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LAND VALUE

AND PURCHASE

Prepared by: Michael D. Duffy, extension economist, Iowa State University, Ames, Iowa.

Lesson 1: Land Value Trends and Determinants

Overview

This lesson provides background information on two important parts of the land purchase decision. First, we will look at land market trends of the past as well as the future. The second part of this lesson will discuss several important considerations in the land purchase decision. Many of these factors are beyond the farmers’ control and even beyond the farm gate, but they are important nonetheless in determining the feasibility and desirability of a land purchase.

It should be noted that in many instances value and price are terms used interchangeably. In most circumstances this should not present a problem. In general, however, price is what someone pays for land whereas value is what the land is worth to an individual. A parcel of land may have the same price but different values to different people.

Land Value Surveys

Current information on Iowa land values can be obtained from several different sources. Each source uses a different timeframe and reports land values in slightly different ways. Iowa State University Extension conducts an annual opinion survey. This survey, released in mid-December, provides estimates of high, medium, and low quality farmland and a weighted average value at the state and crop reporting district level. It also provides county estimated values. (Click here to see the most recent edition of the Iowa Land Value Survey) The Iowa Chapter of the Realtors Land Institute provides an

opinion survey twice a year, in September and March. This survey provides estimates for a variety of Iowa land classifications at the state and crop reporting district level. The Chicago Federal Reserve provides quarterly estimates of the changes in land values. These estimates are provided at the state and federal reserve district level. (Click here for the latest version) The USDA Economic Research Service provides an annual estimate of the land values at the state level. Finally, the Census of Agriculture conducted every five years by the USDA National Agricultural Statistics Service provides estimates of the land and building value at the county and state level.

Land Values Trends

Long-term Iowa land values for the most part have shown relatively stable growth (Figure 1). There are, however, two notable exceptions. Land values more than doubled from 1910 to 1920 and then from 1921 through 1933 decreased by 71 percent.

A more recent phenomenon was the more than four-fold increase in Iowa agricultural land values from 1973 to 1981. As with the 1910-1920 surge, the increase in the 1970s was followed by a significant decrease of over 60 percent, from a peak of $2,147 per acre in 1981 to $787 per acre in 1986.

Figure 1: Iowa Land Values

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The quality of land had some impact on the magnitude of the rise and fall in land values during the 1970s and the 1980s. Based on the Iowa State University Land Value Survey (FM-1825), high-quality land increased in value by 415 percent from 1970 to 1981 and decreased in value by 62 percent from 1981 to 1986. Medium-quality land showed a similar trend as high-quality land, increasing by 414 percent and then decreasing by 63 percent from 1981 to 1986. Low-quality land followed a somewhat different pattern. It increased in value by 384 percent and dropped by 67 percent during the same time periods.

All regions of Iowa followed a similar pattern to the statewide averages; significant increases in the 1970s followed by a substantial drop in the first half of the 1980s. A difference that can be noted, however, is some counties peaked in value in 1980, while the majority of counties and the state estimates peaked in 1981.

Estimating Land Values

Predicting future land values is a risky business. Land prices are determined by three key factors. First, is the potential income expected from the land. The second factor is potential changes in land use. And, third is the capitalization or interest rate. These points will be covered in greater detail in other lessons. It is important to remember that expected income, the expected change in price, and the interest rate shape the land market.

Land is purchased primarily as a long-term asset. Estimating the value of land will be covered in Lesson 5. For now it is only necessary to

remember that the value of land is determined similar to the value of an asset held in perpetuity.

Namely:

Land Value=Net return/Capitalization rate where,

Net return equals all the returns after subtracting costs. The returns include commodities produced, changes in land values, government payments, and any other income.

Capitalization rate is the real interest rate which would be the interest rate minus the inflation rate.

Land values also include how much the land is worth to the individual. Many farmers will pay substantial premiums to own a particular piece of land. Land can be highly valued because of differences in costs of production. Similarly, land can be valued higher for sentimental reasons, because it may fit perfectly with the existing farm plan, or because of the particular buildings. Regardless of the reason, all these factors plus the simple desire to own agricultural land, will cause different individuals to value the exact same land differently.

