Landowners should think twice about a straight cash rent lease

If you are signing farmland rental agreements for 2013, what are the terms?  If you are an operator, are you agreeing to higher cash rent than 2012 because the landowner wants more since prices are going up?  Are you engaging in a flexible lease payment that protects an operator’s financial commitment should 2013 be another dry year?  Are you continuing with the crop share lease that was begun with the prior generation of both the owner and the operator?  Farmland leases vary widely from one part of the Cornbelt to another, but operators still must manage their risk in an agreement that the owner considers a fair lease.  

Illinois, with a high percentage of land owned and operated by different individuals, also has a wide variation in rental agreements because of soil productivity.  University of Illinois economist Nick Paulson says the trend of the past 15 years has been a move away from crop share leases to cash rent leases, in part because of aging landowners who want to avoid all of the bookkeeping chores.  Their simplicity may be attractive, but at high levels that have been recorded in recent years, operators face significant risk of heavy financial obligation without protection against lower yields or prices.  2012 is a good example.  

Paulson compares the straight cash rent agreements to flexible and share rental agreements, and finds the latter not only protect the operator more, but frequently provide more cash to the land owner.  And owners may find that to be a surprise.  Paulson says that has been the case since 2008, including the lower yields of 2012.  

• For the northern third of the state, Paulson calculated rental rates for a 50-50 crop share lease, as well as a flexible lease in which the owner received 40% of actual crop revenues.  He said they resulted in similar payment levels over time, and averaged $318 and $305 per acre, and were larger than the $203 fixed cash rental rate for northern Illinois based on USDA averages.    

• For the central third of Illinois Paulson said the 40% share and flex rate leases averaged $280 and $278 respectively for the past five years, compared to the average of $215 per acre for the cash rent lease reported by USDA. 
  
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• In the southern third of Illinois, the 40% share and flex rent leases were $243 and $241 per acre for the past five years, compared to the $127 average cash rent.    

While the widely variable productivity in farmland returned similar performances for flex and share rent leases compared to straight cash rent leases, Paulson said those five years were times of high and increasing commodity prices.  He questioned if the same could be expected if there was a year of large yield losses, such as in 2012.  

The key to the success is the formula for determining the rent to be paid.  For the flexible lease, Paulson established the level with the crop insurance base or the projected price, along with the average price from April through September as reported by USDA.  He also used a crop rotation which utilized 55% corn and 45% soybean acres.   

Paulson said, “Despite yield levels well below trend in all three regions of Illinois, the flex lease design results in similar or larger payments than the average fixed cash rent reported for each region. This is true for both the base insurance price and the average price received from April through September. In Northern Illinois, where yield losses are expected to be smaller than other regions, the flex payments are considerably higher than the average fixed cash rent. For Central and Southern Illinois, the flex lease rate calculated using the base insurance price is similar to the average fixed cash rent while the flex lease rate based on the average price received is well above the average cash rent level in these regions.”    

Summary:

Trends in land rental rates and agreement types suggest that tenants are taking on more risk exposure. This is a serious concern for all farm operators, but especially for those who are highly leveraged and/or rent a large proportion of their acres. Given market trends toward cash rental arrangements, convincing landlords to use a share or flex lease may be difficult. Price and yield levels since 2008 have resulted in the “typical” 50-50 share lease, and a similar flex lease payment equal to 40% of gross revenue, providing payments to landowners which may exceed average fixed cash rent levels.  Moving to a share or flex lease will also shift some risk from the tenant to the landlord. Farm-level yields will vary around these averages considerably, implying that share or flex lease payments for some operations will be well below comparable cash rental rates for the area.

Source: FarmgateBlog.com

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