Drew Lipke - Director of Investments at AcreTrader - Fayetteville, AR
How Supply Constraints Impact the Capital Cycle in Farmland
The USDA’s 2022 Census of Agriculture, released in February 2024, highlights the continual disappearance of farmland in the United States. The contraction of America’s cropland is, in our opinion, the most important consideration impacting the price of farmland over long periods. A review of the post-pandemic period and current market environment presents an excellent opportunity to review the demonstrated impact of various macro and inflationary cycles on farmland prices in a truncated time frame. The capital cycle for farmland pricing should be viewed through the appropriate lens due to its inherent supply constraints.
Key Points
• Latest USDA data shows the United States losing 4.8 acres of cropland every minute.
• The continual shrinking supply of farmland impacts the typical capital cycle, farmland prices, and farmland price volatility.
• We believe recent headwinds facing the ag economy could provide increased opportunities for farmland buyers.
Looking at the Big Picture
Last week the USDA released the 2022 Census of Agriculture. While the farmland market is frustratingly opaque, in the United States we are fortunate to have the work of the USDA that provides an aggregated view of the agricultural industry over longer periods.
There is a core theme evident in the data that ties together the price of farmland over the last several years, and that is the fact that fundamental supply constraints can provide an asset class with a level of immunity to capital cycles. Simply put, the capital cycle breaks down when applied to farmland.
As Edward Chancellor discusses at length in Capital Returns, capital cycles are a recurring pattern in financial markets that reflect increases and decreases in capital allocation and investor behavior over time. In summary, as investors deploy capital into an asset class, the increased capital flows based on growing optimism for increased returns increases asset prices and capacity expansion of the asset. As capacity is added and competition increases, returns diminish and eventually consolidation occurs.
While increasing capital can drive down returns, this can be mitigated with better data and better discipline. A critical fact for farmland asset values is that almost no amount of capital can increase the supply of productive farmland with sufficient water resources in the United States. Continual technological improvements have driven increased yields per acre for most crop types, however, this is not enough to compensate for the loss of arable acres and increasing demand. As the long term Census data shows, we are consistently losing supply of farmland in the United States.
Figure 1
Source: USDA Census of Agriculture, 2024 Past performance does not guarantee future results and there is no guarantee this trend will continue.
The 2022 USDA Census of Agriculture data shows that the United States has lost 62.97 million acres of cropland over the last 25 years. That means we lose approximately 4.8 acres of farmland every minute. At the same time, an increasing global population and increasing global wealth have driven greater demand for the food and grains produced by America’s farmland, as can be shown by the market value of crops sold by America’s cropland in Figure 2 below.
Figure 2. Nominal Value of Crops Sold by America’s Cropland
Source: USDA, 2024 Past performance does not guarantee future results and there is no guarantee this trend will continue.
When looking at demand for the crops produced by America’s farmland on an inflation adjusted basis, the Census data shows a 51% increase over the last 25 years.
Figure 3. Inflation-Adjusted Value of Crops Sold
Source: USDA, Federal Reserve Bank of St. Louis, AcreTrader Financial LLC Past performance does not guarantee future results and there is no guarantee this trend will continue.
This combination of consistently decreasing supply coupled with increased demand has been a part of why cropland values have appreciated by 5.9% on average annually since 1997, using the USDA data.
Figure 4. Price Per Acre of Cropland in United States
Source: USDA, 2023 Past performance does not guarantee future results and there is no guarantee this trend will continue.
Assessing Recent History
Over the last three years, the long tail impact of the pandemic has thrown a multitude of headwinds and tailwinds to various asset classes. The government led fiscal and monetary stimulus meant to drive economic growth out of the pandemic proved to be a blunt instrument and drove a period of excess for financial assets. In addition, the stimulus helped lead to annual inflation of 4.7% in 2021, 8% in 2022, and 4.1% in 2023, and in turn the Federal funds rate increased from 0.25% to over 5.25% as the Federal Reserve stepped in to rein in inflation.
