The Next Real Estate Bubble: Farmland

Farmers have been taking on mounting debt, risking a crash that would ripple through our economy

by Blake Hurst

Eeyore should have been a farmer. It’s almost impossible to find a farmer happy about his situation. The weather’s too hot, cold, wet, or dry, and prices are too low or too high, depending on whether we’re buying or selling. We can’t, at least in front of our peers, admit to prosperity or even the chance of prosperity. Although we’d never admit it at the local coffee shop, the last few years have been good, at least for Midwestern grain farmers. Prices have been strong — strong enough to make up for much of the production lost to last year’s drought. That’s terrible news for livestock producers, who’ve been faced with drought-damaged pastures and high feed costs, but for farmers producing corn and soybeans, it has been a profitable few years.

Farmers have cash, and nowhere to invest it but farmland. Farmers largely ignore equities, as they tend to balance the inherent risk in farming by investing in what they perceive as less risky places. We aren’t dumb, however, and have figured out that it's a losing game to invest in bonds or CDs at rates less than inflation while we’re in tax brackets we never even knew existed.

So, farmland prices are booming. Land prices in the heart of the Corn Belt have increased at a double-digit rate in six of the last seven years. According to Federal Reserve studies, farmland prices were up 15 percent last year in the most productive part of the Corn Belt, and 26 percent in the western Corn Belt and high plains. Closer to home, a neighbor planning his estate had an appraisal done in 2010 and again in late 2012. In that two-year period, the value of his farm had doubled. According to Iowa State economist Mike Duffy, Iowa land selling for $2,275 per acre a decade ago is now at $8,700 per acre. A farm recently sold in Iowa for $21,900 per acre.

Although much of the increase in land prices has been driven by well-financed farmers and outside investors (many paying a large portion of the purchase price in cash), there are disturbing trends occurring on farm balance sheets. The Kansas Farm Management Association reports that debt-to-equity ratios are highest in large farms, which have over a million dollars in sales. Although the debt-to-asset ratio is low even in the largest farms in Kansas, it's higher than it was in 1979, shortly before the farmland crash of the eighties. As former home owners in Las Vegas and Southern California can attest, equity can melt away in a hurry. A debt-to-asset ratio of 30 percent can enter dangerous territory with a land price drop of 50 percent, which sounds like a lot, until you remember that is a price level last seen only 24 months ago in much of the Midwest.

The number of farmers in the Kansas survey with a 40 percent debt-to-asset ratio is higher now than it was in 1979, and those farms with a debt-to-asset ratio of over 70 percent are three times as numerous today.

We farmers should be more sophisticated than the average subprime borrower and more risk averse than startup investors in the 1990s. After all, we manage multi-million dollar businesses, and since the average age of farmers is near 60, most of us are survivors of the agricultural asset crash of the early 1980s. In 1981, the average price of farmland in Iowa was $2,147 per acre; by 1986, the average farm brought $787 an acre. That period was the formative experience of my farming career, and one I would not wish to repeat. According to a recent article in the USA Today, a third of Iowa’s farmers left the industry during that crash.

In a population thus inoculated, we ought not to catch the fever again. It is a mark of the few investment choices left to farmers that we’ve so eagerly contributed to this unsustainable increase in land prices. We know better, we know it’s likely to end badly, but we don’t feel that we have an alternative.

A personal admission here. We bought our neighbor’s farm a couple of years ago. Yes, I know better, but we’ve had our eye on that farm for a generation.

Interest rates are low because the Federal Reserve believes that low interest rates are the best way to help heal an ailing economy, or at least the best tool available to the Federal Reserve. Our economy is so fragile and our major banks so tenuously financed that the Fed thinks it has no choice but to risk a repeat of the early 1980s bubble in farmland, the 1990s tech boom, and the recent housing market bust.

A cynic might also notice that low interest rates are extremely important to large borrowers, and the largest of all borrowers is the federal government. Need an example of the impact that an increase in the interest rate will have on the federal budget? The sequester — which has caused the White House to cut tours, is increasing lines at airports, and means that Yellowstone National Park will open later than normal this spring — requires budget cuts of around $85 billion. Even a 1 percent increase in the interest rate would eventually increase federal borrowing costs by $160 billion annually; more normal borrowing costs are around 5 percent.

We can argue over what economic policy works best, but the one thing we can be sure of is this: the federal government and the Federal Reserve are not working with a scalpel, but rather performing surgery on the economy with a chain saw. No one should expect our present monetary policy to be unwound in such a manner that farmland prices can be gently slowed to a more sustainable path — one that reflects the slow but steady increase in demand for food and fiber.

The federal government spent billions of dollars in the 1980s supporting farm income and writing off bad debts from various government farm lending programs. Those resources clearly aren’t available today, and agriculture is facing a grim future.

The Kansas City Federal Reserve recently had a symposium examining whether we are experiencing a farmland bubble. Bubbles are impossible to truly define until they burst, but when the Fed is sponsoring seminars on the topic, it occurs to this Eeyore that straws may well be floating in the wind. The ripples from a crash in farmland prices would not have the long-lasting effects on the economy that the subprime debacle did, but the chance of a crash in farmland prices should still concern policymakers. Farmers may well be collateral damage in the quantitative easing battle and are rightly worried that the next victim of our monetary policy will be wearing overalls when the music stops.