Scythe & Spade Blog

Farmland Pricing: Regional Differences

by Chas Bonner

Over the past year, we have read countless articles about “Irrational Exuberance” as it relates to farmland prices, and we have written blogs about it. However, as is usual, the devil is in the detail. One can see huge differences around the U.S., many regions being even more “irrational” and others surprisingly modest.

The most irrational region appears to be the Pacific West, which by definition is only California in the data provided by National Council of Real Estate Fiduciaries (NCREIF). In all U.S. regions, there are annual and permanent crops subdivisions, and the return is split between crop returns and appreciation of land. The base index for all regions and crop types is the first year NCREIF began charting, namely 1990, and all 1990 bases equal 100.

In the Pacific West (California), the index for first quarter, 2012 is 1246, or a total value roughly 12.5X 1990. That number is comprised of both appreciation of property plus return of crops each year. In the case of CA, the appreciation of the land is only 219, or about 219% higher than base year, but the crop returns have been 599.5. Those numbers are for ALL crops in CA, both annual and permanent plantings. When looking at permanent plantings only (fruit trees, vines, tree nuts), we note even bigger disparities. The total index for permanent plantings today is 1376, comprised of 194 for appreciation, and 749 for crop returns. Yes, we have all read about the monster returns of wine grapes, almonds, pistachios, walnuts, clementines, etc. Has it become irrational yet? We know plenty of professionals who are now sitting on the sidelines.

The biggest surprise for us has been the Pacific Northwest. For some reason, despite annual cash returns on a par with the rest of the nation, appreciation of land has lagged. With California as a reference (above), the relative numbers for the Northwest are 348 as a total index, with 105 being appreciation and 334 being crop income.

Problems do become opportunities, just as “one man’s trash is another man’s treasure.” At the same time, prudence dominates our thinking.

Lucky To Be An American

by Chas Bonner

Having been consumed by laziness this week, and having an epiphany last week, I sent the email below to about 100 fraternity brothers because we had a recent reunion. And our friends in agriculture should feel better than most Americans, because we are fortunate to be in one of the best businesses in America.

Brothers Zeta Psi:

I, like most in these United States, complain bitterly about our economy, our government, our ignorant citizens, etc. After reading an article recently in Seeking Alpha, it made me realize how lucky I am to be born in America. All the economic shenanigans of the past 3-4 years have not brought us to destruction:

• Other than AIG, most bank loans have been repaid with interest.
• The frozen banking system is again increasing loans.
• The “too big to fail” banking system is slimming down across America and the world. Over 500,000 layoffs in U.S. banks since the crash.
• The Federal Reserve has made a profit of $79BB on most of the assets seized/traded during the crash.
• The US is one of only 3 developed countries that has seen manufacturing employment INCREASE in the past 2 years.
• Fast-growing wage rates in the Orient as well as shipping costs to and from the Orient are reinvigorating our manufacturing sector.
• Our unemployment rate has shrunk more than most developed countries.
• General Motors has gone from a bankruptcy bailout to the largest auto manufacturer in the world in only 3 years. And they are making money.
• More small businesses are being formed than any time in history. Yes, most won’t last, but many will survive and thrive.
• The stock market is up almost 100% from its low.

My biggest concern today is that OUR generation is a bunch of pigs, leaving our kids and grandchildren nothing but debt, unsustainable Social Security and Medicare, infrastructure decline, deteriorating environment, an educational system in the toilet.

While we definitely have problems, we have opportunity as well. Now to re-invent ourselves so the Product Life Cycle Curve---BIRTH, GROWTH, MATURITY, DECAY---does not put us under. Sorry, but I felt compelled to share this with all of you.

