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November 5, 2013
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And now, the investor farmer

Long-term agribusiness land ventures sprout as asset diversification play and hedge against inflation

By Mark Green

Albert Peterson of Peterson Farms and Brian Luftman of American Farm Investors with a 16-row planter.

Albert Peterson of Peterson Farms and Brian Luftman of American Farm Investors with a 16-row planter.

Farmland investing, an asset-diversification strategy pitched as a hedge against inflation, is testing the ground in Kentucky. Well established in U.S. grain belt states such as Iowa, it’s a financial product that meshes with the agribusiness trend of consolidating farm parcels and row-crop operations into larger units for more efficiency and profitability.

One Bluegrass-based agriculture land investment operation was launched two years ago and in September bought its fourth Central Kentucky farm. Another commonwealth financial adviser is among the principals in a Nashville-based partnership that closed its initial $7 million farmland investment fund in October.

Meanwhile, one member of the commonwealth’s Agricultural Development Board, which invests Kentucky’s national tobacco Master Settlement Agreement money, believes the state should become the first in the nation to certify “investment-grade farmers” – who have at least a 10-year history of success raising crops, who own sufficient equipment and machinery, and who can demonstrate access to financing for additional operations.

It’s a long-throw investment, says Brian Luftman, a Lexington native who spent nearly a decade in the Chicago Board of Trade financial community before returning home to launch American Farm Investors in 2011. His experience buying and selling agricultural commodities has convinced him farm land should be one of the soundest assets available over the coming 10 to 15 years – because he expects the U.S. inflation rate to rise as a result of federal monetary policy that has added at least $1.3 trillion to the money supply.

Expectations that higher inflation is inevitable have risen the past five years as the Federal Reserve’s quantitative easing policy continued to fertilize the money supply. Inflation generally does not devalue hard assets such as real estate and precious metals as it does money.

Folk sage Will Rogers is credited with advising: Put your money in land; they’re not making any more of it. The farmlands investment community likes to cite that Rogers financial planning hint, adding that global population growth and especially middle-class growth in China and India suggest ongoing strength for grain prices – and hence good performance for U.S. grain farms.

There is no debate that land is generally a hedge against inflation, but University of Kentucky agriculture economics professor Greg Halich says farmland investing is tricky business best practiced by agribusiness experts. Ag land values are sensitive to cyclical farm commodities prices that can make big swings, Halich said. Additionally, a property’s farm commodity productivity can change with the weather.

“This is not a low-risk investment, particularly with where commodity prices have been the last few years,” Halich said. However, he has made investment purchases of Kentucky farmland himself.

“A wise investor can do fine,” he said, “but it’s not something that someone who does not know a lot about it necessarily wants to do.”

Land prices linked to commodities markets

There are many potential variables to weigh in pricing farmland, and each piece of property is different. Values are influenced heavily by productivity, accessibility, competition and distance to market. Soil quality and depth are important, as is physical relationship to water sources.

Brian Luftman of American Farm Investors measuring soil depths on an 83-acre farm in Mercer County.

Brian Luftman of American Farm Investors measuring soil depths on an 83-acre farm in Mercer County.

And there is the weather: Famously unpredictable, it affects crop production and can heighten the swings in supply and demand that drive commodities prices – hence land values – through cycles even when rains and temperatures are normal.

Corn prices were high the past two years, especially in 2012 when widespread U.S. drought, including in Kentucky, withered production, cut supplies and pushed a bushel briefly to historic highs topping $8. That was more than double the price of two years earlier.

This, of course, prompted farmers to put in one of the largest corn plantings in history in 2013, whose good growing conditions are yielding a historic bumper crop. As this year’s largest-ever harvest was taking place in late October, a bushel of corn was selling back in the $4 to $4.50 range.

Farm land values are derived from crop prices, but the relationship is exponential rather than linear, said Halich. He explained that it is profitability that ultimately imparts land value rather than mere revenue, noting that “200-bushel (an acre) corn ground is not worth twice 100-bushel corn ground – it’s worth four to five times as much.”

Additionally, as in any business, the true impact of market price swings depends on production costs. In farming, the land characteristics already cited in combination with weather conditions create varying levels of input expenses. Energy prices are a big factor, too, and have fluctuated significantly in the past decade.

For example, consider a farm operation whose financial break-even point is at $3.60 a bushel for corn. A $2 per bushel increase in market price from $4 to $6 would increase revenues nearly by 50 percent, but increase profits 500 percent from 40 cents a bushel to $2.40. If a farm’s costs put its breakeven at $3.80 a bushel, that same 50 percent increase in revenue would boost profits 1,000 percent – from 20 cents a bushel to $2.20 a bushel.

