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Thursday, May 5, 2011 03:56 pm

Betting the farm

Is Illinois farmland the next real estate bubble?

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Central Illinois farmland doesn’t usually return a fat harvest until the fall. These days it’s doing so all year long. Sales prices for prime farm acreage around Springfield rose roughly one fifth in 2010, to as much as $9,000 an acre for the best stuff, and they’re still rising. That’s faster than since the 1970s, thanks mainly to high prices for grain and low prices for borrowed money. At today’s prices an 80-acre tract of land in central Illinois – and a farmer these days needs half of that just to park his equipment – can run three-quarters of a million bucks.

 As usually happens, rising prices suck into the market people eager to buy before prices go even higher. Maybe too eager, in the opinion of ag economists and others. Some farmers are financing their purchases by borrowing against property they already own. The Sangamon County Farm Bureau manager told the Journal-Register that buying land at these prices is “debatable,” but then people aren’t buying it for what they can grow on it, but what they can get from it when they sell it down the line.
If that strikes you as prudent financial behavior, I have some subprime mortgage securities you might be interested in.

Central Illinois farmland has been a good investment for a long time, providing a steady return of about a 6 percent continuously compounded rate from 1970 to 2009, according to the U.S. Dept. of Agriculture. That compares very favorably to betting your money on stocks, bonds, nonfarm real estate or gubernatorial candidates, in spite of iffy weather and fluctuating demand.

That’s because, whatever the weather or the demand for grain, a grain farmer can hardly fail to make money. For decades, Washington’s farm aid has had the effect on farm incomes that a spring rain does on seed. However, the recent faster than normal rise in land prices owes little to deficiency payments, direct payments, crop insurance premium subsidies, price support payments, counter-cyclical programs or market loss assistance and other fixes by which Washington exempts farmers from the free market. After all, such subsidies have been a factor in central Illinois land prices for much of the period since the 1930s.

What’s driving prices today are low interest rates that make it cheap to borrow and the appetites of a hungry world with pockets full of cheap dollars that have pushed up demand. However, federal policies are behind the third big factor – demand for corn ethanol. Various studies suggest that demand for ethanol has accounted for 30-40 percent of the rise in corn prices since the late 2000s, demand that is goosed by government fuel-blending mandates, a production credit and a stiff tariff that prices both cheaper Brazilian ethanol and cheap sugar out of the U.S. market. The result is that corn prices are well above seven bucks a bushel. That’s down from the record set in 2007 but high enough that if I got the same price for a bushel of words I could buy that double-wide I’ve had my eye on for retirement.

Corn ethanol support in effect transfers money from the public (both as taxpayers and consumers, via lost federal revenue and higher food and gasoline prices) to the owners of the land needed to grow corn. Surprisingly few of those owners are active farmers. More are dentists or trust fund kids or retired farmers or institutional investors such as pension funds. According to the 2007 ag census, 38 percent of the nation’s farmland was owned by someone other than the farmer. In Illinois it was 62 percent – the highest percentage in the country. Subsidizing crops to help the family farmer is like subsidizing England’s stately manor houses to help that nation’s gardeners.

It is these worthies who will be first to hear the bang when the price bubble bursts, and it will. By delaying planting, this year’s spring rains are a reminder that bumper crop projections can quickly become bummer crops. Commodity prices will fall eventually even at full production – they always do, either because demand will slacken or because Congress will finally come to its senses and take back the $6 billion a year the government doles out in tax breaks to refiners who blend ethanol into their petrol – and the risk of a rise in interest rates is very real if bond buyers get nervous. Higher carrying costs and reduced incomes will put farmland owners in the same pickle as homeowners who bet on interest rates staying low by taking on variable rate mortgages and couldn’t keep up with higher payments when the recession slashed their incomes.

Unlike the housing bubble, a burst farmland bubble won’t threaten to bring down the national economy. Loans for farm property and equipment make up just two percent of overall bank lending. But such loans are a bigger part of the economy hereabouts. A lot of small country banks hold little but farm loans, and they, with grain and equipment dealers and suppliers of fuel and fertilizers, constitute about the only economy left in much of rural Illinois.

Contact James Krohe Jr. at peptobiz@mindspring.com.

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