Monday, March 18, 2013

Land Prices

There's a nice article in the New York Times about farmland prices.  The article suggests (as do most NYT articles on land values) that it's just another bubble.  Since we've had a couple bubbles in relatively recent memory, now it seems like everything's a bubble.

I'm not so sure.  There is a lot that's different about farmland values as compared to houses.  For one, we don't have quite the same level of debt relative to asset value.  It's reported as 25.5% for farmland.  That's the highest since the 1980s boom.  But then given today's low interest rates, it's not really a fair comparison to the 1980s.  It's also less than half the 60%+ level of debt we had for housing at the peak of the bubble.  Also, we don't have stated-income mortgages.  Banks are more cautious with farms than they were with houses during the Countrywide Mortgage years.

The simple analysis compares the price to rent ratio to current long-run interest rates. Today it looks like land that sells for around $10,000/acre rents for $500-600/year.  That's a 5-6% yield where 10 year T-bill rates at this writing are a little under 2% and 30-year T-bill rates are a little over 3%.

Now, there are costs and benefits to owning land instead of T-bills.  A benefit to land is that is has built-in inflation protection.  Inflation will push up commodity and land prices like everything else. So, the better comparison may be real rates, which are currently negative for 10-20 years out, which makes a 5-6% yield look pretty good.

A cost to owning land is that it's risky.  Rents are high because commodity prices are high.  If commodity prices fall, so will rents and yield.  So, what's the forecast for prices?  I'd say that's hard to tell.  They could go up further, they might crash if rapid productivity growth resumes.  The best bet is to look at futures prices, which suggests prices will fall somewhat from today's levels, but not that much.  Then there is the question of how to price uncertainty around that best guess.

It's not clear how costly that risk really is.  For a family with all their wealth piled into the farm, the risk is a big deal.  Most family farms own their land outright, or have relatively small mortgages.  A downturn in commodity prices, rents and land values would hurt for sure.  But typically there's not the kind of leverage we had in homes (the Times article has a notable exception).

Consider, in contrast, the risk to outside investors.  Wall Street types are pilling into land, probably because they see a reasonable yield.  But their exposure to risk is quite different.  These are highly diversified investors who have large portfolios of assets.  If farmland values crash, it's unlikely to be closely associated with the rest of the economy.  The fact that agriculture is a small share of our economy, and that commodity prices have little association with the rest of the economy, means that risk is far less important to these outside investors than it is to the family farm.  This basic point was implicitly made by Gary Gorton and Greet Rouwenhorst awhile back.

So, the basic math suggest that land investment is a reasonable deal right now.  With prices this high, it may not be quite as good a deal as buying a home in some post-bubble cities with low price-to-rent ratios.  But it's not bad, and probably not as difficult for an arms-length investor to get into.

So, I don't think this is a bubble. However, you should be forewarned that I've been wrong about this kind of thing before.

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