Of course, prices also drop – and so do profits. Farmers have faith that over the course of years they can stay on the plus side of episodic cost and price swings.

What goes up likes to stay up

Halich believes one of the best opportunities to get Kentucky farmland is before an appreciation cycle. Such a cycle recently passed, having occurred prior to and early on in the high-grain-price environment of 2011 and 2012 that pushed grain farm property values up quickly.

Land purchased when corn was $5.50 to $6 or $7 a bushel with expectation that commodity prices would remain in that range is now worth less, he explained. But buyers today will have difficulty obtaining it at a valuation based on the current $4.50 a bushel corn prices. “Land values are a bit sticky,” Halich said.

The futures market expects corn prices to range from $4.25 to $4.75 a bushel during the next two to four years, he said. However, once owners have seen higher prices, they are very reluctant to let go of the thought that higher prices will return.

When it comes to land prices “psychology is more important than reality,” Halich said.

Meanwhile, Luftman said, grain production land is worth twice as much as cattle farm land.

On his own, Luftman bought an Illinois grain farm when he was in Chicago and sold it before moving back to Lexington. Kentucky, he said, offers some “pretty darn good deals” on farmland. And regarding grain production property in general, Luftman is convinced, “I don’t see a safer investment for the next 10 years.”

He founded American Farm Investors in 2011 and through October had formed investor groups to purchase four Central Kentucky grain farms that average 125 acres. Individual deals vary, but AFI averages 12 investors for each at a participation of $80,000. No investor is putting a large portion of their overall assets at risk. A minimum investment is $50,000.

AFI leases all its property to Peterson Farms of Loretto, Ky., in Marion County, an experienced family venture that now has approximately 15,000 acres of corn, wheat and soybean operations encompassing 60 to 70 farms from just west of Elizabethtown to just east of Danville.

“Our emphasis is on production,” said William O. “Bill” Peterson, one of the four principals and a former director of operations for the University of Kentucky research farm.

Investment land leased to veteran farmers

Peterson Farms and AFI sign six-year leases, which allows for three two-year crop-rotation cycles of corn, soybeans and wheat. While the business plan is to own and lease its farms long-term, Luftman said, each investment group “can get out early” if a majority of a farm’s investment group wants to sell. The plan is to conduct formal proxy votes after five year, he said.

AFI’s vetting process aims to assemble groups with similar long-term investment horizons, Luftman said.

cropland values“I’m not telling them to put 100 percent of their portfolio into a farmland investment,” Luftman said. In fact, he won’t allow such an exposure. “They are doing 5 to 10 percent.”

It is a diversification strategy on the opposite end of the spectrum from getting rich quick.

“The stock market is up 20 percent this year,” Luftman said in mid-October. “I’ll never get 20 percent (in one year) from one of my farms.”

The emphasis is on safety and protection against inflation in the long run. The qualms Halich expresses notwithstanding, Luftman shares the bullish view on well-selected grain farms of the four major agriculture land investment entities: TIAA-CREF of New York; U.S. Trust of Dallas; Ceres Partners of South Bend, Ind.; and Hancock Agricultural Investment Group of Boston.

Their collective perspective is: World population growth with development of higher consuming middle classes is generating investment opportunities in food/agriculture, timber and energy; demand for grain products is going to increase. Shifts away from fossil fuel toward ethanol and biofuels will also increase demand for grain. The world’s arable land diminishes annually due to development and desertification. And meanwhile, price inflation creates a need for hard assets with absolute value to counter the diminished worth of a unit of currency.

Bottom line: Good farm land is a good investment.

That’s very similar to the view expressed by John Farris, founder and president of Commonwealth Economics in Lexington and a principal in LandFund Partners LP, a Nashville-based private equity fund formed for farmland property investment. Farris is a former senior economics consultant with the World Bank and spent two years as secretary of the Finance and Administration Cabinet in the Ernie Fletcher administration.

“Farmland is an excellent alternative asset in the portfolios of many investors, partly due to its long history of non-correlation to traditional asset classes such as stocks and bonds,” Farris said. “It has also shown a long history of positive annual returns.”

Access to investment farmland is a challenge

A big challenge for investors, however, is to get their assets into agricultural property.

