Earlier this year, Yale’s Robert Shiller identified farmland as an asset class in the early stage of bubble formation. George Soros, Jim Grant and Jim Rogers have espoused similarly bullish views. But advisors – even those managing the assets of very wealthy clients – shouldn’t bet the farm on these expert forecasts just yet.
That was my conclusion after I attended a presentation on farmland investing by Julie Koeninger at a Boston Security Analyst luncheon last week. Koeninger has 20 years of experience with this asset class and runs Farmland Advisor, LLC, a Wellesley, MA-based firm that helps institutional investors make and manage farmland investments.
Farmland investments have historically delivered high returns with low risk. Farmland has had annual returns of approximately 10.8% over the last 41 years, roughly equal to US equities, with a standard deviation of less 10%, versus 22% for equities. At the end of 2010, farmland had outperformed the S&P 500, the Barclay’s aggregate bond index and the S&P GSCI commodities index over the prior three, five, seven and 10 years.
I’ll look at why it is probably unreasonable for advisors to expect similar returns in the future – and whether you can realistically invest in this asset class for their clients – but first let’s look at how farmland investing is defined and the reasons why so many high-profile investors are now bullish on this asset class.
The basics of farmland investing
Koeninger defined the farmland asset class as equity investments in real estate for which the primary use is cultivation of crops or livestock for food, fiber and energy. Farmland investments are not, according to her, investments in publicly traded agriculture-related companies, nor are they commodities.
She divided cropland into two categories – row (or annual) and permanent crops. The former includes corn, soybeans, cotton, wheat, rice and sugarcane, while the latter includes perennial crops involving trees or vines, such as almonds, pistachios, wine grapes or citrus.
Typically, the farmland investor leases the land to a farmer, whose responsibilities include maintaining the land, growing the crops, and marketing and selling the produce. Both row and permanent crops require careful, ongoing management, according to Koeninger. Row crops must be rotated, and permanent crops must be pruned and pollinated (with bees).
Selecting the right farmer is critical to successful farmland investing. Good farmers will know how to manage the many risks they face – adverse weather, pests, and uncertain prices. Some of the risk can be hedged – for example, by forward-selling the crop – but in those cases the farmer faces substantial risks.
Investors are insulated from those risks; income comes from lease payments that are typically made at two points in the annual cycle – before the crop is planted and once it is harvested. That is what is responsible for the low standard deviation of returns in this asset class. It also explains why most of the historical return has been from income (7.7%) as opposed to land appreciation (3.2%).
Investors do face the risk of regulatory uncertainty with some crops. For example, corn has benefited from ethanol subsidies, but those may be retracted at some point.
Agriculture has historically followed cycles that last a decade or more. Improvements in technology (fertilizers, pesticides, genetic engineering) lead to increased crop yields, which lower prices. Population growth and other factors gradually increase demand and raise prices, until new technology is developed and the cycle repeats. Investors need to be broadly diversified in order to reduce their exposure to these cycles.
According to Koeninger, a good strategy is to have a core investment based on leased row crops located in the US. One can then diversify along several dimensions – by asset type, geography and management style.
Asset type refers to the type of farming operation. Mature, permanent crops like fruit trees are the least risky, with livestock and dairy farmland carrying more risk. Integrated farming operations, through which the investor owns storage and processing facilities, have the most risk.
Geographically, developed countries like Australia and Canada pose the least risk, and Eastern Europe and Africa pose the most. Investments outside the US carry currency risk. Even within a country, investors must be diversified, Koeninger said. Investors should diversify against risks from flood and microclimates; two farms might be geographically proximate but may be vulnerable to very different weather-related factors.
In terms of management style, leased permanent crops are riskier than leased row crops, and directly operated row and permanent crops have the most risk. With direct operation, an investor takes on the weather, pest and marketing risk.
Farmland investing
“This is mostly an institutional and high net worth market,” Koeninger said. Investments are typically made through separately managed accounts and limited partnerships, sometimes with minimum investments of $1 to $5 million. Fund sizes are usually $50 million or more. Some farmland REITs are expected to come to the market, she said, but none are available yet.
The reason you need large minimums is that successful farming requires scale, according to Koeninger. “You want to be investing in large-scale farming operations that are the most efficient, most productive and competitive overall, and that can produce a competitive crop,” she said. “So that is the reason why, to get any kind of diversification at all, you need large investments.”
Large institutions have liked farmland for reasons you are probably familiar with: The world population will increase from 7 billion to 9.15 billion by 2050, and food demand will grow accordingly; globally, population is becoming more urbanized, which leads to fewer rice and vegetable-based diets and more meat-based diets, which demand more land; per-capita meat consumption is expected to increase rapidly in countries like Brazil, China and Vietnam; and 44% of the world’s land is at least modestly degraded, so there will be an increasing need for high-quality farmland.
Even if you are swayed by the investment thesis and can afford the minimum investment – recognizing that farmland should be only a small component of an overall asset allocation – it is not clear that a farmland investment will yield the same outperformance going forward as it has in the past.
First, Koeninger downplayed the claim that farmland values are increasing. She said that the key to performance, over the course of her career, has been income, not capital appreciation.
In addition, the performance data she cited are based on the NCREIF farmland index, which is a non-tradable index. The data is self-reported by large investment pools managed for institutional investors. The index is vulnerable to the same biases as hedge fund indices, which Michael Edesess enumerates in great detail elsewhere in this issue.
Koeninger said that returns in the NCREIF index have not been consistent across all crops. Pistachios and almonds have done very well recently, but other crops have suffered.
Koeninger said farmland should be considered as having a time horizon of at least 10 years. “There are some people putting together farmland portfolios, and they want to unlock alpha,” she said. “They are going to assemble a bunch of properties, do some improvements on them, and IPO the whole thing in a few years.”
She doesn’t think that will work. Farmland has delivered consistent returns precisely because it is illiquid.
Perhaps the most ominous sign for potential farmland investors is that interest in this asset class has been “exploding” recently, Koeninger said. It used to be insurance companies and investment firms that had long time horizons. Now, she said, a lot of hedge funds and private equity firms are assembling partnerships around the world in order to invest in farmland.
She added that in the Midwest, companies that have been managing farmland for families are going upstream to now expanding using capital from outside investors.
“Every day it seems I find a new manager,” she said. “There are more than I can document. That's not to say they are all institutional quality managers.”
Perhaps farmland makes sense for a multi-billion dollar endowment with an infinite time horizon and the resources to be properly diversified and perform sophisticated due diligence across a range of managers and investment vehicles.
For the rest of us, however, farmland looks more like a bubble of the wrong kind. It has the markings of an asset class whose growth arises from investors who are looking to turn an illiquid asset into a liquid one. Volatility and lackluster returns are the likely outcome.
Read more articles by Robert Huebscher
