Roller coaster rents

Roller coaster rents

By: Rich Fee 02/14/2011 @ 2:29pm

If Yogi Berra followed the land rental market instead of baseball, he might be saying, “It’s déjà vu all over again.”

Think back to February 2007. At that point, grain prices were significantly higher than they had been in September 2006, and much of the 2006 crop had been priced before prices started increasing. The 2007 crop could be priced at relatively high levels, but producers were reluctant to sell a large percentage of that crop in advance. Yet there was also concern that those prices might drop between February and harvest. Input costs were going up. And the land rental market was in turmoil.

That’s a lot like the current situation, and the land rental market is once again in turmoil. Corn and soybean prices started going up last summer, but most of the increase came after August. Futures prices for the 2011 crop were relatively strong through the fall, input costs started going up, and land values have increased dramatically in many areas. An Iowa survey released in December shows that land values had increased 16% from November 2009 to November 2010.

Fixed cash rent agreements don’t respond well to volatile markets. “If everyone went back to or stayed with crop share leases, the volatility in grain and fertilizer prices wouldn’t be nearly as problematic,” Kansas State University ag economist Kevin Dhuyvetter said in late December.

At that point, he was partway through a series of land rent meetings around the state. At a mid-December meeting in Clay Center, he asked the attendees what they thought of fixed cash share leases compared to equitable crop share leases.

The group was about equally split between landowners and producers.

• 23% thought fixed cash rent was a good thing.

• 23% thought it was a bad thing.

• 54% thought fixed cash rent was neither good nor bad, just different.

At that same meeting, Dhuyvetter asked the attendees how much they thought rent would increase for 2011.

• 45% said up 2% to 5%.

• 38% said up more than 5%.

• 14% said remain steady.

• 3% said down 2% to 5%.

Purdue University ag economist Craig Dobbins expects fixed cash rents to increase in Indiana, also. And he sees evidence that tenants are being proactive. “This winter, I have been getting a new kind of call from landlords,” he says. “They indicate that the tenant is suggesting that the rent be increased. This is an experience that most landlords have not had before, and they are not exactly sure what to make of this.

“Here is an opportunity for the tenant to strengthen the relationship with the landlord,” says Dobbins. “Explain to the landlord the details for why the rent should be raised. Use as much detail as you would if you were arguing that the rent should be lowered. This is an opportunity to show landlords that you are using sound business procedures. So if you need to ask for a rent reduction in the future, the same procedure can be used.”

Barry Ward, an Ohio State University ag economist, had this to say about the land rental market in late December: “I believe cash rental rates will be higher on average across Ohio for 2011 than they were for 2010. But there will be regional differences as some areas experienced poorer crops in 2010 and may not see the upward pressure that other areas see.”

He acknowledged that grain prices were up significantly, but said, “Many sold 2010 crops ahead and haven’t priced much 2011 crop. And inputs are up.”

Also in late 2010, Iowa State University (ISU) ag economist William Edwards said,

“There will be more than the usual variability in Iowa because the rise in grain prices happened mostly after our September 1 deadline for renewing leases. Leases that were renewed before September 1 probably did not change rents from last year in most cases.” (Most states have later rent renewal deadlines than Iowa.)

“Some tenants and landlords routinely let the lease roll over but expect to negotiate next year’s rent later,” he added. “For these there will be upward pressure, but it’s hard to say how much. Some tenants will voluntarily offer more; some will wait and see if current grain prices persist into the next crop year.

“Most operators will not price a high percentage of the 2011 crop yet,” he said, “so higher incomes are not a given.

“Landowners may overestimate how their tenant did in 2010,” Edwards added, “because much of the crop was priced before the harvesttime price increases. And in some cases, not as many bushels were harvested as the year before.”

Steve Johnson is an ISU Extension farm management specialist in central Iowa. He was dealing with lease issues at the end of the year, and said, “The average cash rental rate for 2011 will be higher than 2010, but forecasting these numbers will be difficult. Likely, cash rents and renegotiated leases are $10 to $30 per acre higher.

“In Iowa, the lease termination deadline of September 1 meant many landowners did not provide legal termination, since 2011 prices had increased only a fraction of their overall prices moves higher,” he said.

There are definitely some dollars on the table.

