October 11, 2023
Recently, a banker inquired about farmers who primarily farm rented land and own minimal farm ground. This banker said, “It appears to work well. What are your thoughts?”
A trend in agriculture
A trend in agriculture is the control of assets versus the ownership of assets. After World War II, approximately 17 percent of farm ground was rented. Today, as much as 50 to 60 percent of farm ground is rented, much of which is being operated by the younger generation.
To make this business model successful, producers must work efficiently and the management mindset has to be moved to a higher level. Businesses in this situation must know their cost of production and break even point, particularly when negotiating rents and leases. Enterprise analysis is required to determine the most profitable crop and livestock enterprise mix. A marketing and risk management program is necessary to cover both upside potential and downside risk.
Growth and equity
For producers who rent most of their farmland, growth and equity is often in machinery and equipment assets. Some producers are utilizing the latest technology for a competitive edge. Others, such as startup producers, will seek and acquire older and used equipment to accomplish the objective.
When working with the agricultural lender, the lack of land collateral increases the emphasis on management execution and monitoring of the business and cash flow plan. Working capital reserves as a percent of total expenses will often have to exceed 40 percent. This provides a backup reserve that lenders will require if profits and cash flow are hindered.
Lenders want to know liabilities
Lenders will also want to know about lease and contractual agreements and any possible contingent liabilities such as future land and soil upgrades or facility improvements. Managers of more successful businesses will aspire to achieve a return on assets greater than 20 percent if utilizing rented and leased farmland. This is achievable because the asset base, or the denominator, is smaller compared to those who own considerable assets.
Some producers have preferred this mode of operation for its flexibility and reduced overhead expenses. It allows them to pursue other business ventures both inside and outside of agriculture that align with their resources and their talents.
The downside of this business model is the potential to lose the asset base as the transition of assets accelerates. The ability to garner wealth through the capital appreciation of land, which historically has been a good return on investment, is another opportunity cost or opportunity return that is lost.
The opinions of David Kohl are not necessarily those of Farm Progress.
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