Flex Leases Land Bubble and Profitability Henderson County January 12, 2011

Flex LeasesLand Bubble and Profitability

Henderson CountyJanuary 12, 2011

Greg [email protected]://www.ca.uky.edu/agecon/index.php?p=169

Dept. Agricultural EconomicsUniversity of KentuckyDecember, 2010.

Agricultural Economics

Areas Covered Today1) Land Bubble2) Profitability by Soil Type3) Communication4) Leasing Game5) Flex Leases


Hypothetical Story

Central Kentucky:• Profit• Knowledge• Competition• Greed


True or False

Cropland Prices drive Cash Rents?

False!!!


What Drives Cropland Prices?

Investor – Expected Land Rents

Farmer – Expected Profits


What Is the Relationship Between Land Rents and

Profits?

Profits Drive Land Rents:• Higher the profit, the more that a farmer

can bid for land rent.• In long-run, most of profit will be bid into

land rents.


What About Land Appreciation?

Yes, but…

Except for Development Potential→ Future land rents and/or profits determine appreciation.


Formula to Estimate Max. Cropland Value

Investor Perspective:

Land Value = Land Rent – Costs Interest Rate


Investor Perspective Example

$220/acre Expected Land Rent$20/acre Expected Costs5% Interest Rate

Land Value = $220 – $20 = $4000 .05


Formula to Estimate Max. Cropland Value

Farmer Perspective:

Land Value = Profit per Acre Interest Rate


Farmers Perspective Example

$300/acre Expected Profit5% Interest Rate

Land Value = $300 = $6000.05


How is Interest Rate Determined?

If self-financed: → Required return on investment.

If Borrowing: → Rate of the loan.


Effect of Interest Rate

As rate decreases: → Land value increases.

Interest Rate and Profitability/Land Rent Effect on Maximum Land Price

Interest Rate 1) Expected Profitability or 2) Land Rent minus Costs

$100 $200 $300 $400 $500

15.0% $667 $1,333 $2,000 $2,667 $3,333

10.0% $1,000 $2,000 $3,000 $4,000 $5,000

7.5% $1,333 $2,667 $4,000 $5,333 $6,667

5.0% $2,000 $4,000 $6,000 $8,000 $10,000

2.5% $4,000 $8,000 $12,000 $16,000 $20,000


What Interest Rate to Use?

Returns on other investments→ Lot of risk out there.→ Farmland seems like safe investment.


Land Rent vs. Profit ApproachShort-run: Farmers will have competitive

advantage over investors in areas with less then perfect bidding.

Long-run: Land rent and profit will be very close.


Ohio Valley DynamicsMost Competitive Land Rents: • $200-$275 last year.• $300+ this fall.

What land prices will this support?


Interest Rate 1) Expected Profitability or 2) Land Rent minus Costs

$100 $200 $300 $400 $500

15.0% $667 $1,333 $2,000 $2,667 $3,333

10.0% $1,000 $2,000 $3,000 $4,000 $5,000

7.5% $1,333 $2,667 $4,000 $5,333 $6,667

5.0% $2,000 $4,000 $6,000 $8,000 $10,000

2.5% $4,000 $8,000 $12,000 $16,000 $20,000


Projected Profitability 2012• Commodity prices down from late summer

high.• Determine if land rents can be supported

in 2012 at current commodity levels.• Evaluate range of commodity prices.


Critical Budget Assumptions

20

1. Does not include land rent.2. Includes “non-cash” costs (e.g.

depreciation/overhead, unpaid labor). 3. P and K application at removal rate.4. Grain trucked directly to elevator.


Corn and Soybean PricesNew Crop 2012

Price Scenario: Corn Soybeans Low $4.50 $9.50 Baseline $5.50 $11.75 High $6.50 $14.00


Agronomic Assumptions

Corn Yield

Soybean Yield

Corn/Soybean Yield Ratio

125 bu 39.0 bu 3.2150 bu 45.5 bu 3.3175 bu 51.5 bu 3.4


Budget Assumptions

Base ScenarioFertilizer: $/ton $/unit Anhydrous (N) $860 $.52 DAP (P2O5) $680 $.53 Potash (K2O) $640 $.53


Projected 2012 Costs (per acre)Inputs: Corn (150 bu) Soybeans (45.5 bu) Seed $76 $45 Nitrogen $83 $0

P, K, and Lime $70 $53 Pesticides $35 $25Total Inputs $264 $123Machinery and Labor $121 $85Other: Drying Grain $23 $0 Crop Insurance $20 $20

Misc. $20 $20 Land Rent Variable Variable Operating Interest $7 $4 Total Other $70 $44Total Costs $455+ Land Rent $252+ Land Rent


Summary Revenues/Costs (per acre)

Yield and Price: Corn SoybeansExpected Yield (rotation) 150 45.5Future's Price Fall 2011 $5.50 $11.75Grain Revenue $825 $535Direct Gov’t Payment $20 $20Total Revenue $845 $555Total Costs (Less Land Rent) $455 $252Gross Return (Less Land Rent) $390 $303


Baseline Scenario (per acre)$ 11.75 Soybeans (elevator)

$ 5.50 Corn (elevator)$.52-N; $.53-P; $.53-K

Gross Return

CornGross Return

SoybeansGross Return

Rotation

125 bu corn $276 $234 $255

150 bu corn $390 $303 $346

175 bu corn $505 $366 $435Note: Subtract land rent to get Net Return.


