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An Intriguing Alternative Investment: Farmland

Every day the total population of planet earth increases by over 200,000 people. There are 1,402 million hectares of arable land, 138 million hectares of perennial croplands and 3,433 million hectares of pasture lands feeding the current population of 6.7 billion… It is challenging to feed the exponentially growing population with an arithmetically growing farming base. Consequently, the increasing scarcity of farmland has resulted in rapidly rising farmland prices across almost on all regions of the world. In the U.S., more and more institutions including endowments and foundations have expressed an interest in the returns that will potentially be generated through farmland assets.

Income-producing farmland is particularly favorable since it provides current income. Generally speaking, farmland investments will benefit from secular increase in demand for grain, environmental demand for energy, and the impact of globalization. The U.S. has great comparative advantages in agriculture, and the declining dollar stimulates the exports of overall agricultural products. In Asia, especially in India and China, the surging global population growth is fueling food supply shortages. The increasing population of the middle class in particular along with its demand for high-quality protein is the key factor that drives the growth of this type of investments in that area.

Over the last 100 years, based on income and capital appreciation, farmland assets have consistently delivered positive returns, with only three brief periods of negative returns, i.e., in the 1930s, 1980s, and in 2008. Beyond that, as a real asset, farmland serves as an inflation hedge.

Farmland investments are linked to food and energy production, and the supply of farmland is inelastic. From the fundamentals perspective, farmland is currently one of the best among the real assets categories. The sound underlying fundamentals are one factor that insulates farmland values from the turmoil in the broad markets. In addition, farmland is a relatively unlevered asset, which is another factor that disassociates its returns from financial markets. Farmland portfolios can be constructed by different aspects of diversification. They can be diversified by farm properties, lease terms, farm tenants, financing sources, crop types, management styles, and geographic distribution within the portfolio.

Compared with owning stocks and bonds, farmland investing is different from the perspective of the volatility and “asymmetrical risks” of the assets; compared with real estate and housing, farmland investing is also different in that there is a finite supply. Investors who are interested in digging into farmland asset class have to respect the averages of land leases, and think of this type of investment on a total return basis and realize its potential for long-term appreciation.

Investors generate the total return through the acquisition and management of selected farmland assets. A significant component of the total return is the appreciation in the value of the farms held in the portfolio.

Additionally, the sources of return also come from two means of leasing, i.e., cash rent and crop share. In the cash rent, the annual rent is assessed based on the farm’s tillable acres. The rent is either paid in full, or with a major portion before any crops are planted. In this arrangement, all risks that are associated with planting, growing, and harvesting are assumed by the tenant farmer. By contrast, in a crop share lease, the owner is paid a percentage of the crop’s revenue, but he also shares the risk of crop failure. The gains from crop share are usually relatively higher since there is more risk inherent in this arrangement.

For less risk-averse investors, farmland futures are another path; however, a significant potential downside is that natural resources in general are volatile and may be impacted by many factors.

Investors can also gain the exposure by investing in farmland is through direct ownership in a diversified managed portfolio of income-producing farms. The total value of global investments in direct farmland ownership is estimated to be between $15 billion and $30 billion as of 2014.

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