“It is difficult for the average investor to gain access to farmland,” Farris said. “It is an even more difficult proposition for an investor to identify farmland, purchase the land at attractive valuations and manage the property in order to generate return on their investment.”

It’s a multistep process requiring special expertise.

The big four agriculture property investment entities are major owners of farmland in Iowa, Illinois, southern Minnesota and western Indiana. Grain-producing farmland in Iowa is acknowledged as the best; flat property with deep soil sells routinely for $10,000 to $20,000 an acre – very close in size to a football field, minus its end zones. It’s a mature market with many farms that are thousands of acres apiece; the average farm was 330 acres in 2007, the most recent year that USDA figures cover, with Monona County averaging 606 acres a farm.

Larger properties can be managed more efficiently and achieve the scale appropriate for investment. The four majors typically want at least 1,000 acres. Alone, an individual investor’s $50,000 or $100,000 is enough for only 10 to 30 acres.

In Kentucky, farm size averaged 164 acres in 2008, according to the USDA. Agriculture land values vary widely with the differences in geography and soil quality from the mountainous east to the flatter and deeper-soiled west. According to an unscientific survey earlier this year by the University of Kentucky Agriculture Extension Service, average cropland values ranged from $5,900 an acre in the 11-county Bluegrass subregion and $5,800 in the 15-county Mid West subregion of the state to $2,500 an acre in the 27-county South East.

Kentucky’s best farmland, according to experts, is in a pair of Western Kentucky clusters: in Daviess, Henderson and Union counties, which border the Ohio River, and directly south in a strip including Christian, Logan, Simpson, Todd and Trigg counties, which border Tennessee.

“You probably have areas of Kentucky that are as productive as Iowa,” Halich said.

They would not be as valuable, though, since other factors are not as favorable.

Farming increasingly a high-tech specialty

“I’m not an agricultural specialist. I’m a financial specialist,” Luftman said.

There are, however, tools he uses to assess prospective cropland – for example, taking soil samples and using a metal probe to measures soil depths can confirm a field’s potential. Corn has a root system that grows at least a foot deep, Luftman said, and in general the deeper the soil the better a field’s production.

“At (soil depth of) one foot or less, you have cattle land,” he said.

Luftman leaves the true agricultural expertise to the Petersons, who trace their continuous farming roots back at least 14 generations to the Van Wycoff family who farmed modern-day New York City’s Manhattan Island in the 1640s. The present Peterson Farms business that focuses on growing grain was incorporated in 1975 and includes approximately 15 full-time employees, nearly all of whom are members, relatives or have married into the family, said CEO Bernard Peterson.

At harvest time, the number of employees doubles and goes beyond the family.

“You will not find in the state of Kentucky a more high-tech operation,” Bill Peterson explained, as he drove along rural Marion and Nelson County roads, pointing out various farms the family leases. Peterson’s explanations were interrupted briefly by calls he took handfree via an iPhone on the dash that had linked to the Ford Super Duty pickup’s Bluetooth system – workers at one of the farms busy that morning had a question about equipment being delivered for use in the ongoing harvest.

Peterson Farms replaces or adds to its machinery and equipment every year, and a single combine today can cost $350,000, said Bernard Peterson. “It’s a very capital-intensive business.”

The trend in U.S. agribusiness is toward larger and more efficient devices, and Peterson Farms now uses a 24-row planter – double or triple the size typical for many Kentucky farms, but only half the size of machines working the largest U.S. grain belt farms. Peterson has its own farm fueling center and bulk storage facilities for fertilizer, pest control and other soil augmentation chemicals.

The Petersons also keep added grain storage capacity. In 2013, they expect to produce 1.5 million bushels of corn, 400,000 bushels of wheat and 300,000 bushels of soybeans. A new crop last year was 600 acres of canola; this year they are growing 1,000 acres.

Adequate equipment and machinery is essential to better production and lower unit price, the Petersons have learned.

“We have become acutely aware of the value of timeliness,” Bernard Peterson said. They have learned that their overall equipment cost per acre is lower if they buy new farm machines every year. Also, he said: “We wear them out.”

One of the newest additions to their operation is a natural-gas-fired grain dryer that creates a wider time window for harvest operations, which must occur when grain moisture content is appropriate for storage. The bumper 2013 harvest will involve 1,500 semi truckloads delivering 1,000 bushels each of corn to the grain bins in Loretto.

Much progress but an even greater potential

Peterson Farms makes intensive use of data analysis developed by the UK Agriculture Extension Service to improve management practices and track the financial performance and profitability of individual farming enterprises. Their grandfather was one of the founders in 1962 of the Kentucky Farm Business Management Program, Bill and Bernard Peterson said.

