Farmland values may be headed for a fall, if a simple economic indicator is any clue. The value-to-rent ratio for farmland - a price-to-earnings (PE) indicator, if you will - has jumped to near historic highs of 1982, just before land values took a nosedive.

"On a price-earnings ratio basis - land value divided by income or rent - it looks like the PE ratio for land nationwide will move up to 21.5 times the income this year," says Mike Fritz, editor of Farmland Investor Letter. "The historic high was nearly 25 in 1982. By comparison, the PE ratio for the broad stock market is around 18.

"If the farmland PE ratio continues at this level for the next few years, it signals that land values are getting over extended," he says. "I'm not suggesting we're going to see a sharp contraction in farmland values, but I think the likelihood that farmland will continue going up at the pace it has been is highly unlikely."

Factors push prices
USDA is forecasting that farm real estate values will rise 6.5% this year, off modestly from last year's figure of 6.8%. Here are six key factors to watch going forward:

Stock market The stock market blew up six years ago, in part due to the tech stock bubble, corporate malfeasance, and a general trend among investors who wanted to move into hard assets like farmland.

No one has measured the amount of money that moved out of stocks, but with the market bumping up against 4 1/2 year highs, there are clear signs that money is flowing back into stocks again.

"Memories fade, and greed does take over eventually," says Fritz. "When the stock market comes back, that will take some of the wind out of demand for farmland."

Farm income USDA's ten-year baseline projections forecast farm income to decline compared to the last three years. Net farm income was more than $82 billion in 2004 but is now forecast to drop this year to around $56 billion, which is average. "The run up in farmland values coincided with this three-year period of historically high farm profits," notes Fritz.

Supply and demand Farmers remain the main buyers of farmland. Their balance sheets are very strong right now, but the reason is because of the run up in farmland values. Over 80% of their assets are farmland, notes Fritz. Meanwhile, edgy land owners have been testing the market.

"There is no firm statistic on number of land listings, but anecdotally, we've heard listings are at record levels," he says. "A lot of land owners have seen the run up in land and a lot of land has gone on the market. That supply is getting out of whack with demand." Even so, there is still strong demand for good quality land.

1031 exchange In Illinois, tax deferred land buyers made up just 22% of farmland buyers in 2002; by last year the number had surged to 56%.

"You can see this wave in tax deferred exchange money that's moved into farmland," Fritz says. "It's coming from Chicago primarily, but also from St. Louis and Indianapolis, and it's becoming more popular nationwide. A lot of brokers have jumped on the bandwagon to promote them, particularly on large parcels."

Commercial real estate Historically, farmland values do not move parallel to commercial real estate values, housing values or timber. That's why institutional investors were attracted to farmland, because it moved differently than commercial property. But in the last several years, those bands have narrowed considerably. These days when housing, timber and commercial property values go up, farmland values go up too. It may be valuable to watch the commercial real estate market for clues to farmland movement.

Farm bill The farm bill will eventually be overhauled in the next two years. Studies show farm program payments get capitalized into farmland values. Meanwhile, huge deficits have provoked increasing pressure to cut farm subsidies, especially if the United States is forced to make changes to its farm programs based on a new WTO trade agreement.

"We all get caught up in the frenzy of concern over farm program payments," says Fritz, "but I think it's a bit overblown. They will be rationed down and probably moved toward environmental programs, but I tend to think the money is still going to be there.

"However, tilting the farm program toward conservation practices could result in a redistribution of payments from farmland with a history of producing certain crops to farmers or landowners who can deliver larger environmental benefits. "