Johnson points out that December 2011 corn futures prices had increased over 45%, and November 2011 soybean futures prices had increased by more than 40% since late June.

“Cash rent represents about 30% of the total cost of corn production costs and 40% of soybean production costs,” says Johnson.

“Think about this one,” he said. “The potential profit margin for corn per acre, assuming other costs remain constant in 2011 (which he acknowledged they won’t), would indicate that more than $90-per-acre net profit potential could be reflected in increased cash rent.” Here’s his math: 180 bushels per acre of corn × a $1.80-per-bushel price increase = $324 per acre. Multiply that by 30% and you get $97 per acre.

For soybeans, he said the soybean profit margin increased by more than $70 per acre over the six months from June until December, if other costs remained constant. Here’s his math for soybeans: 50 bushels per acre × a $3.82-per-bushel price increase = $191. Multiply that by 40% and you get $76 per acre.

In January, ISU increased the cash rent equivalent number in their crop cost estimates by $20.

Cash rents can go down, too, of course. An Illinois survey showed significant erosion in 2009 cash rents according to when the rent was set. Land rented prior to September 2008 brought $285 per acre. Land rented in September and October brought $272. Land rented in November and December brought $260. Land rented from January to March brought $222.

University of Nebraska ag economist Bruce Johnson says to “negotiate cash rent levels annually and understand year-to-year cash rent levels can move both up and down.” He forecasts a saw-tooth pattern for cash rents.

Cash rent for 2010 didn’t change much from 2009 in many areas. And until grain prices took off last summer, 2011 rents had been expected to remain fairly stable.

Purdue University ag economist Craig Dobbins reported in August that the statewide average for top-quality land in Indiana in 2010 increased 2% ($4) to $202 per acre. Average-quality land increased 1.9% ($3) to $161 per acre. Poor-quality land increased 2.5% ($3) to $124 per acre.

Statewide, rent per bushel of estimated corn yield ranged from $1.02 to $1.08 per bushel.

For top-quality farmland, cash rent as a percentage of farmland value was 3.8%. The percentage for average-quality land was 3.6%, and for poor-quality farmland, the figure was 3.5%.

In January, Nebraska’s Bruce Johnson said, “Rental rates will be higher for 2011 due, in large part, to the grain price run-up in the last half of 2010. Many cash rent contracts were already in place before the big grain price gains, but contracts negotiated closer to the first of the year in areas where there is strong competition for rental land are definitely showing increases.” He expects increases in the double-digit range.

Cash Rent Is A Fickle Friend: The pros and cons of fixed cash rent

Cash rent is the primary method of leasing farmland in many areas. That’s especially true in the Corn Belt, where over 80% of the rented land in the Seventh Federal Reserve District (Iowa, Indiana, Michigan, Wisconsin, and most of Illinois) is rented for cash. In tranquil times, cash rent works fairly well. But in tumultuous times like these, its flaws stand out.

“When yields and prices are relatively stable, setting the cash rent may be fairly easy,” says Iowa State University (ISU) ag economist William Edwards. “However, when conditions are volatile, it becomes more difficult to determine a mutually agreeable rent.”

Most years, the volatility relates to grain yields or commodity prices. But over the past few years, there has also been a lot of volatility in input costs, particularly for fertilizer.

Risk has also become a bigger factor. University of Illinois ag economist Gary Schnitkey says farmers now face more risk than they did a few years ago for three reasons.

“First, price variability likely will be higher over the next several years.

“Second, commodity programs will not provide as much downside price protection.

“Third, revenue for crop insurance must fall more in periods of high prices before insurance payments are received,” he says.

Howard Doster, a retired Purdue University ag economist and longtime proponent and developer of flexible cash rents, says the problem with most rental agreements is “they start going out of date the minute they are signed.”

Under a crop-share lease, the landowner and tenant share the expense of raising a crop and the income from that crop. There are many possible arrangements. A recent Iowa survey shows a 50-50 split is still the most common. In central and western Kansas, a 67-33 split is the most common arrangement.

Under a cash rent lease, the landowner receives a cash payment in exchange for the use of the land. This article deals primarily with fixed cash rents that are established in advance. There are also flexible cash rents that have price adjustments for yields, commodity prices, and, in some cases, input costs.