Recent Land Market Trends

The boom in the 1970s and the bust in the 1980s can be traced to expectations of future income and land prices. The boom was fueled by two primary factors. One was the opening of many world markets including the former Soviet Union and China, coupled with exponential growth in agricultural exports. The world demand for food was growing faster than the growth in food production. The second factor was the high rate of inflation coupled with low real interest rates. The high level of inflation kept pushing prices up and the relatively low interest rates made debt financing an attractive tool.

These factors contributed to the general euphoric atmosphere in agriculture during the 1970s. According to data from the Iowa Farm Business Association, 1973 was the only time in the past 50 years when the average return to management for the farms in the lower third profit group was positive. “They don’t make land any more,” “everyone has to eat,” and “land will be worth more tomorrow” were all arguments used to justify the tremendous price rises for agricultural land.

Just as the expectations fueled the boom in the 1970s, they fueled the bust in the 1980s. The two primary factors reversed themselves. World food demand began increasing more slowly than the increases in food production. Exports of the U.S. farm products dropped and the Federal Reserve Board instituted policies to reduce inflation which led to high interest rates. Many real estate loans were on a variable rate. When expectations for future farm income dropped, the expectations for future increases in land prices reversed themselves, and the debt, which was desirable in the 1970s, became a burden in the 1980s. Again, data from the Iowa Farm Business Association shows that 1981 was the only year in the past 50 years when the average return to management for the farms in the highest third profit group was negative.

Since hitting the bottom in 1986, land values in Iowa have been increasing at an average rate of approximately 7 percent per year. Some percentage increases were in the double digits, with two years of slight decreases in values. In 1998 Iowa land values slipped 2 percent, in 1999 they dropped 1 percent and in 2001 they rose 3.7 percent to $1,926 per acre.

Regionally there have been different land value changes from year to year, depending on the relative strength of the area’s predominant enterprises. For example, in the mid-1990s northeast Iowa land values increased more than the rest of the state due to improved milk and cheese prices. A breakdown of land values by quality of land for each crop reporting district from 1950 onward is available at the local county Extension office or by clicking on: . This site also contains the average county land values.

Land Purchasers

The primary purchasers of farmland have changed over the past few decades. Data from the ISU survey shows farmers have always been the predominant land buyers representing over two thirds of the land purchased. In the past few years, however, the percentage of land purchased by those classified as investors has increased. The percent of land purchased by existing farmers has declined steadily since 1989 from 78 percent to 67 percent in 2001. Investors were identified as purchasing 18 percent of the farmland in 1989 and this percentage increased to 27 percent in 2001.

Investor purchases are more prevalent in some parts of the state than others. For example, in 2001 investor purchases ranged from 22 percent in west central Iowa to 41 percent in south central Iowa. There are many reasons why investors are more interested in different parts of the state. One is the expected income from the property. Another factor has been the increase in demand for non-farm land uses such as development, hunting camps, or simply country residences.

There is speculation as to exactly who these investors are. Some feel this category is synonymous with outside investors. However, this is not always the case. It could be local churches, or other institutions. Regardless of how the investors are classified, it is doubtful they will make land purchases for the same emotional reasons as farmers.

The recent changes in livestock production also have added a new dimension to land purchases. The increase in size of operations, particularly for swine, has led to an increased need for land on which to dispose of the manure that is generated. This demand has been spurred by legislation limiting application rates. Some operations are finding it more advantageous to own the land rather than be subject to the uncertainty of renting.

Land Value Projections

As we noted earlier, projecting farmland values is risky. In general, however, land values will increase over the long run. How much they will increase and what will happen in the interim is unknown.

Each year attendees at the Iowa State University Soil Management and Land Valuation Conference are asked to project future land values. The projections are for various points in the future; 6 months, 18 months and 3 more distant years. Not surprisingly, the forecasts for six months are closest to the values that do occur. (Actual values are assumed to be those reported by the Iowa State University Land Value Survey.)

Although the projections have missed by a wide mark over the past 38 years, the averages are remarkably accurate. The six-month forecasts, which varied from 28 percent over to 25 percent below the actual figures, averaged only 2 percent lower than the actual values over the 38-year period. The 18-month forecasts varied from 38 percent under to 79 percent above the actual value. These forecasts averaged less than 1 percent below the reported values over the entire period from 1964 to 2001.