Calculated Leverage

by Monte Nevitt

One of the significant points made in this year’s Urban Land Institute conference held yesterday is that banks have cheap money available for land deals but no one appears to qualify. The bank’s dilemma? They can’t find credit-worthy borrowers. The downturn has left so many of yesterday’s landowners upside down in the greater Phoenix market that the previous players don’t qualify for loans today. It is ironic that the patient and disciplined farmer, who decided to stay on the sideline during the irrational exuberance that was displayed during the last boom is the very individual who is now going to his lender to qualify for the loan to buy back the farmland.

Strong commodity prices, coupled with depressed land values leave today’s farmer with an opportunity to leverage to increase the production and revenue, to address loan payments, to replace aging equipment, or to expand the size of the operation through purchase. In some cases we see dairy farmers buying land, not so much because of a desire to expand – but rather to shore up acreage on which to raise hay to bring their feed cost down.

Ninety five percent of the last thirty five land deals done in Pinal County were closed by farmers or ag related entities.

An article in last Friday’s Phoenix Business Journal highlighted the use of leverage in today’s favorable ag climate to expand and to improve the agribusiness bottom line.

Of particular note in this article is that the Journal highlights a farm purchase in which Scythe & Spade played a key role. The opportunity presented itself for a purchase and expansion onto 1,000 acres in the south Coolidge market. The deal would require a 30 day close. It also required two separate appraisals, a bridge loan of $5.4 million, preparation of material, due diligence, and budgets for a loan underwriting committee, shared well and ditch agreements????, opening and closing escrow, all in a 30 day time period!

Scythe & Spade was able to open its files and due diligence binders, plot in and pull down GIS maps on the property, update budgets, provide materials to appraisers, loan officers at M&I, and to the buyer, coordinate a 1031 exchange, and close escrow by the 22nd of December. In short – the seller , the buyer, the lender, the appraiser, the neighbor/partner, and Scythe & Spade all ended up looking good on the deal.

Take home point: because of Scythe & Spade’s ability to coordinate the deal, this farm family was able to seize a unique opportunity, come to alevel of comfort on a very shortened feasibility, acquire a loan from a cooperative BoM/Harris Bank, and be poised to take advantage of a forgiving commodity market going into 2012 on an expanded acreage.

Farmland: Sometimes a Strikeout

by Monte Nevitt

We are firm believers in farming, and even stronger believers in farmland investment. At the same time, we recognize that on the other side of every reward is RISK; therefore utmost care is essential.

A good example of farmland investment becoming a strikeout is Morgan Stanley investing in the Ukraine. Having made mountains of money in 2006, MS decided to up the ante, and buy some of that world-famous Ukrainian black soil, so fertile it could grow anything, and so well-reputed that Hitler had his troops haul some back to Germany during WW II. After buying 11 large parcels of the black Ukrainian soil, Morgan Stanley hired a young Midwest farm boy with a long farming background as well as advanced schooling in farming. They hit the bull’s-eye.

The new MS farm manager loaded up several containers with John Deere tractors, combines, farm implements, seeds and fertilizers, and virtually anything needed upon arrival.

Then the surprises began. First, before the containers could unload, many licenses had to be purchased, and lots of grease was needed. Much of the seed and fertilizer soon disappeared, parts went missing, and officials insisted that MS build roads as well as farm fields. Within 2 years, Morgan Stanley’s farmland investment became history.

This is a reminder to us, when we hear tales of wealth generation in Ukraine, Brazil, Argentina, and third world countries, we might look in the mirror when seeking a good investment property. Although we don’t expect 20% rates of return, we also know nothing will be expropriated, we won’t be paying bribes at every turn, and we don’t worry about theft of all inputs as well as output.

For all the red tape, regulation, checks and balances -- it is hard to beat farming in the USA, where a man can invest his blood, sweat, tears, and resources with confidence that he will see a return, weather, lender, and markets permitting!

Future Forecasts and Commodity Market Prices

by Patina Thompson

The end of summer marks the beginning of intense speculation and commodity market price tracking focusing on what futures prices will do for Fall planted crops. Farmers and other buyers of commodities use the futures to hedge against the uncertainty and risk associated with fluctuations in the price of the commodity they are selling.

