May 23, 2012
Rising crop and livestock prices have generated significant profits for many farmers, which some are using to buy additional land. The increased demand has driven land values to record highs in many areas of Iowa and other states.
Given these market conditions, the American Bankers Association's Agricultural and Rural Bankers Committee, comprised of leading ag bankers in the country, has developed the following recommendations for buying farmland. The bankers remind farmers to consult with their banker throughout the process, to ensure decisions you make today best position you to prosper and obtain the credit you may need in the future.
These tips include guidance on both financial planning and research into what the land can produce.
1) Have you created revenue forecasts to assess if you're overpaying?
2) Should you go with an all cash purchase?
3) Have you checked gas, mineral and wind rights for the land?
4) How does the soil's history impact your revenue forecast?
Buying land should include a well-researched financial plan
Establish a basis for purchasing additional land and stick to the plan. There are once-in-a-lifetime purchases that have an emotional connection for the buyer: land that may adjoin the home farm or once was part of the family farm. These purchases may take precedence over business decisions, but the majority of farm land purchases should meet cold, hard business tests.
* Assess your business's financial condition. Consider needed investments, expected expenditures, and crop conditions to determine if buying land is the best use for your cash. Is there a more effective way to deploy your cash or are there other opportunities that can provide a better return?
* Create a pro-forma cash flow. Research the sales trends and expected revenue of a potential plot of land to determine how well the purchase fits within your plan. Does the potential return meet your objectives? Your banker can help you develop this essential planning tool.
* Given your revenue forecast, are you overpaying? If you are paying a premium, how long will it take you to recoup? Determine how much your business should prudently spend on a land purchase and the revenue needed to justify your purchase and stay within those targets.
* Give it thought. Never be rushed by a broker and never confide your best price or financial goals with a party working for the seller. Don't buy impulsively or make a deal before visiting the property numerous times. Rework the standard broker's purchase contract with your lawyer, deleting what you don't like and adding what you want, before presenting the offer.
* Does it make more financial sense to rent the land rather than owning it? Rental rates are high, but renting land frees your cash for other activities.
* Should you go all in with your cash? Talk to your banker about alternatives to using all cash in the transaction. Land is an illiquid asset and purchasing it will impact your farm's liquidity. How will you cover other needed purchases if you commit all of your cash? Does it make sense to preserve some cash and finance part of the land acquisition? Your banker can work with you to structure a loan that will enable you to acquire the land you need while preserving some of your working capital for necessary expenditures.
Land purchases require research; put time and effort into it Know as much as you can so you know what you are getting into Land acquisition is a complicated process and the opportunity for things to go wrong at some point in the process is great. When it comes to buying land, you cannot spend too much time researching all of the contingencies.
* How much land are you acquiring? Sounds simple, but many times there is confusion about how much land is actually being purchased. Know exactly what you're getting before making a bid. See if the land has been surveyed and make sure it matches the details of the offer. If it does not match, how much uncertainty are you willing to accept? If the land has not been surveyed, work with your attorney to determine the acreage based on the legal description or consider having the land surveyed. Establish who will pay the cost of the survey.
* What does the land appraise for? Are there some comparable sales in the area? Appraisals are expensive, but they are the best way to establish value. Even if you do not get a full appraisal, attempt to find some comparable sales to determine if the purchase price is reasonable. If there are no comparable appraisals available that can support the asking price, you should pause and consider what your next step will be.
* What is the soils story? What is the capability of the soil you are buying and how does this impact your revenue forecast? Good soil is paramount. Know the type of soil you're buying and the history of annual crop rotation. Any seller should be more than happy to provide you with a soil's profile and information about past farming practices.
* What is the water source? Is the property irrigated? Do the water rights convey with the property? Adequate water is essential to establishing the value of the property. Account for water cost in your financial plan to ensure this cost doesn't negatively impact your return.
* What do you know about the gas, mineral, and wind rights for the property? Do these rights convey to you as the purchaser? Have they been surveyed? Are they currently under lease? If so, under what terms? Have a thorough knowledge of property rights, as mining and drilling can have an impact on surface and water quality, access to the property, and the viability of the farm.
* How is the property zoned? Will your plans for the property conflict with existing zoning restrictions? Are there conservation easements that could restrict use of the property? This factor has a significant impact on your valuation of the property, particularly if your plans conflict with current zoning restrictions.
* Are there any environmental problems? The last thing you want to buy into is a costly environmental problem. Paying for an onsite environmental audit before you buy the land may well be worth the cost and will help ensure you are not buying into an expensive cleanup.
* Need someone to talk to? No one knows more about financial budgeting and cash flow planning than your banker. Make an appointment to talk with your banker about the significance of purchasing land and how it will impact your business.
Contact John Blanchfield at (202) 663-5100 or by e-mail at [email protected] for more information. The American Bankers Association represents banks of all sizes and charters and is the voice for the nation's $13 trillion banking industry and its two million employees. The majority of ABA's members are banks with less than $165 million in assets. Learn more at aba.com.
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