The projections for land values have missed the turning points over the past few decades. Following the turning points, they tended to be higher or lower than the actual figures but then moved closer to the actual values.

Throughout most of the 1990s, the estimates and the actual values were very close. From 1987 to 1997 the 6-month projections averaged just 1 percent above the actual values, while the 18-month projections were only 1 percent below the actual values. Since 1997 the conference attendees have been overly optimistic about land values, with predictions running more than 10 percent higher than the actual figures.

Predicting land values farther into the future is even riskier. The Soil Management and Land Valuation Conference attendees were asked to predict land values for the year 2000 since the 1984 conference (Figure 2). The predictions have averaged just 1 percent below the eventual actual value. However, there have been some interesting changes in the estimates that highlight the problems

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with forecasting land values. For the first two years, the estimates were still based on the high expectations of the 1970s. The first estimate for land values in the year 2000, made in 1984, was $2,716 per acre. This estimate was 46 percent higher than the actual value reported for 2000. The estimates during the 1980s reflected the pessimism felt during the time of financial stress. In 1987 the estimate for land values in 2000 was $1,414 per acre, which was 24 percent below the actual value. From 1986 through 1995 the estimates for land values in 2000 were consistently below what turned out to be the actual value. Since 1995 the estimate of land values in 2000 has averaged 12 percent above the actual value.

Tracking the estimate for 2000 land values over time illustrates the problems with attempting such estimates too far into the future. First, there is the problem of time where the more distant the estimate, the more it becomes subject to distortions. Second is the inherent danger in using the immediate to predict the future. There is a saying, “things are never as bad or as good as they seem.” Tracking the 2000 land estimate clearly illustrates this adage.

In spite of the difficulty in projecting land values, it is necessary to have some idea of the future in mind when making the land purchase decision. Future projections are more important for the investor purchaser, but they are still relevant for the farmer purchaser, who usually buys the land to own it rather than to resell it. In my opinion, the best strategy to follow is to look at several alternative scenarios for the movement of land values. This gives the purchaser a range of possible outcomes with respect to the change in asset value. The would-be purchaser can then make the decision based on the outcomes and the consequences of each option. If the worst outcomes constitute an acceptable risk, the purchase decision can be determined using other factors, but if the worst outcomes might cause the business to fail, the decision must be made with greater caution.

Other Considerations

Following is a discussion of several things to consider in making land purchase decisions. All

of the factors influence land prices directly or indirectly. In some cases, the influence will be on prices received, in other cases the impact will be on the demand for land, while other factors will influence the financial health and well-being of farmers or the country in general.

Changing Structure of Agriculture

U.S. agriculture is undergoing some of its most profound changes in the nation’s history. There is rapid consolidation in all sectors from production to final retail sales. Dr. William Heffernan at the University of Missouri has provided detailed information on the consolidation that has occurred in the processing and the retail areas. Examining the Census of Agriculture data shows the concentration that has occurred in production. For example, in 1980 there were 64,000 farms with hogs in Iowa. At the end of 2001 there were just 10,500 farms with hogs. Over the same time period the average number of hogs per swine operation rose from 219 to 1429.

Farmers who have dropped their livestock operation or who do not have any livestock will need a larger land base to produce an adequate income. This leads to an increase in the demand for land and an increase in the price of land.

The past few decades also have seen an increase in the number of contract opportunities available to farmers. Many farmers have chosen contract production over the open market. Contracts will vary but in general the farmers are told what to plant, what inputs to use, when to harvest, and when and how to market. Contracting decreased the return to management for the farmer because others are doing most of the management decision-making. With lower returns more acres must be farmed to maintain farm income. This increases the demand and price for farmland. Such changes have a profound impact on the farmers’ relation to the land.

The farm population is aging. Today, there are more farmers over the age of 65 than under the age of 35. Many farmers who are entering the stage in their farming career when most farmland is purchased grew up or started farming during the tumultuous period of the 1970s and 1980s. They will view land purchase and ownership differently than their parents.