“It gave us the data very early on in our business to build good decisions onto,” Bernard Peterson said. “I would give those people a lot of credit.”

Today’s high-tech farm equipment is GPS guided and able to use soil quality data to vary the depth and density of seed plantings and of chemical applications multiple times in a single field. And Peterson Farms enhances the capabilities of the new equipment it buys with add-on technology, Bernard Peterson said.

Farming practices have evolved so much, he said, that “it’s not even kin to what we were doing 15 years ago.” Even so, the Petersons think they’ve only scratched the surface of what new agribusiness technology will allow.

“We are at just 1 percent of what can be done,” according to Bernard Peterson.

That’s good enough to attract the attention not just of American Farm Investors but the four major farmland investment firms as well.

“They’ve all been in our office,” Bernard Peterson said. Peterson Farms has gotten offers to buy its business as well as to buy its more than 4,000 acres of grain farms so it can be leased back to the Loretto agribusiness.

Peterson Farms’ plan, however, is to remain “a big family business … for a long time,” he said. “We’re a bunch of brothers that work together.”

The Petersons don’t want to sell, but they do think Kentucky agribusi-ness could benefit from increased farmland investment.

Certifying investment-grade farmers?

Long-time Fayette County horse, tobacco, corn and livestock farm owner Frank Penn agrees. He is a member of the Lexington-Fayette Planning Commission and the Kentucky Agriculture Finance Corp. board.

The majority of today’s Kentucky farmers and farm owners are small in scale and do not generate enough income to pay for land. “Most farmers owe more than they own,” Penn said.

Brian Luftman on the floor of the Chicago Board of Trade, where he spent about 10 years working before returning to Lexington and founding American Farm Investor in 2011.

Brian Luftman on the floor of the Chicago Board of Trade, where he spent about 10 years working before returning to Lexington and founding American Farm Investor in 2011.

To compete and succeed in today’s economy, he said, Kentucky agribusiness operations need to integrate vertically and produce value-added products, he said. For example, rather than selling corn to a processor or feedlot operator, a farm could feed livestock that generate higher gate receipts. Land owners should sell furniture rather than timber, baked goods rather than wheat, wine rather than grapes, cheese and finished dairy rather than milk.

These operations require capital that Kentucky land owners and most of the farmers who lease it do not have the ability to obtain it through conventional channels. Outside investors have the money, though, and could create long-term financial structure and security that allow farm operations here to shift to value-added operations that create jobs and increase income, Penn said.

The major ag land investment firms are looking at Kentucky but so far are staying with the large farm model they can achieve in Iowa, according to the Petersons and others.

Penn has an idea on how to change the playing field, however.

“You’ve got to have what I call investment-grade farmers,” he said. Penn believes Kentucky should become the first state to certify farm operators with proven track records of success, who own sufficient equipment to farm at larger scales and who have proven access to lines of credit that will enable them to make the ongoing equipment and machinery investments necessary to operate productively.

“Most states do not see agriculture as economic development,” said Penn. “They see factories, they see manufacturing, they see all types of stuff as economic development, but they don’t see agriculture.”

A certification program for farmers, Penn said, will bring more business to those who have the capability to take on more operations, and it will be an incentive towards better agribusiness productivity.

It also would attract outside investment dollars to Kentucky land – upgrading an asset that cannot be removed, said Penn, who has made a practice during extensive travel around the world over the years to examine land usage.

If the inflation that Luftman, Farris and the large agriculture land investment firms expect takes place, money definitely will shift to land and other hard assets, Penn said.

“Money chases stability,” he said.

Kentucky will be in a better position to attract money seeking stable agribusiness operations if it creates a program to certify investment-grade farmers, Penn said. “I’ve been playing with this (idea) for about three years.”

The ability to contract with a certified farmer who will conduct quality operations, he believes, will boost investor confidence in the future value of an ag land investment in Kentucky.

Meanwhile, grain price levels after the big 2013 harvest comes in will affect land values and the calculations of owners, farmers and investors.

UK ag economics professor Halich said he hears many individuals and experts profess to know what grain prices will be in the future, but has a system to measure the commitment of their analysis:

“Do you have any money in the futures market?” he said. “If you don’t have anything in there, you’re probably not very certain of what you’re saying.”

Mark Green is editorial director of The Lane Report. He can be reached at markgreen@lanereport.com.

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