a good leasing relationship while owners accept some risk and farmers can still make money.

"I recommend to anyone who has a landowner saying a 50-50 isn't providing enough income and want a cash rent to suggest a modified 50-50 with a privilege rent," he adds.

Flexible formulas. Dale Aupperle's phone rang this fall with calls from farm operators and owners asking for help to prepare fair cash rents. Aupperle runs Heartland Ag Group, a diverse farm management, real estate and consulting business in Decatur, IL.

"It is unusual that we get phone calls from both the operator and owner," he says. "I attribute this to the stress that a single cash rent price has put on both parties. One party or another is probably disadvantaged and is seeking relief."

Aupperle's advice for making cash rent fair is to create a flexible agreement. One way to do this is to establish a base cash rent and vary it according to gross income. The gross income should take into account yield, price and government payments and should be acceptable to both the landowner and operator. When gross income exceeds the level, the operator pays a percentage of the excess to the owner plus a base cash rent. When income drops below the amount, the operator deducts a percentage from the base cash rent.

Aupperle gives an example of a base rent of $125/acre and a gross income of $300/acre. The farm operator pays the owner $125 plus 25% of the income over $300/acre. If income drops below $300/acre, the $125 rent is lowered by 25% of the amount below the $300 figure.

Flexible agreements are not new. Iowa State University has promoted several flexible cash rents for years. But the rents haven't become popular. Edwards estimates that only 5% of Iowa farmers with cash rent agreements use some flexible formula.

Times change, however. Low prices and high rents may compel tenants to consider these flexible rents. Edwards says a cash rent that pays the owner a percentage of the gross value of the crop may be the most applicable today. The crop value is determined by multiplying the yield by market price and adding government payments and crop insurance. The most common percentage falls between 30 and 40%.

As an example, an agreement calls for a cash rent equaling 35% of the gross crop value. A corn yield of 140 bu. multiplied by a $2.40/bu. market price comes to $336/acre. Add a USDA transition payment of $18/acre to bring the total crop value to $354/acre. The landowner receives 35% of the crop value, amounting to $123.90/acre.Another example of flexible rents from Iowa farm operators is an agreement that specifies a base or minimum rent plus a bonus based on actual yields harvested. Bonus prices range from $0.85 to $1/bu. for corn yields over 105 to 140 bu./acre and $1 to $3/bu. for soybean yields over 32 to 40 bu./acre.

Multiyear leasing. A slightly soft rental market may also be the time to lock in a multiyear rental lease, according to Steve Taff, University of Minnesota agricultural economist. "People aren't falling all over themselves trying to rent land," Taff says. "Maybe it is a good time to look around and think about renting more yourself. Multiyear leasing is an option we don't often think about."

He suggests obtaining a rental agreement with some flexibility for price changes and locking it in for a period of time. Instead of a handshake and cash payment, write up a contract and ask an attorney to review it. The money involved in renting warrants attorney scrutiny. "Talk about big bucks, that's renting land," Taff says. "One hundred acres at $100 is $10,000. That's worth hiring someone to look over a contract."

Government payments. Although most people expect a slight decline in farm rents overall, a wild card still may hold prices at steady levels. Additional government payments this winter are expected to help farmers finance high rents.

"Watch what the government is doing," cautions Aupperle. "Those dollars are big and they have a major impact. [The payment] may be an identical payment to what we've already received for 1999."

More land to rent. What is certain is that more land should be open for rent. Edwards in Iowa has watched the amount of rented farm ground grow from 42% of the state farmland in 1982 to 50% in 1992. The next five years saw an even bigger increase to 61%.

He credits tax laws for fostering this trend. A farmer selling land at retirement faces substantial taxes on any capital gains. One option is to keep the land and rent it out. "We know the average age of landowners is growing," he says. "And more and more of the land is in the hands of retired people."

Farmers retiring often do so with large blocks of land. To increase a farm operation, watch for these acres to become available.

"I've had the occasion several times in the last few years to rent a farmer 700 to 800 acres of land," Aupperle relates. "In general, this increases a farmer's operation by 40%. They are pretty anxious to have those opportunities."

Watch for investors. Although the most likely way to find available land to rent is to watch for a neighboring farmer's retirement, Aupperle also suggests looking for investor purchases.

"In the last couple years, we've seen a significant purchase of land by outside investors," he explains. "A lot of it is tax-free exchanges because of the overheated economy. It is amazing how much money is out there to go into investments like farming."

Aupperle says that, in Macon County, IL, where he resides, 72% of the farmland is owned by people who don't farm it.

Tracking down these investors and renting from them may make for a beneficial, long-term relationship. "I've seen a number of farm operations get involved with investors for a purchase of maybe 160 acres and now they may farm 1,500 acres for them today," Aupperle says.

He advises farmers to stay in touch with real estate agents, bankers, lawyers and accountants. The first phone call from investors goes to one of those people. If you let them know you're interested in renting land, you may receive the next call.

Hearing the hoofbeats. Not everyone intends to stay in farming, as Aupperle is learning. For the first time in his 28 years of farm management, he is seeing successful farmers consider exiting the business to save assets and not because bankers are forcing them out.

"One farmer told me last week if he sold out today, he's positive he can protect $300,000 in equity," Aupperle explains. "One more bad year could erode it away. I find this amazing. Normally a farmer hangs on until the banker drags him out the driveway. People are saying it will do absolutely no good to experience another bad year, lose all their equity and at the age of 51 go look for something else to do."

What may have prompted this change in business attitude? "They heard the hoofbeats," Aupperle says. "The cash grain farmer looked at the livestock farmer and said there is my friend who worked harder and was rewarded for it and, in a couple years, lost everything. I don't want that to happen to me."

But for farmers not hearing hoofbeats, Aupperle believes a good farm career lies ahead. He believes the market will rebound faster than many people believe. And for the farmers who survive, more land will be available to farm.

Land values, like cash rents, generally peaked in 1998 and dropped slightly this year. Although experts believe that values will remain strong for land, some price drop may occur in the next year or two.

After dropping 15% last year, the price of prime central Illinois farmland hovers around $3,000/acre, reports Dale Aupperle, president of Heartland Ag Group, Decatur, IL. The slow drop in cash rent, additional government payments and good yields keep land prices strong, he explains.

Aupperle, who deals with farm management and real estate, remains bullish on long-term land prices. "Farmland is a growth stock," he says. "There are speed bumps on the road, but not very many." He likes to remind people that, since 1972, the cost of land in Macon County, IL, has increased an average of 5.6% annually.

Iowa farmland declined in value somewhat from 1998 to 1999. The price of top farmland dropped 2.7% to a state average of $2,643/acre. Average farmland declined 2.9% in price, averaging $2,092/acre. Poor land suffered a bigger drop in value of 5.3% to $1,546/acre.

"I would expect that next year we'll see some further decline," adds Craig Dobbins, Iowa State University extension economist. "The land market is interesting, however, because local factors have big influences in it." Farmland near urban development will continue to bring prices that are higher than those for rural land where no demand for development exists.

Minnesota's land market isn't being widely tested. "We hear stories that folks are holding land off the market instead of lowering prices because there is the expectation that prices will continue to be fairly strong," reports State Taff, University of Minnesota agricultural economist.

He generally doesn't recommend buying land right now at these prices, anyway. Instead, he suggests renting what you can and refraining from purchasing land that costs more than it returns in value.

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