Call it Emmanuel's Bubble Theory: the popping of one bubble eventually begets another bubble. The implosion of the dot-com bubble led to interest rates being cut, thus giving rise to the housing bubble. Now that the latter is fast deflating and interest rates are again being cut to soften the blow of an oncoming recession, where are we (or at least the US) headed? I'll put my money on a new farmland craze that's taking shape. The reasons for this new craze are simple and require little explanation: First, growing prosperity overseas--especially China and India--ensures a steady source of demand for farm produce in yonder lands. Second, the biofuel craze--fueled in large part by government incentives--makes investment in agriculture a seeming sure-fire bet. Third, historically low interest rates have been mooted by the likes of Jeffrey Frankel as a mechanism for making commodities relatively more attractive. The end result is rising prices for agricultural lands. However, this Reuters article also points out that just as the owner-renter ratio got out of whack in the US housing market, so too is the ratio between the cost of farmland and the rents obtained from farmers. Interesting stuff...Investors who have never sat behind the wheel of a tractor are helping drive the price of U.S. farmland to record levels, attracted by its assumed safety following the meltdown in mortgage-related securities and excited by the potential of plant-based biofuels. But is agricultural land really a good long-term investment? Or could the rush into rural real estate be just another Wall Street craze -- one that ends like the Internet and housing manias that preceded it?An analysis of rents -- a key measure of U.S. cropland values -- suggests the returns investors can expect from farmland are not only substantially below those available in the stock market but in a long-term decline to boot. That disconnect -- between fast-rising farmland prices on the one hand and fast-falling returns from farmland rents on the other -- has some growers and government officials worried a bubble may be forming, one similar to the one that took hold 30 years ago and left rural America reeling once it popped.
Iowa Bank Superintendent Thomas Gronstal is among those concerned. "Current agricultural conditions," Gronstal told lawmakers in U.S. Senate testimony on March 4, "are reminiscent of conditions experienced in the 1970s, which led to the economic and financial collapse of the 1980s." Gronstal said soaring crop prices made "the agricultural sector look strong." But he warned that retreats in those prices could have an immediate and devastating effect on land values. "If there has been too much leveraged or loaned against the inflated value of farmland, the bubble will burst and we will once again experience an economic crisis similar to that of the 1980s," Gronstal said.
Over the past decade, the average price of an acre of U.S. cropland has doubled, according to the U.S. Department of Agriculture, from $1,340 in 1998 to $2,700 in 2007. Last year alone, average prices nationwide jumped 13 percent. Several factors are driving the increase. Farmers are scrambling to ramp up production to take advantage of record prices for many crops -- from corn to soybeans to wheat.
Big city investors, meanwhile, have also gotten in on the act, optimistic that a government push to commercialize biofuels like ethanol is fundamentally altering the rural landscape. But while land prices have surged, cash rents -- the price that landowners charge farmers who work their land -- have failed to keep pace. Last year, according to U.S. Agriculture Department data, average cropland rents rose just 7 percent to $85 an acre. Over the past 10 years, the data show, they've only risen 28 percent.
As a result, rents as a percent of cropland value -- a metric akin to the earnings yield on a stock -- have declined over the past 10 years nationwide, from about 4.96 percent in 1998 to 3.15 percent last year. (By comparison, from January 1926 through December 2007, the annualized total return for the S&P 500 was 10.4 percent per year.) So while the cost of U.S. farmland is rising, the real returns that land generates have fallen.
If that disconnect between purchase price and rents doesn't sound eerily familiar, it should. In 2002, several years before the U.S. residential housing bubble popped, Ed Leamer, an economist at the UCLA Anderson Forecast, warned that the run-up in house prices in some markets had already reached unsustainable levels because prices were rising faster than rents.
Indifference to the relationship between price and earnings on any asset, Leamer said, "is the same error that Wall Street analysts made during the Internet Rush when they imagined that the New Economy changed the rules and created a fundamental disconnect between corporate earnings and stock prices. "We know differently now," Leamer said.
Investors bullish on farmland say, essentially, that things are different because the world is in the midst of an unprecedented agricultural supercycle, driven by growing food demand and wealth in the developing world and a U.S. government mandate for plant-based alternative fuels. Rents, they say, which typically lag changes in land values, will catch up. "Purchase prices have been going up faster than rents," said Iowa State University economist William Edwards. "But I think we're going to see a pretty big push on rents this year."
But rents will have to be pushed pretty hard to get them back to levels seen even five years ago. With other costs rising, including fertilizer, seed and farm equipment, it's difficult to see how land owners make such hikes stick. Ominously, it's growers who seem most worried about the surge in farm prices.
When Iowa State canvassed farmers recently as part of its annual land value survey, it reported that many respondents "expressed a great deal of concern that land values were too high and that the market might be due for a correction." And this week, a survey of farmers by the University of Illinois found "people looking over their shoulder," according to the report.
