Your farm may be candidate for flex cash lease
Volatility in grain prices, input costs and increased variability in Iowa crop yields due to this summer’s drought could make setting 2013 cash rental rates even more challenging. Steve Johnson, Iowa State University Extension farm management specialist in central Iowa, says flexible cash rent leases are something to consider as a way for both landlords and tenant operators to cope with the increased risk involved in renting cropland.
• Setting cash rental rates for 2013 will be even more challenging than in 2012.
• Volatile grain prices, input costs and widely variable yields are reasons why.
• A flexible cash rent lease can help share the greater risk and potential reward.
In this article, Johnson explains flexible cash rent leases and takes a look at the performance of a flex cash lease for the past five years using a central Iowa farm lease as an example.
Will rent rates rise in 2013?
The Iowa State University Extension cash rental rate survey released in May with 1,419 respondents indicated the average market value for cash rent in the state for 2012 is $252 per acre, an increase of nearly 18% over 2011. That’s a jump of $38 per acre following a $30-per-acre increase the previous year. Cash rental rates have risen throughout Iowa, especially since 2010 with higher grain prices.
So, will cash rental rates continue to rise in 2013? The rate of cash rental rate increases will likely slow, says Johnson, because drought conditions have cut into 2012 yields of nearly all Iowa farms. Despite the higher crop prices, most operators will have fewer bushels to sell. That means lower gross revenue per acre in order to pay cash rent. Some operators might have to use crop insurance loss proceeds to make final 2012 cash rent payments.
Crop share rental arrangements
Another way to share the risk between landlord and tenant is to use a crop share rental arrangement such as a traditional 50-50 crop share lease. “Crop share arrangements were probably more fair to both parties in 2012 than many fixed cash rental arrangements,” notes Johnson.
“Since yields varied statewide, at least the yields on those particular farms are reflected in the amount the landlord receives in rent,” he says.
Johnson doesn’t expect the number of crop share rental arrangements to increase significantly in 2013. Landlords will likely remain reluctant to manage the additional risk of both yields and prices, despite their ability to use crop insurance to protect revenue. However, he does think the number of flexible cash rent leases will increase in 2013. These “Iowa flex leases” as they’re known around the Corn Belt, blend a guaranteed base cash rent plus a potential bonus that landlords receive. Since this bonus uses the farm’s yields and reflects costs, it has some of the components of the crop share lease.
Flexible lease has moving parts
Johnson has taught farm operators and landlords about the use of flex leases since 2006, and he hears consistently that flex leases have too many variables and are just too difficult to understand. He doesn’t disagree, as they aren’t as simple to understand as fixed cash lease arrangements. But he feels that flex cash leases are often more fair than fixed leases to both the tenant and the landlord.
There are advantages to both parties that are often not realized until the flex lease has been put into place. The operator doesn’t have near the risk if the fixed amount is extremely higher than the base rent. This base rent is likely more of an average cash rent for that particular area, not a market price for land available to cash rent.
The operator on a farm with a flexible cash lease arrangement isn’t locked into extremely high cash rents should weather cut into production or market prices drop. The landlord isn’t holding out for the highest cash rent, and is willing to take some risk in receiving a bonus, should the yields on that farm and local cash harvest price bids warrant.
Keeping flex leases simple
The typical “Iowa flex leases” set a base rent, and use the farm’s actual yields as reported by their tenant to their crop insurance agent as the Actual Production History, or APH, on that farm. The farm’s yield for each crop is then multiplied times the average cash price bids for harvest delivery in October at a local co-op or elevator.
To balance these new-crop cash price bids used to determine the bonus, four dates are used: Jan. 15, April 15, July 15 and Oct. 15. The gross crop revenue (yield times price) then subtracts the average cost of production for that crop, including the base rent amount. Many times the ISU Cost of Crop Production figures released annually in January are used to determine non-land costs.
The bonus paid for each crop (corn and soybeans) is a percentage of the net revenue. Net revenue is gross crop revenue minus total crop costs. This percentage of net can vary, but a 33% rate is a blend for both corn and soybeans.
Performance of a flex lease
Once the tenant operator and landlord understand the moving parts of a flex lease, the questions they typically ask focus on how much bonus might be paid.
To explain how to figure that amount, Johnson uses an example of a central Iowa farm with a $250-per-acre base rent and a bonus of 33% of the net revenue. The actual yields are multiplied times the average new-crop cash bid for harvest delivery at the local co-op on the weekday closest to Jan. 15, April 15, July 15 and Oct. 15.
Since the yields and prices are not known for 2012, he estimates the yield to be a 10-year average, and he used $5.50-per-bushel corn and $13-per-bushel soybean prices, respectively. The chart above reflects the performance of that flexible cash farm lease.
Note for each of the five years this flex lease was in place, the landlord received a $250-per-acre base rent, not unlike a fixed cash rent lease. However, a bonus based on 33% of the farm’s net income would have been paid in 2008 of $36-per-acre average and a $59-per-acre bonus in 2011. No bonus would have been received in 2009 and 2010, simply the $250-per-acre base rent. With average 2012 yields, the landlord can expect a bonus again this year. Yields that are below-average might be partially offset by the higher cash prices offered for harvest delivery on July 15 and Oct. 15.
Also, the bonus is likely larger for acres producing corn as compared to soybeans. This might make soybean production more competitive as a rotational crop as compared to corn on corn. The farm’s potential cash prices received are known after Oct. 15, and yields should be known following harvest. The determination as to the bonus should be made in November or by early December. That bonus paid to the landlord can be made in the same taxable income year as base rent was paid and the crop was grown.
Get it explained in lease
The landlord should request in a written lease the specifics of the flex lease arrangements. Include this requirement in the lease that the tenant show how the bonus or non-bonus payment was determined. This includes a copy of their APH yields for that farm, as well as the average cash price calculated for the harvest delivery bid. Include in the lease the weekday closest to the specific dates used to determine the cash price, as well as the location of the local co-op or elevator.
Some farm operators may prefer to calculate their own cost of crop production annually rather than use those in ISU Extension publication FM-1712 or File A1-20 on ISU’s Ag Decision Maker website. Just make sure those specifics including dates for payment of the base rent and potential bonus are spelled out in the written lease.
“You should expect setting the 2013 fixed cash rental rate to prove challenging with the volatility in grain prices, input costs and the drought of 2012,” sums up Johnson. The use of flexible cash farm leases is expected to increase in 2013 as compared to traditional fixed leases. The “Iowa flex leases” blends a guaranteed base cash rent plus a potential bonus. A summary of the performance of flex leases in central Iowa over the past five years points to the fact that bonus payments are typically made in years with good yields or a high local cash price average bid for harvest delivery.
Source: ISU Extension
This article published in the August, 2012 edition of WALLACES FARMER.