One of the more common questions we have received over the last few years has been, “When is the farmland market bubble going to burst?”. Potential sellers wanted to know if they needed to sell before losing value and investors wanted to know if they should stay on the sidelines in anticipation of prices drastically falling. As of now, it appears that there will be no large burst, but the continued leaking of air that we have been experiencing the last few years.
A recent article on Market Watch (Spiking Farmland Prices Offer a Lesson on Market Bubbles) takes a look at the topic of market bubbles and why they may not always be similar. The article suggests that the farmland market was not in a bubble, but responding to the financial boom in the underlying agricultural economy during the same time period as we say prices dramatically increase. The argument against the bubble theory is that cash flows increased along with the pace of farm prices, but once cash flows started to decrease, then farm prices followed suit. In a bubble market, argues Purdue agricultural economist Brent Gloy, farm prices would have continued to rise as cash flows decreased.
Another telltale sign is to look at who was actually buying land and paying the highest prices. In our experience, it was farmers and local landowners that were paying most of the “high water mark” prices, not investors. The local farmer who has been driving by a tract of ground his entire life is typically going to bid more for a piece of farmland than an outside of investor because the farmer has the emotional attachment to that tract that the investor simply doesn’t have. According to the article, during a bubble, investors would have been bidding right along with farmers up to the record-breaking sales, regardless of the underlying return. In most sales, this was not the case. Investor bidders would come to an auction knowing what rent they could receive on the farm and knowing what they needed their net return to be and they backed into a price they would stop bidding at.
So what does that mean for the market moving forward? The article insinuates that caution still needs to be taken and the possibility of a larger correction is still a possibility. Two items to keep an eye on are 1) Interest rates – If we start seeing rates creep up then buyers will scale back what they are willing to spend. 2) If commodity prices continue to fall, some over-leveraged farmers may need to sell off some farmland to cover expenses. If a glut of farms come on the market at the same time, it may dilute the pool enough to cause a more rapid decline in prices. Although at this time it appears that while the market may continue to soften in certain areas, the risk of a drastic across-the-board drop is unlikely in the near term.