Land Rental Rates and Relationships: Insights from an Agricultural Economics Analyst

10 December '13

One of our recent blogs was based on a Western Producer article that provided an economist’s perspective on where farmland rental rates are headed. The article shared information that James Bryan, a strategy and agricultural economics analyst with Farm Credit Canada, had presented in a recent Farm Management Canada Agriwebinar: Get the most out of your rental relationship. The Western Producer article and our previous blog focused on pricing rental land, however the full webinar had many great insights that we wanted to cover in more depth. We also wanted to encourage you to check out the webinar video for yourself. (Note: free registration is required, but it's quick and you'll get access to other great resources!)
First, Bryan gave an interesting overview of how global economic growth is driving optimism in the agriculture sector. He described a recent shift in economic growth, away from developed countries and towards emerging economies like China and Indonesia, and the impact this has on global food demand. He contrasted economic growth in developed vs. developing countries as it relates to food consumption. Bryan gave the example that an extra $1.00 accessible to someone in a developed country may result in an extra 10 cents being spent on food. In this scenario, the extra spending is unlikely to increase the amount of food consumed, whereas in a developing country it almost certainly would. In developing nations an extra $1.00 is likely to result in 40-50 cents being spent on food, increasing the overall food demand. Patterns in food consumption may also shift, trading grains for proteins, yet the overall outcome is increased global demand for food. 
This paints an interesting picture that helps us understand commodity price increases. While Bryan points out that grain prices have dropped in comparison to the most recent spike- considering the long-term trend, “crop prices are actually pretty strong.”  Other factors impacting commodity prices are biofuels and production concerns, including last year’s U.S. drought that contributed towards prices upwards of $8.00/bushel of corn. Bryan notes that the price spike caused by the drought was generally understood to be a temporary response to the production disturbance, so the recent downturn was widely anticipated (or should have been). Despite the drop in prices, commodities are expected to remain solid in the long-term. 
So how will this impact rental rates? 
Bryan notes that crop income, (clearly dependent upon commodity prices), relates to rental prices, but that they do not track evenly. Like we mentioned in our previous blog, Bryan describes rental rates as “sticky” both on upturns and downturns. In this webinar he highlighted data from Illinois, demonstrating that from 1997-2003 crop revenues declined, yet lease prices didn’t decrease. This is an important thing for both landowners and farmers to understand.
This is because a variety of factors also come into play, including the significant impact of interest rates. Interest rates have declined steadily for the last 20 years, driving land values upwards due to increased affordability. Yet, when increases or decreases in interest rates affect land values, rental values do not necessarily follow suit. Bryan explains this as an outcome of the rate of return expectations landowners have when comparing their land investment to alternative low-risk options (e.g. bonds or savings accounts). When interest rates are low, landlords are willing to accept a smaller rate of return. It is important to note that an increase in interest rates, which is likely to happen since they can’t go much lower, does not necessarily mean that rental prices will go up. Again, Bryan highlights that farmland rental rates are more complex outcomes of a variety of factors, including what producers are willing to pay. 
Bryan stresses that rental rates need to reflect the profitability farmers expect from their businesses in the short-term, and that this all boils down to the farmer’s cost of production. Bryan describes the cost of production as “100% the most important thing to know”, noting that without this information farmers are taking a “shot in the dark” when it comes to realistic rental prices. Cost of production is also one of several considerations in determining whether to rent or buy land. 
In the webinar Bryan highlights the advantages of both options. For example, renting offers more flexibility, can more readily adjust to market conditions, and requires no large down payment; in contrast, buying offers a more secure land base, lets producers capitalize on asset appreciation, and can be a more simple option. However, again, a producer’s personal scenario will dictate which course makes the most sense, and when it comes to buying vs. renting, there are many differing opinions. 
One drawback to rental is that pre-arranged prices at the start of a rental term might not reflect real-time changes in the economy. While crop share arrangements have historically been used to let landowners share in the risks and benefits of production, these arrangements are often complex and vulnerable to inequity. Over recent decades there had been a marked shift towards simpler cash rent arrangements. 
Next, Bryan explored, 'who are today’s landowners'?
Today’s landowners are a diverse mix of retired farmers, widows, those who have inherited farmland, investment companies, government and non-farmers who decide to live in a rural area. The final category in fact amounts to 33% of today’s landlords, and since this type of individual often doesn’t have extensive knowledge about agriculture, the nature of creating and maintaining a rental relationship is unique. 
Bryan cautions farmers against the temptation to low-ball landowners, noting that it will lead to strained rental relationships and potentially damage the farmer’s reputation. 
Bryan also presented intriguing information about what landowners look for in rental relationships. He cited data from a U.S. survey noting that only 17% of landowners described the rental rate as ‘very important’, yet over 50% thought factors like trustworthiness, reputation, caring about the landlord and the land, and paying on time were ‘very important’ factors. Other factors include maintaining soil productivity, avoiding erosion, protecting wildlife etc. So overall, the rental rate is not the most important factor for most landowners.
When describing the qualities of a positive rental relationship, Bryan suggested that they bear similarities to the qualities of a friendship. Included in this are listening, and taking time to understand the landowner’s unique values
Bryan admit that the most common, but also the hardest question of all is, ‘What is a fair rental price?’ He categorized the determinants in terms of the land quality (e.g. drainage, obstructions, soil types, production history, landlord expectations etc.) and the farmer’s cost of production. Again he stressed that the individual cost information is essential to understanding an affordable rate. 
Finally, Bryan described successful rental contracts as those which are fair to both parties, written, simply, and clearly communicated. He noted that a price of $15 and $50 per acre can sound similar in verbal agreements, but taking time to have a properly written contract will ensure accuracy and reduce conflict. 
So there’s a recap of this insightful webinar. Again, here is the link, which we encourage you to check out for yourself. The video also includes some questions and answers asked by the live participants.

If you have questions of your own, be sure to let us know and we’ll track down answers and address them in upcoming blogs!
*Note: The insights provided by James Bryan and within this blog should be considered as ‘general information’ and should not be substituted for legal or other applicable professional advice.