There has been a steady shift from crop share leases to cash leases over the past 30 years or so. Iowa State University conducts a land ownership and tenure survey every five years. The last one was taken in 2007. In 1982, 49% of the leased farmland in Iowa was under a cash lease, and 49% was under a crop share lease.

Twenty-five years later, in 2007, 77% of the leased farmland was cash-rented and only 22% was crop-shared. (A flexible cash rent was used on 12% of the acres that were cash-rented. The other 88% had a fixed cash rent.)

In 2007, 60% of the farmland in Iowa was rented. More land was cash-rented (46%) than was farmed by the owner (40%).

There are lots of reasons for the shift. ISU ag economist Mike Duffy, who conducts the survey, says, “The most important reason appears to be the relative ease of using the cash rent. As tenants have more landlords and vice versa, it is simply easier to remember a dollar amount than some division, especially if it involves dividing a crop.”

Over the past decade, there has been a significant shift from crop share rent to cash rent in Illinois, as well. University of Illinois ag economist Nick Paulson says, “The average proportion of total acres that are operated under a share rent agreement has fallen from about 48% in 1997 to 37% in 2009. Over the same time period, the proportion of total acres operated under cash rent agreements has increased from just over 25% to approximately 40%, while ownership rates among grain farm operators have declined slightly from 25% to about 23%.”

Paulson says these trends have significant implications for farm profitability and the risk exposure facing both the producer and the landowner. He links the risktakers to the increased availability and breadth of crop insurance programs.

“While economic theory would suggest that farmers should earn a premium for taking on additional risk, lower farm returns have been linked to Illinois farms which cash-rent a significant portion of their total acreage,” says Paulson.

Kevin Dhuyvetter, a Kansas State University ag economist, says, “A risk premium, or risk adjustment, represents a reduction in the cash rent relative to what is expected from a crop share arrangement, to account for the shift in risk from the landowner to the tenant. The amount of risk adjustment is a function of an individual’s aversion to risk as well as the income variability.

“Since an individual’s aversion to risk is difficult to quantify and because this varies considerably between people, recommending a risk premium appropriate for all situations really isn’t possible,” Dhuyvetter says. “In the mid- to late 1980s, a risk premium of 10% was typically recommended. But in the late 1990s and early 2000s, we often observed risk premiums of zero. That is, producers would pay cash rents equivalent to the expected crop share returns. Today, I think the value is back to at least 10% and, in some cases, is significantly higher than that due to the increased volatility.”

Cash rent has worked fairly well or it wouldn’t have kept growing in popularity. But with the tremendous volatility in grain prices since late 2006, the inherent problems with cash rent have surfaced.

“Extremely volatile input prices and crop prices make negotiating fixed cash rents very difficult and risky,” explains Dhuyvetter. “Most crop share arrangements have a built-in buffer to much of this risk.”

Kansas is a state where crop share leases are still common. “Crop share continues to be the most prevalent in Kansas, but the trend has been a shift from crop share arrangements towards more cash rent leases,” says Dhuyvetter. In 2006, 64% of rented ground was crop-shared vs. 31% that was cash-rented.

As grain prices soared in 2007 and the first part of 2008, tenants on cash rented ground experienced a windfall. Some producers paid landlords a bonus in an attempt to maintain good relationships. And some producers lost rented land for the next year because landlords didn’t think they received enough rent.

Cash rents went up, but not as far or as fast as commodity prices. There is always a lag time with cash rent. Then, in the second half of 2008 and on into 2009, as input prices (primarily for fertilizer) skyrocketed while grain prices fizzled, rents lagged the downturn.

Purdue University ag economist Craig Dobbins points out the problems with trying to set a cash rental rate in the fall of 2008 for the 2009 crop. “Given price and cost expectations in September 2008, the estimated return to land and unpaid machinery and labor resources for a 2009 crop corn/soybean rotation was $308 per acre. Given this estimate, a cash rent of $200 per acre for 2009 may have been reasonable. During October 2008, cash corn and soybean prices went through a significant decline. Expected grain prices for fall 2009 also declined,” Dobbins says.