In futures markets, participants buy and sell futures for a number of commodities. The futures contract is a specific price and specific date (sometime in the future) for a given commodity. A farmer may want to purchase a futures contract when they anticipate the price for a given commodity to be increasing in the future. A farmer may also want to purchase a futures contract because they need to sell goods in the future and they want to be able to count on selling those goods at a specific price (determined now).

The current (active) crops that are involved in the futures market for Fall are wheat, barley and canola. September 15th, 2011 marked the start of what the Risk Management Agency (RMA) and Insurance companies call the Discovery Period. The Discovery period is a 30-day tracking of futures prices on various markets including the Chicago Board of Trade (CBOT) and Kansas City Board of Trade (KCBT).

At the end of the Discovery Period, the RMA issues an Approved Price for active crops and this price is used by farmers and agents to determine what plans and levels of insurance they elect for the upcoming crop year. October 15, 2011 is the estimated date that the RMA will release approved prices for wheat and barley for the 2012 crop year.

Factor all these together and a farmer has many decisions to make. Not only costs associated with prepping, planting, irrigating and harvesting the crop, but also the price now, the price you may receive in the future, and how much you’re willing to risk that those changes may or may not occur. Throw in Mother Nature and fluctuations in the cost of diesel fuel and you’ve created a perfect storm.

As always, Scythe & Spade is up for the challenge and ready to help you navigate through these factors to help make 2012 another fruitful year.

P.S. An excellent resource for commodity market price tracking is www.barcharts.com

To Sell or Not to Sell

by Chas Bonner

The $64,000 question:

U.S. farmers are aging, with average farmers over 57 years old, and now they are facing that question---probably the biggest of their careers. Do we sell the farm that has been in our family for generations, do we sell part of it to liquefy, do we rent out to professional managers, or do we let our “un-tested” children take over?

First, remember one thing: If you are faced with that decision, consider yourself lucky. Most are merely faced with the decision of retirement and having nothing to sell, plus wondering when their Social Security will run out.

Farming and ranching are usually occupations that chew up capital, leaving owners cash-poor and asset-rich. Therefore, the necessity of an exit strategy---the subject of our blog a few months ago. Our best advice would be to consider this early, looking at absolutely all aspects of the decision. We have all heard the maxim that “timing is everything,” and a farm sale decision is a critical timing question. My 20 year history in the merger/acquisition business demonstrated that maxim in spades: Out of many businesses sold over 20 years, 95% were over their peak; owners simply waited too long to pull the trigger. Perhaps that was evidence of another maxim: “Pigs get fat, but hogs get slaughtered.” In short, plan your work, then work your plan, even if 20 years away.

Another opportunity that is a combination of selling and holding, AND avoids the “cash-poor, land-rich” dichotomy is to sell part of the farm, perhaps to family members or to other farmers or to farming organizations. That strategy would enable you to liquefy your holdings, maintain input into direction, and provide an exit when too old to farm.

Finally, and perhaps most important, consider market context. If everyone is buying, now is the time to sell, partially sell, or rent. If on the other hand, everyone is selling, consider a buy. That is “industry timing” context. Next, if you see industry sale timing coming, prepare your farm to look like Grandma’s Apple Pie---“specific entity” context.

Don’t try to do this alone. There are countless services, attorneys, accountants, farm advisors who will provide valuable input.

Accounting for Decision Making

by Danielle Stephens, Head of Accounting and Finance

Farm operation management continues to become more and more complex. While success has traditionally been measured by increasing production, higher production does not always lead to higher profits or a higher net worth. Like any business, raising production (or providing additional services) requires additional input costs (building new facilities, purchasing additional equipment, hiring more employees, etc.). Other considerations include whether financing is necessary for expansion, the cost of financing (high vs. low interest rates), and whether the market can endure increased production (potentially leading to decreased commodity prices).

