Investing In Farmland: Is Farmland In An Asset Bubble?

| December 14, 2010 | 0 Comments

Since 2000, U.S. farmland values are up 58% on an inflation adjusted basis…

The surging farmland values caught the attention of FDIC chair Sheila Bair.  She said farmland could be the next asset bubble at risk of bursting.

Her revelation isn’t surprising given the impressive gains and the recent history in the residential and commercial real estate markets.  But I think she missed the mark on this one.

I believe farmland is the ideal diversification asset for investors.

Simply put, it’s a better hedge against inflation than gold.  It generates more income than government bonds.  And if the “you-know-what” really hits the fan, you can still live off the land.

But doomsday theories aside, farmland is still a very attractive investment.

Remember, price appreciation is just gravy.  Farmland’s real value comes from the steady flow of income it generates.  Owners easily earn around 4% annually by renting the land.

4% isn’t huge but it still knocks the socks off what you’ll get from a bank CD or government bond.  And price appreciation will protect your investment when inflation rears its ugly head.

But the fact remains… price appreciation has outpaced inflation by 58% since 2000.  Does it mean farmland prices are getting bubbly?  Not by a long shot!

Here’s why…

The commercial and residential real estate asset bubbles of early 2000s were inflated by a number of factors we don’t see in farmland today. These asset bubbles were driven by excessive leverage and “liar loans”. They pumped up values beyond reason.

By comparison, bank lending requirements for farmland purchases are downright stingy.  Most require down payments of 20% to 30% or more. And many farmland purchases are all cash deals.

As long as bank lending practices remain sound, the risk of a bubble like we had in other real estate markets remains remote.

That’s not to say there aren’t risks.  But the risks to farmland values are of a more fundamental nature.

Say for instance, grain prices plummet.  This would surely put a dent in farmland values.

The good news is the outlook for grains is spectacular.  It’s buoyed by strong demand (especially from China), a weak dollar, and government subsidies for ethanol.

Unless we get a shock to the grain commodity markets, I think we can safely put the asset bubble talk to bed…

A much more likely outcome is grain prices will continue to surge.  And farmland appreciation will continue to outpace inflation by a wide margin.  I think this will be driven by two main catalysts.

According to the USDA, farm income is forecast to be nearly $82 billion this year.  That’s up 31% from 2009 and is 26% higher than the ten year average.

Over the last six years, farmers are enjoying a period of high output and high income.  It’s the first time we’ve had these conditions since the mid 1970s.

Now many farmers have cash they need to spend.  Or they’re going to lose it to Uncle Sam when the tax bill comes due.  As a result, they’re buying land as soon as it becomes available.

But that’s not all… Interest in farmland is going institutional.

According to the Wall Street Journal, pension funds are looking to reallocate $1 trillion worth of stock market investments into more stable investments like real estate.  They said, “[Pensions are] looking at agricultural land as a class of assets that they should have in their portfolio”… And we all know institutional money can drive prices higher in a hurry.

The bottom line is fears of an asset bubble in farmland are way off base. (And so is Sheila Bair.)

The increase in farmland prices are being driven by strong fundamentals. Cash rich farmers and institutional investors are investing heavily.  It’s driving prices higher in a hurry.

But it’s not too late.  You can still buy farmland at a fair value.  The rents will generate a solid 4% annual return.  But if commodity prices continue to climb… you may never get another chance to buy farmland at these prices again.

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Category: Real Estate

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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