Agricultural land investment is clearly the hot ticket of the moment, with every level of investor from institutional funds such as Schroders and Barings investing millions of pounds, to smaller retail investors with a few thousand seeking good quality farmland for investment. Whether you have access to 50 million or 20,000, there are projects and strategies available on the open market to suit your budget and requirement, from the UK to Australia, and from the Ukraine to South America, all with subscribing to different investment strategies, and some less credible in terms of end value than others.
One part of the current trend that alarms me is the apparent rush of retail investors to invest in farmland overseas, buying up title or leases with little or no comprehension of the true value of the underlying asset. For which they are parting with hard earned cash for. Agricultural land produces soft-commodities (food), and as such the value of the land is intrinsically linked to current pricing trends for whichever commodity is being produced by that land, along with a host of other factors. Currently food commodity prices are at a forty year low, indicating a huge margin for growth in value of both soft-commodities and therefore the underlying asset that produces them, yet investors that lack experience seem to be purchasing or leasing farmland outside their domiciled country without sight of any kind of credible, regulated valuation, seemingly smitten with the story of growth and income, without truly understanding the fundamentals supporting farmland investment, risk, or exit strategy.
When speaking to clients on a daily basis about the relevance of investing in farmland as part of an overall low-risk strategy, I think it is most important for investors to understand the fundamentals supporting agricultural land investment, as well as the various investment strategies that can be employed to gain exposure to this sector and asset class, and more importantly, investors should have enough knowledge to decide whether farmland investment is a suitable asset allocation strategy to suit their own needs. Here are some of the broad profiles of investors that should or should not investigate the prospect of investing in farmland:
- Investors that Should Consider Farmland
- Investors that Should Not Consider Farmland
- Investors holding cash as part of a low-risk portfolio
- Investors with a requirement to leverage
- Investors requiring stable, consistent income
- Investors with a high-risk approach / strategy
- Investors with a necessity to hedge inflation
- Investors with a risk-averse approach
- Investors desiring exposure to property
Current Market Conditions
If this article is to be well-rounded and achieve the goal of helping the investor to make an informed decision, it is important to explore the current market conditions that have led to this whirl of interest in farmland investment from both the retail and institutional sectors.
Firstly, we are seeing price volatility in more traditional asset classes such as stocks and bonds, which is a result mostly of the fact that the world is still in a precarious economic position with very poor levels of forward visibility. With Economists unable agree with each other and comfortably project where our global and national economies are headed, it is very difficult to price and value assets such as companies, and therefore the shares that make up these businesses.
Secondly, on a global basis, and specifically in the UK, the central bank has undertaken a policy of quantative easing, i.e. printing more money and flushing it into the main supply in an effort to kick-start the economy. This will lead to higher levels of inflation to some degree, and in an inflationary environment investors seek to protect their wealth by purchasing assets that have a positive correlation with inflation i.e. their value rises when inflation rises, providing growth for the investors over and above the rate of inflation..
Thirdly, investors have always kept back some cash as part of their portfolios, feeling it is the safest of assets offering the lowest level of capital risk, whilst at the same time providing an income return relevant to the interest rate they achieve. In the current climate with central bank interest rates so low, investors have lost these risk-free returns, so must seek out an asset that not only grows in value, but also produces an income to replace the lost revenue.
These three characteristics that define the current economic playing field all combine to draw investors to the idea that investing in farmland is a sound strategy, and that a well-placed farmland investment will provide not only the inflation beating growth that is required, but also replace the income lost from cash deposits, as well as provide the low-risk stability that is required in times of poor visibility, as farmland is one of the very few assets that are absolutely essential to the survival of the human race yet is in ultimately short supply, ensuring that sound fundamentals support a continuation of the current value growth, and increasing income streams as food commodity prices start to increase to previous levels.
So how does arable land perform as an investment asset? Well some of the key characteristics of agricultural land investment are as follows:
Investing in farmland provides a proven inflation hedge, with data showing very clearly that tillable land shares a positive correlation with inflation. Historically farmland values increase faster than inflation, which lend investors confidence in the asset as not only an inflation hedge but also a capital preservation tool as farmland is viewed as a low-risk asset as the investment is underpinned with an asset that is in limited supply but where demand for food is increasing at an astounding, and frankly unsustainable rate, and unlike other commodities that we require for day to day operation such as oil, metals or gas, farmland is a renewable resource that continues to produce food season after season.
