Investing in Farmland through a REIT

We have talked before about the REIT option when investing in farmland. Additionally, we wrote about being able to see the value of your investment daily is often tough psychologically. The main benefits is that it is a very hands-off investment and requires only a minimal level of investment.

Gladstone Land (NASDAQ:LAND) closed yesterday trading at $12.84. Overnight it came out that they were going to issue 1,000,000 new shares at $12.25 (and possibly 150,000 more). They are expected to raise $11.6 Million from the issuance and are going to use the cash to pay down debt, which they potentially may issue in the future for new acquisitions.

Unfortunately, as a REIT Gladstone Land needs to payout at least 90% of its income to keep the tax benefits of the REIT status. So they are paying out a dividend at over a 4% yield, but they need to raise money to fund growth. We have no problem with a company issuing new shares to raise money. It could be a good idea if the company is funding good projects and issuing shares at a high valuation. In this case, though it raises some red flags.

The first issue is with the cost associated with constantly issuing new shares. They are selling $12.25 Million worth of stock to raise $11.6 Million, so right off the bat they are losing over 5% of the value of the issuance.

Secondly, the stock was trading nearly 5% higher than the issuance price just the day before the announcement.

But most importantly, the company says that based on the appraised values of the underlying land the shares should be trading well over $14 per share. So either one of two things is happening. They are diluting existing shareholders by selling additional shares at a steep discount (and high transaction cost). Or, the shares are trading at a discount because the company is destroying value and they are trying to raise even more money to invest in a value destroying proposition.

One of the things that has always struck us as odd about Gladstone Land is their compensation structure. Besides taking a fee for operating expenses they are also set up to collect a performance fee, which is not uncommon. We just don’t like the way it is set up. From page 56 in their 2016 Annual Statement:

FFO is a special term for a REIT. It is basically ROE (Net Income / Book Value of Equity) except they add back Depreciation and Amortization (which isn’t a big deal here because you can’t depreciate land) while subtracting out the income from the sale of a property.

There are two issues we have with them taking 100% of the fee between 1.75% and 2.1875% quarterly. The first is that the stockholders’ equity is a historical value. You can’t adjust the price of it up if the underlying farmland appreciates, whereas the rents will likely increase overtime if the value of the farmland rises. Our main complaint however, is that this calculation is done quarterly and the net income for rental farmland can be very lumpy since there are often revenue sharing agreements with the farmers, which are generally paid out at the end of each year. Therefore, the quarterly return can be well under 1.75% for 3 quarters then balloon in the 4th quarter. The company will then collect a performance fee even though the return may be sub par over the year.

Below is a chart of the quarterly returns for the NCREIF Farmland Index. From the NCREIF website: All properties in the Farmland Index have been acquired, at least in part, on behalf of tax-exempt institutional investors – the great majority being pension funds.  As such, all properties are held in a fiduciary environment.

The quarterly returns are due to both appreciation in the farmland and also the income generated that quarter. The spikes all come in the 4th quarter of each year and are primarially due to revenue sharing payments.

If the value of the land was truly worth over $14 a share they should be selling farmland and raising cash instead of raising cash to pay down debt and potentially buy more farmland.