Interest Rate1) Expected Profitability or 2) Land Rent

minus Costs

$250 $300 $350 $400

7.0% $3,571 $4,286 $5,000 $5,714

6.0% $4,167 $5,000 $5,833 $6,667

5.0% $5,000 $6,000 $7,000 $8,000

4.0% $6,250 $7,500 $8,750 $10,000


High Commodity Price Scenario$14.00 Soybeans (elevator)


Gross Return

CornGross Return


Rotation

125 bu corn $401 $322 $361

150 bu corn $540 $404 $472




minus Costs

$375 $425 $475 $525

7.0% $5,357 $6,071 $6,786 $7,500

6.0% $6,250 $7,083 $7,917 $8,750

5.0% $7,500 $8,500 $9,500 $10,500

4.0% $9,375 $10,625 $11,875 $13,125


Low Commodity Price Scenario$ 9.50 Soybeans (elevator)


Gross Return

CornGross Return


Rotation

125 bu corn $151 $146 $148

150 bu corn $240 $200 $220




minus Costs

$150 $200 $250 $300

7.0% $2,143 $2,857 $3,571 $4,286

6.0% $2,500 $3,333 $4,167 $5,000

5.0% $3,000 $4,000 $5,000 $6,000

4.0% $3,750 $5,000 $6,250 $7,500


Land Bubble?

• 1970’s vs. 2010’s→ What are differences?→ Let’s look at land values.


Land Bubble?

Main difference today vs. 1970’s?

Politically imposed demand for grain.→ Ethanol used 40% of corn crop 2011.→ Political issue, not market issue.


SummaryCurrent farmland values not unreasonable at

current profitability levels.However price levels will hinge on ethanol

policy.How will market react to: → 40% of corn crop dumped on market.

→ Market response to higher profitability.


Land Rents by Soil ProductivityQuestion: If 150 bu ground rents for $200,

how much would you pay for 125 bu corn ground?

We will look at partial budgets to help answer this.

Note: Base rents are purely hypothetical.


Land Rents by Soil Productivity

If productivity increases 20% → Land Rent increases by 20%.Does this seem fair?

38

Corn - Partial Budget for Increased YieldYield Increase (bu/acre) 25 Elevator Price ($/bu) $5.50 Increase in Revenue $138 Increased Costs: Seed ($/bag) $200 1000 $2.50Nitrogen $0.52 15 $7.80Phosphorous (P2O5) $0.53 10 $5.30Potassium (K2O) $0.53 9 $4.64Harvesting ($/bu) $0.08 $2.00Trucking (miles) 15 $2.93Drying ($/gal LP) $2.00 $3.13Other ($/acre) $0.00 $0.00Total Increased Costs $28.30 Net Increase Revenue $109

39

Soybeans - Partial Budget for Increased YieldYield Increase (bu/acre) 6.0 Elevator Price ($/bu) $11.75 Increase in Revenue $71 Increased Costs: Seed ($/bag) $45 0 $0.00Nitrogen $0.52 0 $0.00Phosphorous (P2O5) $0.53 4 $2.23Potassium (K2O) $0.53 7 $3.50Harvesting ($/bu) $0.08 $0.48Trucking (miles) 15 $0.70Drying ($/gal LP) $0.00Other ($/acre) $0.00 $0.00Total Increased Costs $6.91 Net Increase Revenue $64



Productivity Change of 25 bu corn:• $109/acre net corn.• $64/acre net soybeans.• $86/acre net 50-50 rotation.

Note: Based on assumptions previous two slides.


150 bu Base Rent

Yield (bu corn)

Equivalent Land Rents


200 $373 $348175 $286 $261150 $200 $175125 $114 $89

Note: Base Rents examples only.


175 bu Base RentYield

(bu corn)Equivalent Land Rents


200 $336 $311175 $250 $225150 $164 $139125 $77 $52

Note: Base Rents examples only.



Summary:• 17% dec. yield → 43-50% dec. rent.• Not linear relationship.• Better ground may be underpriced. • Poorer ground may be overpriced.

Documents

Flex Leases Land Bubble and Profitability Henderson County January 12, 2011