Over this time frame, financial assets, such as stocks and bonds, experienced significant volatility. For example, the S&P 500 was up 27% in 2021, down (19%) in 2022, and up 24% in 2023. In 2021, 2022, and 2023 the S&P 500 experienced max drawdowns of (5%), (25%), and (10%). Meanwhile, the Bloomberg U.S. Aggregate bond index was down (2%) in 2021, (13%) in 2022, and up 6% in 2023 while experiencing max drawdowns of (4%), (17%), and (7%).* Investors maintaining the traditional 60/40 portfolio have had a wild ride over the last 3 years.
Unfortunately, no farmland index consists of actual farmland transactions and provides a look at total returns. AcreTrader’s affiliate Acres is dedicated to addressing the need for price discovery through transactions.
However, we do have the survey data provided by the USDA, the survey work of many of the land grant universities across the country, Federal Reserve data, and Acres’ expansive datasets. These multiple sources all provide context into farmland’s historical price performance.
It is important to note that these farmland price sources exclude the rental income associated with farmland and are therefore only indicative of the underlying farmland value and not total return. Nonetheless, these various indexes all paint a similar picture.
According to the annual USDA survey data shown in Figure 1, cropland prices in the United States showed year-over-year increases of 7.8%, 14.3%, and 8.1% in 2021, 2022, and 2023.
The Federal Reserve Bank of Chicago also provides quarterly survey data of farmland values in the states of Iowa, Illinois, Indiana, Michigan, and Wisconsin. According to the Federal Reserve Bank of Chicago, 7th District farmland prices, which represents a highly productive cross section of the corn belt, increased by 6% in 2023 through October 2023. Both the USDA 2023 year-over-year increase of 8.1% and the Federal Reserve Bank of Chicago index showing a 2023 increase of 6% demonstrate the resilience of underlying farmland prices in the face of higher interest rates and lower commodity prices, which are further discussed below.
Figure 5. 7th District Farmland Values
Source: Federal Reserve Bank of Chicago, 2024 Past performance does not guarantee future results and there is no guarantee this trend will continue. 7th District does not report farmland values for Michigan quarterly due to insufficient survey results.
When we further break down the USDA data by region, again the same picture holds, with all regions showing low-to-mid-single digit % increases in 2023.
Figure 6. Regional Farmland Values
Source: USDA, 2023 Past performance does not guarantee future results and there is no guarantee this trend will continue.
When thinking about farmland prices, it is also important to consider the maximum drawdown, or more appropriately lack thereof. Again, the Bloomberg U.S. Aggregate bond index, experienced max drawdowns of (4%), (17%), and (7%) in 2021, 2022, and 2023. That is in just a 3-year period. Over the last 25 years, according to the USDA data, cropland values in aggregate experienced a maximum drawdown of (4.3%). This goes back to the importance of how the continual disappearance of cropland in the United States, as shown in Figure 1, impacts the capital cycle. As the late great real estate investor Sam Zell put it, “The most intelligent investment may perform poorly if it is surrounded by too much supply.” The limited volatility of cropland prices per the USDA historical data also highlights the importance of diversification in farmland holdings. As the regional data in Figure 5 shows, volatility can be greater at the regional level.
Parallels to the impact of constrained supply on the capital cycle for a given asset class can also be observed over the last 18 months in single-family housing in the United States. For example, according to Freddie Mac, the average 30-year fixed rate mortgage in the United States increased from 3.1% December 30, 2021 to as high as 7.8% on October 26, 2023. As this steep rate increase occurred, the expectation among most market participants was that housing prices would correct. However, the S&P CoreLogic Case-Schiller U.S. National Home Price Index has increased by 12% over the same time period. This is due to the lack of supply in the single-family housing market. The critical point however, when comparing single-family home prices to farmland prices is that the supply of single-family homes can easily increase over time with increased capital, whereas almost no amount of capital can increase the supply of productive farmland with sufficient water resources.
Impact of Hitting the Supply Wall
In our opinion, the state of Iowa provides a good representation of the potential impact of supply constraints on farmland values. We believe Iowa represents the most homogeneous farmland market in the country as the most productive soil is consistently dedicated to a rotation of growing corn and soybeans. As shown in Figure 7 below, according to the 2022 USDA Census, Iowa has lost 1.83 million acres of cropland, or about 7% over the last 25 years. Corn and soybeans harvested acres have consistently represented 86%-88% of this cropland since the passage of the Renewable Fuel Standard in 2006.
