There are some wild claims out there about how farmland is a higher returning investment than stocks. Not so fast there honcho! I do love farmland as an asset class but let's see how the hype matches the reality.
How Farmland Generates Returns
Farmland earns returns two ways
- Through the cash rent paid by a farmer, or if you are the farmer, through the actual harvest profits.
(This varies depending on crop, location, and other factors)
- Through growth in the value of the land.
In this way, farmland is similar to stocks…the rent is similar to a dividend yield, and land values per acre similar to a price per share. Bonds typically only generate yield from interest rates with no potential for growth in your investment.
The combination of these two return factors has been very lucrative for farmland investors over the very long term. I’ve seen many analysts argue that farmland has had a return equal to stocks with less volatility.
Current Projected Returns Are Overly Optimistic
Some of the investment pitches are getting a little aggressive. Here’s one I have trouble with:
“Farmland has returned 12% since the Great Depression”. Talk about cherry-picking your data!
At the bottom of the Great Depression in 1936, real farmland values fell lower than they were in the 1890s, almost 50 years before. Real farmland prices in 1964 were the same as they were 53 years earlier, in 1911, dropping more than 50% in the interim.
By manipulating start and end dates we can change the “land value” part of your return. For example, in real terms:
1942 – 1981 farmland values grew at 4.34% per year
1914 – 1950 farmland values decreased by 1.77% per year
These are two very long periods with two wildly different results.
I believe a good long term projection is between 1.0% and 1.5% over inflation per year.
Cash Yields Are Very Low By Historical Standards
Cash rents are also quite low by historical standards. 6%-8% was the norm a few decades ago but rents today are closer to 3%. This downward trend follows similar decreases in yield in virtually all markets from real estate to bonds to music royalties.
There doesn’t seem to be a reason why we might expect cash returns to increase as a percentage of farmland value. Therefore it’s probably easiest just to assume that the current yield is going to be your future yield. And that’s lower than it has been in the past.
What This Means For Projected Returns
My simple return formula is as follows:
Current rental yield + Inflation + Real Land Appreciation = Total expected return.
Since I expect rental yields to be about 3%, inflation about 2%, and land prices to appreciate 1%, I’d expect the average farmland investment today to return 6% over the medium to long term, or 4% over inflation.
So it’s not 12% but…it’s not bad! Better than bonds, with some diversification benefits. It shouldn’t come as a surprise then that I just invested in farmland!