Another change is that there are now more people living in the country but not on farms than there are people living on farms. In the late 1950s, Iowa’s population shifted to having more people living in urban areas than in rural areas. In the late 1980s, the makeup of the countryside shifted to more non-farm, country dwellers than farmers. This changing population demographic will influence the way that land can be farmed in the future.

Government Agricultural Programs

Predicting future land values is difficult and predicting future agricultural programs can be just as troublesome. However, the impact of the farm programs on land values can be substantial.

Data from the USDA Economic Research Service shows direct government payments to Iowa farmers averaged $907 million per year (54 percent of net farm income) over the 1990s. In 1993 and again in 1999 net farm income would have been a negative without the government payments (Figure 3). This level of government support has a tremendous influence on land values (Higher Cropland Value from Farm Program Payments; Who Gains?; C. Barnard, et.al., USDA, ERS, Agricultural Outlook Nov. 2001, pp 26-30). It has been estimated that one-fourth of the current land values can be attributed to the government subsidies. Coupling of farm program payments to the land base (rather than the operator) is critical to the impact on land values.

At this time it is not possible to predict the details of future government farm programs. The 1996 program was intended to be the last program and it was anticipated that production agriculture would move to a strictly market-based system by the year 2002. This has not happened and the 2002 farm bill continues supporting production agriculture.

The basic farm production support programs are just one way in which government agricultural programs influence farm profitability and hence land values. The programs for food stamps, school lunch programs and food for the elderly are examples of programs that stimulate demand for agricultural products.

Exports have become a significant portion of the market for most agricultural commodities: corn, soybeans, cattle and hogs. U.S. export policies influence the level of export activities, which in turn affect price and profitability, and ultimately the value of land.

Export Markets

U.S. policies influence U.S. exports, but there are other factors that also have an impact. The World Trade Organization establishes rules and regulations that govern the trade among most nations. There are regional agreements such as the North America Free Trade Agreement. In addition, individual countries have policies that affect all aspects of international trade.

Recent concerns with communicable animal diseases altered trade among some nations. This influence will likely continue and it is causing some to reconsider the current approach to international agricultural trade.

Another factor that has emerged recently is sales competition for our export commodities. Whereas the United States used to be the sole or major supplier for several farm commodities, we now find ourselves in a position of being the residual supplier with uncertain demand from year to year.

The recent furor over genetically altered commodities poses yet another trade uncertainty. Some U.S. consumers and other countries are becoming more insistent that commodities and food be certified free of biologically engineered material.

Regardless of the many other factors that influence U.S. agricultural exports and world trade, we have become more dependent on export markets for our products. Anything that disrupts these markets influences price, land values and the land purchase decision.

General Economic Policies

The linkage of agriculture and land prices to the rest of the economy occurs at at least three major points:

1. purchase of inputs,

2. effect on output sales, and,

3. non-agricultural financing sources.

As agriculture has changed over the last few decades, these linkages have become stronger. There appears to be little chance that this trend toward the greater integration of agriculture into the domestic economy will reverse itself.

The economic variables with the greatest impacts on agriculture and land values are:

• gross domestic product,

• disposable income,

• population growth,

• inflation rate,

• interest rate, and

• the exchange rate.

The Gross Domestic Product (GDP) is a measure of how the U.S. economy is growing. In general, as the economy grows, the demand for agricultural products will increase. The current Blue Chip forecast is for GDP to grow at just over 3 percent, which will be close to the 30-year average.

Disposable income is the personal income consumers have left to spend after taxes and influences agriculture primarily through retail sales. As disposable income rises, the demand for more food services also increases. The recent tax cut should have an impact on disposable income, but in general growth in disposable income should coincide with growth in the general economy.

Interest rates for agriculture are determined by the interest rates paid in the general economy, which are reflected in the supply of money and the demand for funds. Changes in interest rates affect agriculture primarily through the cost of capital. Interest rates are subject to a variety of factors that will influence the projections. It is also important to note there are both long- and short-term interest rates that impact agriculture.

The inflation rate affects farmers both directly and indirectly. The most direct impact is on the cost of purchased inputs. Studies have shown a nearly direct link between an increase in inflation and a similar increase in costs of production. The indirect impacts of inflation are felt through the effects on the value of the dollar and volume of agricultural exports.