Figure 7. Iowa Cropland Acres and Corn & Soybean Harvested Acreage
Source: USDA, 2024 Past performance does not guarantee future results and there is no guarantee this trend will continue.
Figure 8 below shows annual harvested acreage of corn and soybeans in the state of Iowa. This harvested acreage we believe is largely indicative of productive farmland in Iowa. As the chart below shows, harvested acreage in Iowa peaked in 2014 and has been largely flat over the last 25 years.
Figure 8. Corn & Soybean Harvested Acreage in Iowa
Source: USDA, 2024 Past performance does not guarantee future results and there is no guarantee this trend will continue.
The impact of supply constraints on productive farmland is a dynamic that has only begun to unfold over the last 10 years and will likely occur gradually. When including the 1980s, a period of abundant farmland supply spurred on by the United States government’s push for farmers to plant fencerow to fencerow, the Iowa State farmland price data shows annual appreciation of 2.4% prior to the passage of the Renewable Fuel Standard in 2006. The impact of abundant supply is evident in Figure 8 above. For context, harvested acreage of corn and soybeans increased by 39% from 1970 to 1981. This ability to add supply simply does not exist today, as shown in Figures 7 and 8. The passage of the Renewable Fuel Standard drove a period of significant price appreciation in both commodity and land prices until harvested acreage peaked in 2014. With the state of Iowa losing over 73,000 acres on average annually over the last 25 years, the ability for a supply response to higher demand will continue to be limited in the absence of material technology improvement to drive higher yields per acre.
Figure 9. Historical Iowa Farmland Values
Source: Iowa State University, 2023 Past performance does not guarantee future results and there is no guarantee this trend will continue.
Looking ahead
AcreTrader has had investors we greatly admire look at the chart in Figure 1 and think, “I’m not buying that chart!” It's a reasonable response in the context of the capital cycle for most asset classes. However, when one then considers statistics from the USDA Census of Agriculture indicating we have lost over 14% of the supply of cropland while the value of the crops produced by that lower supply base has increased by 179% over the same time frame it helps provide proper context.
Parcels of farmland are not assets that are frequently traded and therefore not typically subject to short-term overbought and oversold conditions. Farmland rarely turns over. We believe this illiquid nature of the asset class can be a feature and not a bug for long-term investors.
Farmland prices have, appropriately, been described as resilient through 2023, which is demonstrated in the various farmland price charts above. While many macro indicators have turned positive of late for the broader economy, there’s a plethora of foreboding headlines across the ag economy today. Many key commodities are down significantly, for example with cash corn prices down over 37% year-over-year and soybean prices down over 20% year-over-year. The University of Illinois farmdoc 2024 crop budgets project negative return expectations for corn and soybean farmers across all regions for cash rented land. According to the USDA ERS (link), net farm income is expected to be down (25.5%) year-over-year, marking the second year in a row of declines. However, it is critical to point out that this broad measure of net farm income is only (1.7%) below the 20-year historical average. In addition, interest rates on operating loans for farmers are over 8% and term debt is over 7%.
The current headwinds facing operators in certain regions can have an impact on farmland pricing as direct operators are the primary buyers of farmland. For example, in Iowa direct operators represent over 70% (link) of farmland buyers, according to Iowa State. If direct operators pull back in land purchasing activity, this may have potential to present opportunities for investors. Our farm team fully reviews 20+ farms each week and consistently monitors auction activity. In our opinion, auctions are great for sellers in a strong land market as the sense of urgency and human nature can drive up valuations. For this reason, we believe auctions tend to represent the froth of a strong land market. In recent weeks we have seen an increase in “no-sale” activity at farmland auctions where seller expectations were significantly out of line with bidding activity in light of the primary buyers' (direct operators) current underlying economics. If seller expectations rationalize and direct operators are less aggressive overall, opportunities may arise for disciplined buyers. In addition, we see opportunities to partner with direct operators who wish to pull equity out of their existing farmland through sale and leaseback opportunities or simply to provide growth equity to a farmer wishing to expand their operations.
As others are increasingly fearful, we believe the fundamental underpinning of a shrinking farmland supply base and rising demand could provide for attractive long-term opportunities for this asset class.
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