Farmers who rent a large portion of their land base can generate large annual returns. These high returns come with risks that must be managed
We recently did some work for a young client, Curtis Makiteezy. Curtis had a very interesting operation that caught our eye and made us do a double check.
There are very few farming models that surprise us any more however this one was worth noting. The operator was a young fellow operating a midsize grain farm with a net worth of $1,300,000. What was unique about this operation was that after we completed his projection his return on assets was an incredible 14 per cent. A typical return on assets for a grain farm has historically been between two and five per cent!
It was no mistake
We began looking for a mistake that we had made while entering in numbers, looking at gross income per acre, operating expenses, machinery investment and every other factor that generally leads us to finding some error. After spending almost an entire day we finally came to the conclusion that there was no mistake. The operation was just capitalized very well, the machinery was matched almost perfectly to the size of the operation and the operation was being run very efficiently.
The one thing that we did identify as somewhat abnormal for the area was that the operation only owned 10 per cent of the acres farmed and the balance of the acres were rented. Owning that small of a percentage of the land base is generally considered rare. This led us to ask a different set of questions relating to risk in the operation and also led us to a different approach as to how to go about mitigating this risk.
However, the fact remained that the operation was projected to have a return on assets of 14 per cent. The operation’s projected net income was over $350,000!
In an a geographical area where the focus is typically on how can we afford the next land purchase, this situation was a nice reminder to separate land ownership from the farm business.
Risks to manage
Curtis’s decision to leverage his equity into growth in operations as opposed to land ownership has paid tremendous dividends in the past few years with strong commodity prices. This is a great reminder that allocating the operation’s resources or capital to the areas of greatest opportunity can generate impressive returns.
This business model is not without risk. We identified five risks that needed to be managed.
1. Loss of rented land. This potential risk can be mitigated through developing strong land lord relationships, creating unique rental terms and staggering lease renewal dates.
2. Limited ability to term out operating losses, should they occur. Operating with a limited land base offers creditors little opportunity to extend amortizations. This risk can be mitigated through maintaining strong liquidity.
3. High machinery utilization. In a normal season the machinery on this operation is matched perfectly with the land base. However, should adverse weather conditions arise (yeah right — when does this happen!) field operations may not be completed on a timely basis. This can be mitigated through access to custom operators or developing a strong relationship with a machinery dealer.
4. Grain storage. This operation was extremely short of grain storage. This risk can be mitigated through proactive marketing, buying grain bags renting bins, and developing strong relationships with grain merchants.
5. Lack of diversification. For the same reason the operation is so profitable right now, its greatest strength can also be its greatest weakness. This risk can be mitigated by proactive planning in marketing and financial management.
The moral of Makiteezy’s story is that profit can be achieved in many ways regardless of the size of the farm. Efficient allocation of resources to seize opportunity can yield tremendous return on assets. This doesn’t come without risk. “The first step in the risk management process is to acknowledge the reality of risk. Denial is a common tactic that substitutes deliberate ignorance for thoughtful planning.” †