The final key economic variable to watch is the value of the dollar. The exchange rate is a measure of the relative worth of our currency compared with other world currencies. The value of the dollar, therefore, depends not only on U.S. economic conditions, but also on economic conditions existing in other countries. A strong dollar reduces exports while a weak dollar will increase them. Due to the complexities of determining the value of the dollar, it is almost impossible to accurately project what will happen over the next few years.

Energy Prices

A factor to watch closely will be energy prices. Our agriculture is dependent on cheap fossil fuel energy. As this energy increases in price, there will likely be shifts in our production practices.

Fertilizers are the primary energy consumers in production agriculture and nitrogen is the chief energy user among the fertilizers. It takes the energy equivalent of approximately one gallon of diesel fuel to deliver five pounds of nitrogen. This means that 100 pounds of nitrogen would have the same energy as approximately 20 gallons of diesel fuel.

Propane for corn drying is another significant agricultural energy use. The amount of propane used depends on the type of dryer and the amount of moisture to be removed from the corn.

Recent estimates show an increase of 50 percent in the cost of diesel, anhydrous ammonia, and propane would add 6 percent per bushel to the cost of corn production. This increase would be on top of a base price of a $1.10 per gallon for diesel, $340 per ton for anhydrous, and $1.00 per gallon for propane. A 50 percent increase beyond these costs is definitely not out of the realm of possibility.

Energy price increases will have a ripple effect throughout all of agriculture, not merely in production. Increasing fuel costs will increase the cost of delivering and processing agricultural products. In addition, there will be regional shifts in production as the cost of transportation increases.

Agriculture is the residual user of energy after domestic and industrial uses. In case of shortages, agriculture will be the probable sector to experience a cut in supply, as we saw during a recent natural gas shortage.

Energy will be the key domestic and global issue in the 21st century. What happens to energy prices will have a direct bearing on agricultural profitability and on agricultural production.

The energy situation also will bring to the forefront some alternative crops and enterprises that are not currently profitable. Biomass production for electrical generation is no longer a dream. Production of switchgrass, reed canary grass, and other biomass crops will become more attractive with higher energy prices for petroleum-based products.

There also has been some discussion of using agriculture for carbon sequestering. This would require a change in agricultural practices but it would also yield an increase in returns.

Conservation

Soil conservation has long been a critical topic. Some existing programs reward good stewardship practices and it is quite likely they will be expanded in the future. The programs for soil conservation offer not only an opportunity for landowners to increase their income but to protect their investment as well. Farmland will be subject to different conservation rules and programs depending on its quality, which is another factor to consider in the land purchase decision.

Technology

Changes in technology are constantly occurring. In production agriculture these technological

changes generally lead to yield enhancing characteristics or they lead to cost reductions. Recent changes in crop genetics and genetic modification through biological engineering are examples of technological changes that impact the return to land. Recent applications of global positioning and variable rate application technology are other examples of changes in technology that have influenced returns.

It is not possible to predict the form or even the direction that new technologies will take. However, it is almost for certain that there will be technologically induced changes in production agriculture. The impact of these technologies on land values depends on a variety of factors. Does the technology impact all farms equally or is there a size bias? Does the technology increase net revenue or does it make the job of farming the land easier? The answers to these and many other questions will determine whether or not a technological change will impact land values. They will also determine the magnitude of the impact.

Summary

Farmers, for the most part, do not purchase land for the same reasons as investors. They purchase the land intending to farm it. This means there can be many different values placed on the same land.

Another inescapable fact is that agriculture has become increasingly tied to the rest of the U.S. and world economies. Farmers cannot afford to ignore this reality in making their land purchase decisions.

Farmers should not try to be economic forecasters. Rather, they should be aware of the past, acknowledge their links to the rest of the economy, and formulate their own opinions. Careful evaluation of a wide range of possible outcomes will indicate the level of risks and consequences possible from purchasing land. Remember that the land purchase decision is a long-term one. The economy can grow and contract, but if the purchasers have carefully evaluated their decisions, they should be able to weather the storms.

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