“Using the futures market as a guide for prices for the fall of 2009, the estimated return to land and unpaid machinery and labor resources for the corn and soybean rotation in late October 2008 was $200 per acre. In this case, $200-per-acre rent would not leave any margin for the cash rent tenant’s unpaid machinery and labor,” he says.

There is evidence that crop share arrangements or flexible cash rent arrangements are more equitable than fixed cash rent arrangements and that they foster more cooperation. Operators come and go more often on cash rented land than they do on land that is crop-shared. According to the 2007 ISU survey, the average crop share acre was leased by the same person almost twice as long as a cash rented acre – 18.1 years vs. 9.5 years.

The ISU survey also shows that older landowners are more inclined to crop-share land than are younger landowners. “This means it is likely that the crop share lease of today will be converted to a cash rent,” says Duffy. “However, there are signs this change to cash rent will not continue indefinitely. More of the crop share leases are between relatives. Crop share is one way an older party can help a younger party by sharing risk. This is not only the production risk but also the costs of production.”

A major problem with setting cash rents is that accurate information is scarce and usually a year behind. As Edwards points out, “Informal information about cash rents is plentiful, but often focuses on extreme cases.” It’s also hard to avoid comparing apples and oranges. Soil types, tile drainage, and fertility levels can vary a lot among nearby fields.

Dhuyvetter says, “Publicly reported cash rental rates often represent a relatively wide geographical region and, thus, may not reflect local conditions.”

Schnitkey adds, “The cash rental market has local factors that influence rental rates. Hence, what may be occurring in one county may not be occurring in another county. And cash rents vary considerably from farms of similar productivity within a county. There will be rents more than $100 higher and $100 lower than average. Some of the differences between averages from year to year may simply be based on which farms get sampled.”

Although published information is scarce, some is available. The National Agricultural Statistical Service (NASS) started providing county rent estimates in 2008. That information is available at www.nass.usda.gov/Surveys/Guide_to_NASS_Surveys/Cash_Rents_by_County/index.asp

ISU Extension conducts a survey every spring after rates for the year have been set. Results are usually available in May. Past surveys are available on the ISU Ag Decision Maker website (www.extension.iastate.edu/agdm/).

Timing can also be an issue with cash rents. The deadline for breaking rental agreements varies by state. In Iowa, rental agreements that aren’t cancelled by either party by September 1 remain in effect for the following year. Some tenants and landowners, and many farm-management firms, routinely break the rental agreement each year and then renegotiate it during the winter as more information becomes available. Grain prices started going up last summer, but most of the increase came after September 1. Input costs increased during the fall, also.

By March, there may be less uncertainty on grain prices and input costs, and the base prices for revenue crop insurance policies should be set. Provisions are made for compensating the operator for fall tillage and fertilizer application if an agreement on price is not reached during the winter.

Many tenants and landowners have willingly turned from crop share arrangements to cash rent. Depending on individual circumstances, there are lots of valid reasons for making the switch. But there are also lots of valid reasons to avoid cash rent.

An ISU publication entitled Improving Your Farm Lease Contract lists the principal advantages and disadvantages of a straight cash lease. Here are the advantages cited in the ISU publication:

• The lease is simple with relatively few chances for misunderstanding.

• The owner is relieved of making day-to-day operating decisions.

• The owner has very little financial risk.

• The tenant has maximum freedom in planning and developing the cropping and livestock programs.

• The tenant has fewer records to keep.

Here are the disadvantages and potential problems of the straight cash lease, as presented in the ISU publication:

• A fair cash rental rate may have to be renegotiated each year.

• Cash rents are likely to be too low in times of rising prices and increasing yields, and too high in times of low prices or low yields.

• Tenants are required to supply more operating capital.

• Tenants bear all the risk of price and yield variability.

Edwards sees that first disadvantage as the main drawback of cash rental arrangements. “The primary disadvantage of a cash lease is the need to agree on a rental rate that accurately reflects the profit potential of the farm,” he says.

Edwards contrasts that with crop share leases. “The most desirable feature of a crop share lease is that both parties automatically share in increases or decreases in profits, making yearly negotiations about rental terms unnecessary,” he says.

Flexible cash rental agreements can accomplish that, also. “Tenants and owners who are willing to share risk but want the simplicity of a cash lease may prefer some type of flexible cash rent agreement,” says Edwards.