On most farms land is the largest farm asset, which means it can also account for the largest portion of farm debt — especially for farmers just starting out, taking over from the previous generation or expanding the business. What can farmers do, in the face of more potential interest rate hikes, to make sure they can continue afford to pay for more land, and the land they already have?
Farmland accounted for around 70 per cent of all farm assets in Canada in 2017, and in its 2017 Farmland Values Report Farm Credit Canada (FCC) says the average value of Canadian farmland increased 8.4 per cent in 2017, following gains of 7.9 per cent in 2016 and 10.1 per cent in 2015. Of the Prairie provinces Saskatchewan led the way with an average increase of 10.2 per cent (which was also the highest in the country), followed by Alberta at 7.3 per cent and Manitoba at five per cent.
It’s important to note that most of the increase in farmland values occurred in the first six months of 2017, before interest rates increased in the last six months of the year. The report suggests that recent increases in borrowing costs and expectations of further rate hikes could cool the farmland market off in 2018.
To buy or not to buy?
There is also a strong relationship between farming income and land values, said FCC’s chief agricultural economist, J.P Gervais in a recent FCC video on the topic. “From year to year you are going to see some deviations between the pace of increase of farmland values and the pace of increase of farm incomes but over a longer period of time these two should actually be moving up together,” he says.
What’s the best strategy in an area where land prices are moving up? That depends, says Gervais, on what stage the operation is at. “If you are an established, mature business not looking to expand, high farmland values solidify your balance sheet and may open up opportunities and possibilities down the road,” he says. “On the flip side, if you are a young producer or a business looking to expand, higher farmland values make it more challenging to purchase farmland.”
Historically it’s always been a good thing for producers to build some equity and own some of the land that they farm, but there are possibilities to complement the scale of their operation, for example by renting land to scale up the operation, lower their cost of production and be more competitive, adds Gervais.
Interest rates affect farmland values
Farmland values are also very sensitive to interest rates. In its 2017 Farm Assets and Debt Report, Farm Credit Canada estimated that an additional interest rate increase of one per cent (100 basis points) would decrease appreciation of farmland values by 1.5 per cent.
When interest rates are low it’s more affordable to buy land to expand. FCC gives the example in its Farmland Values Report of a $100,000 mortgage amortized over 10 years with an interest rate of 5.8 per cent. Monthly payments are roughly the same as for a $110,000 mortgage with the same terms and a rate of 3.7 per cent. Borrowing power is higher with low interest rates, but unless the rate is locked in, producers could find themselves in a squeeze to meet their debt obligations, especially if farm incomes fall.
Farmland values are also highly correlated with farm debt — they tend to rise or fall together. Between 2011 and 2016 farmland values increased by more than 50 per cent, while farm debt over the same period grew by 32 per cent. That growth was fuelled by strong commodity prices and low interest rates.
Following farmland values, farm debt was also up in 2017 (reaching a record $102 billion). The figures aren’t out for 2018 yet but many agricultural economists are predicting increases in both farmland values and total farm debt to be significantly lower than last year. That’s partly due to the volatility in agricultural markets because of trade, weather and other economic factors, but a big brake on the train is rising interest rates.
Canadian farmland prices
Farmland is generally less affordable. That’s a result of farmland values continuing to rise, but the effect of higher interest rates has taken a bite out of some farmers’ appetite to invest in more land too.
The Land-to-Revenue (LRR) ratio measures the relationship between land prices and farm income. LRR assesses the affordability of land through gross revenue from crops. It is calculated by dividing farmland value by farm crop receipts, on a per acre basis. There is no ideal LRR level. Crop mix and productivity, which varies by province, will influence the number.
The LRR increased in all Canadian provinces in 2017, to 10.3 in Manitoba, 7.2 in Saskatchewan and 20.8 in Alberta, well above the 10-year LRR averages in each province. Although land values are definitely at a historic high, low interest rates over the past 10 years have, among other factors, helped keep LRR figures lower and partly explains why 2017’s LRR numbers are higher than the 10-year average.
The outlook for farmland?
What’s the outlook for farmland value? Can the market support continued increases like we have seen over the past 10 years? Is the financial environment and the outlook for Canadian agriculture stable enough for the sector to grow and increase farm revenues?
No matter what stage a producer is at, understanding the farmland market requires them to step away from the annual numbers and look at it from an historical standpoint. Look at the trend in farmland values compared to the trend in gross income and try to fit this within the business’ cost structure. “That is really what is going to make it successful for the future,” says Gervais.
“Farmland is often the foundation over which producers and farm operations deploy their knowledge, expertise and other farm assets to grow their business,” says Gervais. Understanding how farmland fits within the business vision is critical to the success of the operation, so Gervais advises producers to make sure they have a strategic plan in place that sets the vision for the future.
Back to the future?
Farmer Lawrence McLachlan posted this photo below of his bank statements from 1980 on Twitter. The interest rates on his loans at that time ranged from 13 to 19 per cent.
McLachlan wrote: “Just in case anyone is wondering how fast things can go bad… This was my third year farming. Rates went up six points in four months.” McLachlan bought his first farm in 1979, after starting out with rented land in 1978. His interest rates peaked at a massive 21 per cent.
“The only reason I survived was because of the help from family and friends that believed in me. I will be forever grateful,” McLachlan wrote.
– Leeann Minogue, Grainews editor