I recently read an article on the MSNBC Web site with the headline: “Red hot housing markets stir fears of bust.” The article reported on an FDIC analysis of real estate values in 362 metropolitan areas over the last 30 years. The results showed that boom markets —areas where inflation-adjusted real estate values have risen 30 percent or more in three years — existed in 15 percent of the metropolitan areas in the study. This is the highest proportion of cities with boom markets in the history of the FDIC’s study, and it is twice that of the peak that occurred in the late 1980s.
I mention the 1980s as a reminder of collapsing farm real estate values. Midwestern farmland values fell by as much as 50 percent in a three- to five-year span, causing many land-owning farmers to lose most, if not all, of their equity. It was this bust that triggered the “farm financial crisis” of the 1980s.
Given the marked increase in the number of metropolitan areas with booming real estate markets, it would seem to follow that farmland markets in some states are also boom markets. I decided to see if that was the case.
I used farmland data published by the ERS-USDA to compute the inflation-adjusted percentage change in state farmland values between 2001 and 2004. The inflation adjustment used was 6.52 percent, which was the percentage change in the Consumer Price Index from 2001 to 2004. Here’s what I discovered:
Under FDIC’s definition, no state farmland markets would be considered boom markets.
Only a dozen or so states had farmland values increasing at inflation-adjusted rates in excess of 15 percent.
Only one state — Massachusetts — had farmland values increasing at inflation-adjusted rates in excess of 25 percent.
The low number of states with relatively high farmland value growth rates is comforting because it is an indication that the vast majority of farmland markets are not booming and, therefore, not setting the stage for a possible crash. (Please see the chart at right.)
However, the Lake States region — comprised of Michigan, Wisconsin, and Minnesota — is one region were farmland values have grown at rates well above the norm for the rest of the country. Farmland values in these three states rose by more than 20 percent in real terms between 2001 and 2004. Anyone thinking about buying land in this region should understand that the recent “boom-like” increases in farmland values could be followed by bust-like declines.
Purchasing land is always risky. But purchasing land in a booming market is even more risky because substantial losses can occur if values plummet. In a boom market, you must not get caught up in the prevailing belief that land values will always keep rising.
The best way to control the risk is to make a bigger down payment and use less credit to buy land when the market heats up. This management strategy may make it more difficult to purchase land, but it also will prevent you from getting into a heavily leveraged land deal that could result in financial disaster if the land market were to suddenly go bust.
Bruce Jones is a professor of agricultural economics and extension farm management specialist at the University of Wisconsin.