Tuesday, August 16, 2016

Farmland investing in the US

buffett on farmland in 2011 when commodities were at highs.

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices. A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.”


Planning for water shortages before a drought
Pests and weather pose risks to crop yields, but a season or even a few seasons of drought should not have a long-term impact on farmland investing. Many farmers have successfully managed droughts, pests and floods. Drought is a well-understood, age-old risk that can be planned for and mitigated, especially in short time horizons. The current drought is an excellent case in point. TIAA owns multiple properties in California across more than 37,000 planted acres, and as part of the property acquisition process, the stability of the water supply is always a primary focus of due diligence. This review includes research on the following water-related subjects:
Where possible, TIAA seeks to acquire properties with multiple sources of water, such as reliable groundwater wells that are supplemented by the right to receive surface water from water districts. Properties that are not serviced by water districts or other surface water rights are located in areas with historically reliable ground water supplies. Furthermore, advanced planning for those properties that typically receive most of their water from water districts, which are likely to have no supplies available in 2014, is required to ensure access to and availability of banked water. When droughts linger, however, they may cause problems for all farms—no portfolio is immune from a long-term drought. The current drought has demonstrated the value of planning for short-term water shortages.
In addition to acquiring land with fundamentally strong water supplies, actively managing farms may offset, to the extent possible, the impact of drought conditions. Strategies to accomplish this may include the installation of water-conserving technologies such as drip and micro-sprinkler irrigation systems; acquiring and banking water when possible; and winter transfers of underground water to above-ground storage to make the water more readily available to the farm during dry periods.

A long-term view of farmland investingLooking back at the 2012 drought across the U.S. Midwest, it is important to note that the drought impacts had no material negative impact on farmland values, and similarly we expect minimal long-term impacts for our California investments. This does not mean the danger of droughts, pests and floods are to be ignored; indeed, planning for these hazards is critical to maximizing returns and managing farmland investment risk. The longer a drought persists, the greater the potential for material impacts to any farmland portfolio. TIAA’s long involvement in farmland and deep connections within the agriculture industry provide us with the experience and expertise to properly analyze these risks, which fall outside the traditional realm of financial markets. We believe that farmland is among several private investments in real assets that offer the potential for competitive risk-adjusted returns, a hedge against inflation and improved portfolio diversification.


Farm real estate remains the most direct method of investing in the agricultural sector. In recent years, the agricultural sector has provided consistently positive returns as a result of high commodity prices and rising farm income levels. The success of the agricultural sector has led to increased attention from investors outside of the traditional agricultural finance sector. 


The plan was relatively simple, in the absence of attractive fixed income yields, large asset managers (like TIAAmentioned above with $850BN of AUM) decided to purchase hard assets like farmland instead.  Farmland could then be planted with the highest value crop, which just happens to be almonds in California, to drive attractive ROICs on invested capital.  A few simple charts illustrate perfectly how the story played out. 
          Per the chart below, planted almond acreage in California nearly doubled from 2003 - 2016...  

We don't know about you but we're not sure about underwriting California farmland to a 4% return particularly in light of that "minor" little drought issue they're facing.  We would be looking for ROICs closer to 8% - 10%, at a bare minimum, which, at current almond prices, implies that acreage needs to come down around 45%-55% from the $35,000 per acre level.  

But the story doesn't end with almond acreage which only represents about 1mm of the total 8mm acres of irrigated farmland in California (see data from the United States Department of Agriculture).  So if we assume that California's 8mm acres are worth $25,000 per acre on average that implies roughly $200BN worth of farmland in total.  Now, even if that number is only inflated by 35% (and not the more draconian 45%-55% we suggested above) it implies that farmland owners, many which are New York institutional buyers, in California alone are sitting on $70BN worth of losses.