Agricultural land investment is also a good strategy for stable, consistent income, as unlike other popular low-risk investments such as gold, farmland also provides regular income, either from the commercial farming activities, or from renting the farm to a farmer to work the land and capturing a rental income instead. With farming tenancy occupancy rates at nearly 100% in the UK, this income is stable and regular, making investing farmland ideal for those investors seeking low volatility income.
Investing in farmland also provides some excellent tax planning opportunities and many investors look to farmland investment to provide relief for IHT and various other tax strategies.
Aside from all of these characteristics that help farmland investment fit very well into the current market conditions that we described earlier, investing in farmland is simple and transparent and very easy to overcome one of the first hurdles I mentioned in this article; value for money. One choosing to invest in farmland in the UK for example would commission a regulated Red Book Valuation undertaken by a RICS regulated Chartered Surveyor, ensuring that the investor receives value for money. Again, one of the biggest mistakes that investors are making right now, is purchasing asset without knowing whether they are overpaying as there is no evidence to support the sale price. One piece of advice, if it doesn’t have a proper valuation, don’t buy it, simple.
So exactly how can investors gain exposure to this low-risk, income producing inflation hedge? Well there are various investment strategies available to the qualified investor with liquid capital in the region of 20,000 +, here we will cover the two main options, and also break down the various sub-categories to give the reader a broad understanding of the options available to him/her. The two main options available to the retail investor are farmland investment funds and
Aside from taking into account the particular investment strategy, all farmland investment funds share the same pros and cons as any other type of investment fund when compared to direct asset ownership. The fund will be managed by person or persons with the relevant experience and successful track record (or not) of investing in agriculture. You will own shares in a vehicle that will own many different underlying assets rather than focussing your capital and attention on one asset you believe to show good qualities. Essentially the investor relinquishes control of his capital to the Fund Manager who will invest it on their behalf, hopefully scoring well. In actual fact many studies have shown that the benefits of spreading the risk of investing capital over many different assets is equalled by the added risk of acquiring much larger assets in the first place, and should one particular acquisition turn out to have an overall negative effect, then the value of the entire fund is likely to drop.
Investing in Farmland Directly
Investing in farmland directly allows the investor ton gain exposure to the raw asset that is increasing in value, and allows the investor to dictate the terms of the investment strategy, location, size of the investment, and most importantly in my opinion this is the only strategy that allows the investor the opportunity to directly own a tangible asset that has no correlation to financial markets and is most likely to increase in value above the rate of inflation and also gives the investor the chance to have their asset produce an income.
Selecting a good quality piece of farmland is the key of a successful strategy here, and this is where expert advice is useful. To keep things nice and simple a good rule is looking at how much revenue that land could produce, this will give an indication of the level of income that could be generated through rent of farming activity. Also, carrying out a Red Book Valuation via a RICS regulated Chartered Surveyor with comparative values and working historical data to get an idea of whether this farm has increased in line with, above, or below the national average.
In my opinion, when investing in farmland, the only land that should be considered at all is land that is part of, or could be part of a profitable working farm. Using this as your golden rule will ensure that you only invest in farmland that produces revenue and profit and therefore will grow in value in line with commodity prices and inflation.
This all leads me to believe that whilst farmland investment funds are an option to take a hands off approach, direct ownership of farmland as an investment asset provides the investor with less risk, a tangible asset, and full control of their holdings.
Farmland investment is not a risk free affair, as with any opportunity to part with cash, investing in farmland presents the investor with a number of risks that should be considered when assessing the asset for acquisition as the income produced may be contingent upon them.
Firstly one should assess they type of crops being producing, seasonal or row crops are best as they van be changed each season to take advantage of whichever foodstuff is commanding the greatest price on the commodity market, these crops include wheat, maize, soy, and barley. These crops are much more reactive to market than permanent crops such as vines as vines will not produce any income within the first three years during their maturation period and also are much more susceptible to disease during this period.
Secondly one must consider whether to buy existing farmland for investment, or to buy a Greenfield site and convert it to agricultural use. Investing in farmland that already has a proven track history of producing revenue offers the investor the lowest risk and also the lowest cost.
Lastly the structure of the deal to which the investor commits will dictate overall risk profile to an extent. You may choose to simply rent out the land to a farmer for a fixed rental payment, this in my opinion offers the lowest risk and most stable income as any default in the rent van result in eviction of the farmer. Another option is to start a farming enterprise and work the land for a profit, only seriously experienced and successful farmers should consider this route. Also there is some middle ground here too, with the landowner sharing in the revenue from crop sales and also taking a top up rental payment, and whilst this does allow the investor to participate in any spike in commodity prices, it also exposes the investor to unnecessary risk.