indiana Prairie Farmer Logo

Why are farmland values increasing so rapidly?

Farm Business: Several basic economic factors support higher land prices.

Michael Langemeier

November 22, 2021

4 Min Read
snow-covered farmland
LAND PRICES ON THE RISE: Several surveys document higher land prices across Indiana. There are sound reasons why farmland values have increased and may continue to increase in the short term. Tom J. Bechman

Recent surveys indicate that farmland values have increased from 12% to 17% in the last year. Using Purdue University survey data from 1973 to 2021, the long-run average increase in farmland values for west-central Indiana is 5.4%. What accounts for the recent strength in farmland values?

There are several key factors that drive or influence farmland values. They include cash rent or net return to land; working capital; interest rates; inflation; investment potential of farmland compared to other investments such as the stock market, corporate bonds or similar assets; and the supply of land.

We will examine these factors in two groups. The first group consists of cash rent or net return to land and working capital. The second group consists of interest rates, inflation, investment potential of farmland and the supply of land. Both sets of factors are positively contributing to the current strength of farmland values.

Net returns to land

Cash rent is primarily driven by net returns to land. Using a case farm in west-central Indiana, net return to land has averaged approximately $254 per acre since 2007. During this time, cash rent in west-central Indiana for average-productivity soil has averaged $233 per acre. Thus, average net return to land has been higher than average cash rent. This relationship signals upward pressure for both cash rent and farmland values.

It is particularly important to note that net return to land during the last couple of years has been substantially above cash rent. In 2020, cash rent was $252 and net return to land was $328, while in 2021, cash rent was $262 and net return to land is projected to be about $390.

The relatively strong net return to land during the last couple of years has also strengthened working capital. Working capital is an important source of funds when making down payments on farmland, and when purchasing depreciable assets such as machinery and buildings.

Supply chain issues, low inventories of new machinery and relatively high used-machinery prices have created a situation where farms are more apt this year to use working capital for farmland purchases than for purchases of machinery or buildings. So, both cash rent and working capital are contributing to the current strength in farmland values.

Interest rates

Now let’s turn to the second group of factors impacting farmland values. Long-term interest rates or capitalization rates are a major factor impacting farmland values. The capitalization rate depends on the long-term rate on U.S. treasuries, which is the risk-free interest rate, inflation, and the risk premium between the long-term interest rate for land and the long-term rate on U.S. treasuries.

If any of these factors increase or decrease, the interest rate on farmland is likely to increase or decrease. Though inflation has increased in recent months and the risk premium could increase in the next couple of years due to a potential decline in net farm income, the long-term rate on U.S. treasuries remains at historical lows, subsequently providing support to farmland values.

Turning to the supply of farmland, that market is often considered to be very thin, meaning that at any particular time, the supply of farmland on the market represents a very small percent of total farmland. The thin land market often results in strong demand when land becomes available in a local area.

Farmland is also considered to be a good hedge against inflation. The recent increase in inflation expectations is providing support for farmland values. Finally, because of its low correlation to stock market returns, farmland is also attractive to institutional investors. So, as a whole, the second group factors also contribute to the current strength in farmland values.

Future farmland trends

Now let’s take a more long-term view of farmland values. Even though net return to land and working capital could be lower in the next few years compared to 2020 and 2021 levels, there are several other factors helping support current farmland values.

Historically low interest rates, inflation, investment potential and the thin farmland market may create a situation in the next few years in which there is not as much upward pressure on cash rents, but stable to increasing land values.

Langemeier is a Purdue University Extension ag economist and associate director of the Purdue Center for Commercial Agriculture.

Subscribe to receive top agriculture news
Be informed daily with these free e-newsletters

You May Also Like