There is risk involved in the decision to increase production or maintain the status quo. However, managing farm finances has the greatest potential for adding profits and financial stability to the operation. Financial analysis may show increased profits for the increased production or analysis may show that the farmer would be financially better off maintaining the current production level. If the increased revenue received from additional production exceeds the costs necessary to increase production, the operator may have created a profitable situation. At the same time, opportunity costs must also be identified and analyzed.

In today’s farm economy, increased production and hard work cannot guarantee success. Keeping good records and constantly monitoring the financial condition and performance of the business is required. The key to agricultural success lies in identifying the highest sustainable output of resources; both natural and financial. The result is a maximized return on investment that you can count on for years to come.

Expanding vs. Selling

Introduction by Chas Bonner

Jeri Engstrom is a man who knows first-hand about the subject of “expanding vs. selling.” He was a 4th generation farmer in Glasgow, Montana who decided to sell his stake in the 8000 acre family ranch to an investor who then rented back to Jeri’s brother. Jeri took some cash, and moved to a friendlier climate in Boise, Idaho at the suggestion of friends. He now brings his considerable farming talent and experience to Scythe & Spade. The farm’s loss is our gain.

by Jeri Engstrom

Expanding vs. Selling

This is the age old question for families in the farming and ranching community. There are a multitude of factors involved in making this kind of decision; let’s focus on a few of the main factors.

There are five primary reasons one may consider expanding:

First: Younger family members want to come back to the farm as a career. This is probably the most predominant reason for farmers to add acres to their existing operation.

Second: Shrinking profit margins. You can only produce so much off of that same sized acreage, yet after thirty years your expenses have doubled, tripled or quadrupled and the profits have not kept up, requiring expanded acreage to feed the family.

Third: Is there economic sense in the expansion move, i.e.: does it cash flow? Most farm ground bought by farmers is financed through a bank or sold under a contract for deed. Usually there is a 25 or 30 percent down payment made, then annual payments for usually between 10 to 20 years. Outfits like Farm Credit are more than happy to carry the paper for 25 years, but in the end, it all has to cash flow.

Fourth: Locality, what is its proximity to your current location. The farm ground right over the fence always garners a premium to the expansion minded farmer. Conversely, it will cost you money to drive 50 miles out of your way to farm a piece of ground you thought was a bargain (windshield time is expensive ).

Fifth: Long term investment is another important reason for expansion. When an investment like this is made in a family operation and combined with a life insurance policy for the surviving spouse, it can become a very sensible investment for generational transition and continuation of the family legacy of being on the land.

Now, what about the selling side? If you don’t have heirs or children that are interested in agriculture, your view of the future may be much shorter term. You and your spouse probably spent several decades on that farm, raising crops and kids, and making sure the farm does all it possibly can do for you. Now you want to see some of the world while you are still limber enough to enjoy it. You can’t do that if you take on more ground, more debt, more worry. You think this could be just the perfect time to sell. Land, over time, always appreciates and now you have a nice nest egg just waiting for you to use.

Some of the biggest positives to selling now would be:

• Lower capital gain taxes
• Becoming debt-free (possible for the first time in your life)
• Freedom
• Semi-retirement
• Move to a better climate

It takes a lot of soul searching, family discussions and mathematical calculations to make such an incredibly difficult and final decision, but it can be done. It will happen more in the future as well because the statistics currently show 45% of U.S. farmland is being farmed by people who don’t own it; that statistic is expected to climb to around 70% in the future.

Anticipating Rather Than Reacting-- Tomorrow’s Farm Economy

By Scythe & Spade’s

CHAS BONNER, VP of Business Development & MONTE NEVITT, Program Developer

We’re consumed with a passion to thrive rather than survive. Often times, this has caused us to go against “the grain” and look beyond immediate circumstances. For example, in mid 2005, we realized it no longer made sense to continue to sink money into overpriced farmland in Pinal and Maricopa Counties of Arizona where everyone was rushing to participate in the now-famous land boom. Instead, we studied other stable markets west of the Mississippi to identify growth areas where farmland was still priced at ag values. This strategy caused us to point people’s attention to Boise and the Snake River basin. It helped us place clients into farms that have not depreciated in value (unlike Arizona), while at the same time, generate solid returns.

