Framework for Potential Farmland Investment Return

What return should one expect when investing in farmland? Well, it obviously depends on the where, what, and how. But as an asset class in general there are a few considerations. One of them is how fast the market for crops is expected to grow. For example, how much is the expected return in dollars per acre expected to increase?

The USDA has a lot of great data series, one is the major land uses and another is the farm income data. Putting the two together we can check the real (adjusted for inflation) growth in gross cash receipts from crops since 1929 to see the past trend in $/acre yield. We are focusing on the gross cash receipts, not the profit because the profit is affected by more variables, where as the total gross cash receipts is a measure of the size of the pie, the profits are how much the farmer gets, which could vary.

At first glance this seems promising. The real cash gross income per acre has grown through time. However there are long periods in which it doesn’t seem to grow at all and if you calculate the average annual change each year it is around 2%. This is despite large population growth and a decrease in the number of acres being harvested for crops. In 1929 the USDA estimates that there were 379 cropland acres and in 2016 there were 337.

There are two sources of return for those who buy and lease farmland. The first is the current yield or rent, which has a current average in the mid to high single digits. The second is price appreciation. This basic analysis would argue that the size of available economic pie that would be available to landowners has historically grown by around 2% per year. So in order for the real return on farmland to grow much in excess of the rent received plus a couple of percent, one of a few things would need to happen.

1. Farmland prices need to appreciate faster than rents. In all asset classes (for example bonds) investors have been accepting lower yields in recent years and it is no different with farmland. This could continue to happen and going forward farmland investors may continue to be willing to accept even lower rents per price paid for the farmland. While this would drive average prices up in the short run, it seems like an unsustainable source of expected return in the long run.
2. More of the economic profit could accrue to farmland. Our analysis above indicates that the gross income needed to pay all parties involved in producing crops  has only grown at about 2% an acre per year (in real dollars). Out of this income the farmer, any laborers, landowner, equipment provider, the government (taxes), seed and fertilizer provider, etc. all get a slice of the income. However some of these services may begin to take more of the pie than any other. It could be that more of the pie gets used to pay the landowner as farming gets more efficient and equipment gets cheaper.
3. The historical trend is wrong and going forward demand increases more than supply. Although there seem to have been a lot of tailwinds for crop demand since 1929, it could be that going forward demand outpaces supply by an even higher rate.

Any actual investment might perform differently than the average. This analysis also assumes that the land will be farmed on an ongoing basis, which is not necessarily the case with all farmland. One of the reasons that there has been a decrease in farmland is because some land has been taken out of commission for other uses, like housing development.

These factors have an infinite number of things that influence them, but should guide as a framework for thinking about return expectations for farmland going forward. For example demand could be increased by global trade or energy policy for ethanol. Supply is increased by new technology like precision agriculture and decreased by the shrinking number of acres in production. Also, the economic profit available to farmland is constantly in flux, for example farmers might be willing to accept less of the economic profit if farming becomes less labor intensive due to technology or less risky due to crop insurance, thus more of the economic return could be allocated to farmland.