Over the last couple of weeks I have been talking about some economic analysis of farmland prices done about a decade ago, and how that analysis can help the savvy investor (or farmer) understand the trends in the market price for land.
We understand now that when something permanent or long-term changes in the fundamentals (the interest rate, and the level of farmland rents), this has an impact on farm prices for many years. The current regime of low interest rates means a steady inflationary trend for farmland prices, if other factors remain steady. And we understand that more transient changes in the market – the weather, for example, or world events – will also impact farmland prices, but will tend to do so over the short term rather than the long term.
Most of Falk and Lee’s categories are easy to understand – temporary fundamentals means basically the weather, and every farmer understands the weather in his or her bones; the non-fundamentals tend to be the things that you hear about on the news, but not directly on the farm report. We all know what interest rates are. But what about farmland rent?
Farmland rent is a concept that economists use to cover a whole host of information. A change in the quantity of arable farmland, for example, is going to cause an increase or decrease in average farmland rent, for obvious reasons. Changes in the total global agricultural demand cause a change in rents. Permanent climactic changes can cause a change in rents; if global warming makes all of Canada a breadbasket, we’ll be watching those Iowa land prices sink into the basement. If (as seems more likely) global warming makes all farmland somewhat less productive, we’ll see a somewhat-paradoxical increase in rents. (You would think that less-productive land would be worth less rent, and if everything else was staying the same, that would be true. But if the total output of the farm system goes down, then the importance of each particular piece of land goes up.) Changes in global wealth level can cause a change in rents; aggregate demand may not go up or down, but consumption patterns might shift, making some types of land more or less valuable than others.
The key element to look at is whether a change, innovation, shock, or development is likely to impact the underlying value of farmland or the overall trend of national interest rates. Next in importance is the magnitude of the change. A huge decrease in arable land is going to have a much bigger impact than a modest shift in the eating preferences of a midsized European nation. And remember that in the case of economic shocks, such as the fiscal crises in Europe, there are two important elements: what is the overall economic trend, and of more direct importance, what will it do to interest rates. For example, the current European economic crisis is likely to lead to a decrease in agricultural demand as austerity-pinched citizens of the Eurozone cut back. But the crisis is also likely to keep interest rates down as central banks, including ours, work desperately to hold the value of their currency.
So with all that in mind, what are the current trends looking like? I am going to go into more detail on this in upcoming posts, but the overall picture is very positive for farmland values. The long-term trends favor higher prices, while the short-term picture is more mixed but still quite positive. Continued economic development of the third world, adjustments to make the European markets more viable, the overall impact of climate change, and continued global population growth are all combining to push values higher. Is there an end in sight? I’ll look at that question too.
Fads versus Fundamentals in Farmland Prices, Falk & Lee. http://www.jstor.org/discover/10.2307/1244057?uid=3739568&uid=2129&uid=2&uid=70&uid=4&uid=3739256&sid=47698761047467 (Retrieved March 2012) (JSTOR Subscription required.)