We’ve come across very similar, sound reasoning in Harry Dent’s recent book, “The Great Depression Ahead.” Dent began his career as a Harvard-trained economist and gravitated to demography after complaining that economists have a very short-term viewpoint. Rather than follow his peers who generally look no further than three to five years out, Dent typically projects ten, twenty, and fifty years out. He is known for quoting “The Kondratief Wave” (focusing on fifty eight to sixty year cycles). At times it even illustrates effects of 250- and 500-year cycles. He puts forward carefully-studied, documented, and well-laid-out material for consideration.

Granted, we here at Scythe and Spade well understand the concept that “…He who lives by the crystal ball must be prepared to eat glass.” We know thattechnological advances and other unseen factors can and will come into play that change life as we know it having the effect of embarrassing anyone who proposes to dares to comment on the future, but--Dent causes one to think deeply and long-range.

In reading Dent’s book, we agree that we are in the right industry. Dent, the author of several previous best-sellers, including “The Roaring 2000’s,” “The Great Boom Ahead,” and “The Next Great Bubble Boom,” predicts a depression during the next four years, although not as bad as that in the 30’s. He provides compelling evidence for his thesis, all of which points to harrowing times, but it becomes apparent that agriculture is one of the few bright spots.

Here are some of the key agricultural-related findings in his book, which are documented by many other works:

• Worldwide population is expected to grow 50% from today’s 6.3 million, and peak in about 2065. 
• Arable land in the world is decreasing by about 25 million acres per year.
• ChinaAs middle classes increase (China, India, SE Asia),caloric intake increases exponentially because of the addition of meat to diets.
  
• While agricultural productivity continues to increase, it does so at a decreasing rate.
• More and more food is becoming bio-fuel.
• Cap and trade proposals will continue to trim output.
• Commodity prices and food shortages are expected to soar.

Fortunately, the subtitle of this depressing-sounding book, “The Great Depression Ahead,” is “How to Survive and Prosper.”  It becomes obvious that agriculture will be a needed profession, that productivity must increase, that more output with less input will be critical, that sustainable agriculture will be a focus, that knowledgeable and professional management will not be optional, and that farms will be sought out by all kinds of investors and companies.

Like Harry Dent, Scythe & Spade hopes to always be looking 10-25 years out, anticipating trends before they become trends, and avoiding the invariable pitfalls.

Politics and the Farmland Market

Long term,  we feel the bailout efforts by our government will help build money supplies and improve liquidity but eventually this will result in inflation.  Land as opposed to equities, is an excellent long term hedge against inflation.  Adding support to this concept is the recent apparent burst in the commodity bubble, helping temper the speculative nature of investments in farmland we have experienced of late.  Farmland in general is not highly leveraged and farmer’s balance sheets are healthy, putting agriculture on firmer footing than other areas of our economy.  We can only hope that this trend continues but as commodity prices fall and inputs stabilize at record high levels the farmer’s balance sheet may suffer.  Keep in mind too that farmers are buying more farmland and consolidation continues at a rapid pace.  This is no more evident than Co Banks recent issuance of $200 million of Series c preferred stock in an effort to enhance their ability to continue meeting their customers borrowing needs which are at an all time high.  Nonetheless, concern resulting from the subprime mess is resulting in more conservative lending on farm Real Estate.

So what does all this mean:

• Farmland is in a niche of its own, somewhat insulated from other real estate investments 
• Banks will help curb over leveraging of investments in land 
• As the economy moves toward a recession, we need to look for safe havens and areas to place money otherwise invested in equities 
• Trends in agriculture (consolidation and stabilization) will help mitigate the speculative nature of investment in farmland of late

BM