Maximizing Opportunities and Minimizing Risks Requires Careful Planning

Rapidly increasing land values and the strongest commodity prices in nearly a decade are impacting the economics of agriculture this summer throughout the Midwest, and particularly Kansas, creating unprecedented opportunities for farmers and landowners throughout the region. But managing the risk associated with a volatile market requires careful planning.

Driving Factors Behind Trends

The dramatic increase in land values – with some properties nearly doubling in value since the first of the year – is being driven in part by the announcement that a large cheese manufacturing facility will open in Dodge City. In anticipation, dairy producers are shopping for large blocks of land in the region so they can supply milk to the new plant.

New interest by the dairy producers has driven impressive gains in land values and a flurry of sales since the California-based Hilmar Cheese Company announced its planned facility this spring. More transactions are expected to take place – and to continue driving up land values – as the Hilmar facility prepares for its 2024 opening.

At the same time, crop producers are enjoying some of the strongest commodity prices in nearly a decade, with wheat selling for $7.08 per bushel, milo for $5.56 and soybeans for $13.47. The commodity prices are being driven partly by increased foreign demand for U.S. crops as weather trends threaten production in the Americas and other regions.

Opportunity in Land Leasing

This unusual confluence of events creates opportunities for both farmers and landowners who lease land for crop production, and the impact will likely be most influential in the renegotiation of leasing prices.

After several years of holding the line on fixed rent farmland rates, landowners will likely want to take advantage of strong commodity prices to boost rental rates this year.

Typical crop share arrangements are based on a one-third/two-thirds split. The landowner receives one-third of the crop, and they’re responsible for the property taxes, maintenance of the land and, usually, some of the fertilizer. The farmer takes care of the rest. Another type of arrangement utilizes the average of the spring and fall crop insurance price multiplied by the actual production history (APH) yield multiplied by 33%, or so.

Flex leases, on the other hand, sets a minimum cash price that is less than a fixed rental would be and includes a potential increase in rent that is based on a formula that includes production and price at harvest. When that formula exceeds a predetermined base, then the landlord would get a percentage of the excess with a total per acre cap on the addition. In short, a landlord’s base might be 50-60% of a fixed rate rental value. With the variable option, if production and prices support the variable portion, they might end up giving them well above what they would receive on a fixed rental rate.

Variable leases are a risk-sharing tool that can benefit both the farmer and the landowner. Landowners share in the risk a bit more with variable leases, but they also share in the reward in good years. For farmers who are renting land, we recommend:

  • Be proactive and approach the landowner with your terms. If you have a bad year next year, you’ll end up not having to pay a portion of the rent. But if you have another great year, you’ll have the money to pay the full rent plus a bonus that the landowner will receive as part of the variable lease deal. Everybody wins.
  • Use the farm management technology you have at your fingertipssuch as Figured – to negotiate a variable lease that is realistic based on your historical data. You know how much yield you get off each field, and you know the cost of your inputs.
  • The alternative is to pay a flat rate rent, but that’s a gamble and farming is not about gambling. It’s about managing risk.

For landowners, the opportunities right now lie in buying or selling land and in renegotiating bank loans based on higher land values.

It may seem counterintuitive to buy land when prices are going up, but this can be a good time to consolidate holdings and benefit from increased cash flow if the new land can be leased out. As with all things, you need to run the forecasts and see if buying or selling makes sense.

There’s also an opportunity to strengthen your equity position and renegotiate bank loans. Take a look at your loans and see if your security matches your level of debt. At today’s land values, you may have untapped equity that can support new land acquisition or equipment purchases. If you are over pledged on your debt, it’s time to renegotiate with the bank. Banks want your loans when times are good, so you are in a strong position.

Risk for Landowners

One pitfall that landowners need to consider as land values climb is the federal estate tax. If your land is worth significantly more than you thought it was, you may be in estate tax territory.

The federal estate tax exclusion for 2021 is $23.4 million for a married couple filing jointly ($11.7 million for a single filer). Remember, your estate isn’t just the land you own; it includes equipment, your home(s), financial accounts and any other assets you may hold. It adds up quickly.  We also are closely watching developments  in Washington as these exclusions are on the table for reductions taking them below these current levels.

If rising land values are pushing you close to the estate tax exclusion limits, it’s time to review your estate plan with an advisor and possibly take action to mitigate your risk,.

There’s a Lot Going On

Clearly, many factors are coming together to impact the farming economy this year. To take advantage of the opportunities and mitigate risk, farmers and landowners alike need to speak with advisors, pay close attention to their financials, and be ready to act quickly to maximize the advantages they have in the marketplace.

If you would like to have a conversation about the opportunities and risks you have in front of you, contact your Adams Brown advisor.