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What's the best way to configure a flex lease?

Land Values: Take a look at two flex lease formulas based on one farm manager’s experience.

In recent years, the flexible cash rent lease has become a popular way for landowners and farm tenants to share a small amount of risk and reward together. What’s the best type of flexible lease? That will depend on your situation, and there are many ways to structure an arrangement that can work for both parties.

The first thing to consider is “how do we want to structure the lease?” A flexible lease looks at one or more factors that affect a tenant’s profits. The simplest flexible leases look at applying a simple formula to either crop production or average commodity prices. The more complex formulas account for crop production, commodity prices, crop insurance proceeds, government payments and crop input expenses.

Once you have decided on the structure, you can start building the formula and how you will account for each variable. Will the crop production be based on the actual bushels delivered, dried and shrunk to account for actual salable bushels? Or will it be based on the average production history for the last 10 years? Will the price be based on the average of what the farmer sells the crop for, or will you create a simple average of prices on specific dates, set in advance? The details matter when designing these leases.

Example 1. This first example shows a flexible lease with crop production as the only variable, using the actual production from the farm. The rent will be a minimum of $200 per acre, and the landowner will receive $1 per bushel for corn and $3.75 per bushel for soybeans. If the tenant produces a 250-bushel average corn yield per acre, then he or she would owe another $50 per acre at the end of the year. If the tenant produced a yield of 65 bushels per acre on soybeans, he or she would owe another $43.75 per acre.

Example 2. This one is a little more complicated. Let’s maintain a $200-per-acre minimum rent and use a net income calculation. Using the actual production, we’ll base prices on a six-month average from April to September. Then we estimate the tenant’s cost of production by budgeting for the seed, chemicals and fertilizer expenses.

Let’s assume $3.75 and $9 for the six-month averages for corn and soybeans, respectively. The tenant’s costs are $375 per acre for corn and $165 per acre for soybeans. Any income above the tenant’s expenses would trigger an additional 15% flex rent. A formula would be written as follows: ((yield x price) – production cost) x 15% = flex rent. A corn yield of 225 bushels per acres and soybeans at 60 bushels per acre would produce an additional rent payment of $70.31 and $56.25 for corn and soybean acres, respectively.

No matter which formula or variables you use, the key to making a flex lease work is to come to an agreement that works for both sides — and that’s the most difficult part for many landowners and tenants. 

Flex cash rent leases are not for everyone, and they require both landowner and tenant to share information, which may not have been shared in prior leases. One final recommendation: Draw up the new flex lease for no more than one year. If the formula didn’t work the way you anticipated, you can always make changes next year. 

Wilkinson is a farm manager with Hertz Farm Management, Kankakee, Ill., and a member of the Illinois Society of Professional Farm Managers and Rural Appraisers. Email questions to ispfmra@countryside-marketing.com.

TAGS: Crops
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