To demonstrate the weak link between land values and farm income, the economists use a rent to value ratio, which is the average cash rent per acre divided by the average per acre value of land. And they say the relationship has been decreasing over the past 45 years, pointing to the influence of the non-agricultural factors.
The economists say farm operators who depend on farming for their livelihood and who are interested in buying farmland should answer two questions:
- Is farmland still affordable?
- How vulnerable are farmland values to unexpected changes in interest rates and the residential housing market, both of which have experienced significant changes in the last 10 years?
Not many years ago, any farmer who contacted a lender wanting financing to buy land, would be asked whether the land would cash flow enough to pay the debt service. But those questions are becoming fewer and further between, say the USDA economists, “In recent years, farm incomes have increased and interest rates have declined, and these two trends have combined to increase the maximum value of farmland that can be supported by current farm incomes. In 2009 and 2010 and between 1986 and 2004, farm real estate values were closely aligned with farm income. However, during two periods in particular--1978-85 and 2005-08--income from farming alone was insufficient to service the debt on farm real estate purchases. Nonagricultural factors likely had a large role in buoying farmland values during these two periods.”
While land sales typically restrict about 0.5 percent of the land from changing hands in a given year, changes in farm earnings may influence the rate of turnover. Currently the demand for crops as sources of food and energy has kept stocks tight and commodity values high. The termination of farm program payments may also have an impact on the desire to own farmland and the price that investors are willing to pay.
Farmland sales have been subject to interest rates, and with rates at historically low levels, land values have increased due to the low cost of borrowing. USDA data indicates that land purchases in 2008 and 2009 were financed predominately by credit. If interest rates had been at 6 percent over the past decade, the cash flow stream from farmland would have been unable to service the debt. But with low interest rates land values have been allowed to rise to current values. Should interest raise rapidly rise, most farm operators would not be weighted down in debt that interest would be a problem in making land purchases.