Spring 2007, Vol. 13 No. 2
Agricultural Situation Spotlight: Land Rents: How High Will They Go and Who Gains?
Land Rents: How High Will They Go and Who Gains?
Bruce A. Babcock
The outlook for corn and soybean farmers looks exceedingly bright because of continued strong growth in U.S. ethanol production. December corn futures contracts are trading above $3.80 through 2010. Soybean futures are trading above $7.50 through 2009. The reason for this price strength is that U.S. corn plantings are projected to exceed 93 million acres from 2008 and beyond because of strong demand.
Higher corn and soybean prices will affect Iowa agriculture in a number of ways. The first impact will be felt by land renters as they renew their contracts late this summer. Higher crop prices have increased the returns to crop production. These increased returns will translate into increased competition for land, which in turn will drive up land rents.
Calculating Potential Changes
An idea of the possible magnitude of the changes in land rent can be made by calculating the impact of higher commodity prices on the returns over variable costs of production. Farmers who are considering whether to expand their farming operations will generally bid no more than they expect to earn after paying variable expenses. Thus, the change in returns over variable costs due to higher prices provides a good guide to how land rents may change.
Recently, CARD researchers conducted a study on the likely impacts of expanded ethanol on corn and soybean prices. Results show corn prices of about $3.40 per bushel on average over the next five years and soybean prices of around $7.00 per bushel on average. Using current estimates of production costs and corn yields of 165 bushels per acre for corn following corn, 180 bushels per acre for corn following soybeans, and soybean yields of 55 bushels per acre following two years of corn, projected crop returns over variable costs of production would average around $315 per acre. If instead we use low commodity prices to reflect the recent pastï¿½$2.10 per acre for corn and $5.50 per acre for soybeansï¿½returns over variable costs of production will average around $160 per acre.
At first glance, you might think that we should see land rents go up by the difference in per acre returns, which would imply that the average Iowa land rents would more than double given that the state-average land rent was approximately $140 per acre in 2006. However, the 2006 land rent includes expected benefits from government farm programs, including direct payments, loan deficiency payments, and countercyclical payments. If the 2007 farm bill looks much like the 2002 farm bill, and if higher prices are with us to stay, then Iowa farmers will receive only direct payments because prices will not fall low enough to trigger the other payments.
Direct payments average about $25 per planted acre in Iowa. The average payment received from marketing loans and countercyclical payments under the 2002 farm bill was approximately $35 per acre. Because farmers will receive direct payments under both high and low prices, the effect of these payments will be neutral to any increases in land rents. However, under high prices, farmers will receive $35 less in payments than before. Thus, Iowa farmers should expect to receive an additional $155 per acre from the market due to higher prices, and $35 less per acre in government payments due to higher prices. This nets out to an increase in returns of around $120 per acre. If Iowa land rents increase by $120 per acre, they would approach $300 per acre in many parts of the state. How likely is it that we will see $300-per-acre land rents in 2008? The answer depends on whether crop farmers can actually capture projected additional returns over costs.
Nobody can guarantee that corn prices will average $3.40 per bushel or that soybean prices will average $7.00 per bushel. However, farmers can lock in today's prices for the next three years by buying futures contracts. This suggests that there are at least some farmers who can afford to pay higher rent because they have already locked in price levels that justify higher rents. Of course, price is only one side of the revenue equation. There is also the risk that farmers may not be able to produce a crop. But the probability of a crop loss is no greater under high prices than under low prices, and so this risk should not really influence farmers' willingness to pay more for land. The one uncontrollable part of the future profit equation is production costs. If seed, fertilizer, fuel, and pesticide costs continue to rise, as they have over the past few years, then future margins will be lower than anticipated.
Impacts of Higher Land Rents
Higher land rents, and the inevitable increase in land prices that follow, will have little impact on the competitiveness of Iowa agriculture. Because the value of Iowa farmland is determined primarily by the value it generates in current and anticipated future production, higher property values are a reflection, rather than a determinant, of the competitiveness of Iowa agriculture.
It might seem intuitive that higher land rent would hurt farmers who rent land. But if higher land rents simply reflect higher expected returns over variable costs, then farmers who rent their land will be largely unaffected by changes in rent. On average, the extra they make from the marketplace will just be handed over to land owners in the form of higher rental payments.
The clear beneficiaries of higher crop returns would be existing land owners because the returns to owning land would increase. Because farmland is a major financial asset, the net worth of Iowa would grow significantly. To the extent that this increase in net worth is leveraged into productive investments, income growth in Iowa should also eventually increase.
Higher land rents could significantly reduce the amount of Iowa cropland that is enrolled in the Conservation Reserve Program (CRP) and the Wetland Reserve Program. Past experience has demonstrated that farmers will remove land from CRP if the land can earn significantly more in crop production than it can earn in the program. Reductions in CRP land will likely increase soil and nutrient losses and reduce wildlife habitat.
One option that USDA will be considering to offset the negative impacts of land coming out of conserving uses is to use the money saved from expiring contracts to increase bid rates for the most environmentally sensitive land. If USDA follows this path, conservation programs may be smaller but the per acre environmental benefits that they provide could be much greater. ♦