What Impact will Increased What Impact will Increased Commodity Prices Have on Commodity Prices Have on

Land Values?Land Values?

Rising Food and Energy Cost Conference

Oregon State University

October 2, 2008

John B. Penson, Jr.

Regents Professor and Stiles Professor of Agriculture

Texas A&M University

Factors Affecting Land ValuesFactors Affecting Land Values

• Expected future commodity prices.

• Expected productivity and future cost of production inputs like fertilizer and seed.

• Expected future interest rates.

• Expected future land appreciation.

• Income and capital gains tax rates.

• Attitude toward risk and risk premium used when discounting annual cash flows.

Overview of Historical Trends in Overview of Historical Trends in Cropland Values and RentsCropland Values and Rents

Source: NASS - USDA.

Nominal Farm Land Values Per Acre

$0

$250

$500

$750

$1,000

$1,250

$1,500

$1,750

$2,000

$2,250

$2,500

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Do

llars

Pe

r A

cre

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

An

nu

al P

erc

en

t C

ha

ng

e

Land Values Per acre Annual Percent Change

Land values started falling in late 1979.Farm debt continued to expand well into 1982.

Land values started falling in late 1979.Farm debt continued to expand well into 1982.

Real net farm income in 1983virtually identical to 1933.

Real net farm income in 1983virtually identical to 1933.

Today’s boomToday’s boom

Production Region 2003 2004 2005 2006 2007 2008

Northeast $3,400 $3,800 $4,390 $5,040 $5,450 $5,900

Lake States $1,860 $2,030 $2,270 $2,550 $2,950 $3,250

Corn Belt $2,270 $2,450 $2,880 $3,240 $3,720 $4,260

Northern Plains $737 $783 $916 $1,040 $1,170 $1,390

Appalachian $2,490 $2,670 $3,040 $3,470 $3,830 $4,060

Southeast $2,350 $2,460 $3,660 $4,550 $5,150 $5,420

Delta States $1,210 $1,270 $1,460 $1,600 $1,780 $1,910

Southern Plains $863 $902 $1,010 $1,160 $1,330 $1,490

Mountain $1,170 $1,200 $1,420 $1,730 $1,900 $1,940

Pacific $3,500 $3,570 $4,620 $4,850 $5,450 $5,600

48 States $1,660 $1,770 $2,110 $2,390 $2,700 $2,970

Average Value of Cropland by Farm Production RegionAverage Value of Cropland by Farm Production Region

Source: NASS - USDA

Source: NASS-USDA

Markets studied todayMarkets studied today

Historical Trend in Iowa Cropland Values

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

19

60

19

61

19

62

19

63

19

64

19

65

19

66

19

67

19

68

19

69

19

70

19

71

19

72

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

Do

llar

s p

er A

cre

Source: Iowa State University Extension Service.

Growth in global food demand.Russian wheat deal in 1972.

Export expansion, low stocks.

Growth in global food demand.Russian wheat deal in 1972.

Export expansion, low stocks.

Global recession.Fighting inflation.

Strong dollar.

Global recession.Fighting inflation.

Strong dollar.

Tight world stocks, supply.Asian financial crisis in 97/98.

Tight world stocks, supply.Asian financial crisis in 97/98.

Rising crop prices. Growth in emerging countries.

Growth in renewable fuels.

Rising crop prices. Growth in emerging countries.

Growth in renewable fuels.

Production region 2003 2004 2005 2006 2007 2008

Northeast $42.00 $44.50 $46.00 $47.00 $48.00 $51.00

Lake States $74.50 $76.20 $78.00 $80.00 $85.00 $98.00

Corn Belt $110.00 $114.00 $117.00 $119.00 $126.00 $140.00

Northern Plains $48.00 $50.00 $53.00 $53.50 $58.00 $64.00

Appalachian $52.00 $55.00 $58.00 $56.00 $58.00 $58.00

Southeast $44.00 $45.00 $48.00 $48.00 $50.00 $57.00

Delta States $65.00 $68.50 $70.50 $69.50 $72.50 $88.00

Southern Plains $28.00 $30.50 $30.50 $29.00 $29.50 $34.00

Mountain $60.50 $62.50 $62.00 $65.00 $78.00 $86.00

Pacific $180.00 $180.00 $185.00 $192.00 $210.00 $230.00

48 States $73.00 $76.50 $78.00 $79.50 $85.00 $96.00

Average Cash Rent by Farm Production RegionAverage Cash Rent by Farm Production Region

Source: NASS – USDA.

Source: NASS-USDAMarkets studied todayMarkets studied today

Percentage Change in Cash Rent per Acre

-20

-15

-10

-5

0

5

10

15

20

25

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Per

cen

tag

e C

han

ge

Source: Chicago Federal Reserve District (IL, IA, MI, IN, WI); Chicago Federal Reserve District Bank.

Rents fell during financialcrisis in the 1980s.

Rents fell during financialcrisis in the 1980s.

Catch up time?Catch up time?

A Practical ExampleA Practical ExampleAssume that operating expenses for an Illinois

corn farmer are $500 an acre as a result of rising fertilizer and seed prices.

Assume producer achieves a yield of 200 bushels an acre.

If cash rents are $300 an acre, the producer would need to receive $4.00 per bushel just to break even.

This would leave nothing for profit, debt payment coverage and family living expenses.

Historical Financial Historical Financial IndicatorsIndicators

Source: Derived from Farm Sector Balance Sheet and Income Statements published by ERS – USDA.

Trends in Key Debt Service Ratios

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

De

bt

Bu

rde

n R

ati

o

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

Tim

es

Inte

res

t E

arn

ed

Ra

tio

Debt Burden Ratio Times Interest Earned Ratio

Source: Derived from Farm Sector Balance Sheet and Income Statements published by ERS – USDA.

Farm Debt Burden Ratio

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Rat

io o

f D

ebt

to N

et In

com

e

With Government Payments Without Government Payments

Importance of government payments in 1980s crisis

Importance of government payments in 1980s crisis

Net Farm Income and Total Farm Debt

$0

$50

$100

$150

$200

$250

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Bill

ion

Do

llars

Net Farm Income Total Farm Debt

Source: Derived from Farm Sector Balance Sheet and Income Statements published by ERS – USDA.

Heart of farm financial crisis

Heart of farm financial crisis

A questionable USDA conceptgiven that only one third of farmers have term debt!

A questionable USDA conceptgiven that only one third of farmers have term debt!

Macroeconomic OverviewMacroeconomic Overview

Uncertainty in Capital MarketsUncertainty in Capital Markets

Capital markets in disarray.Commercial paper market seized up.Libor rates up markedly.10 million home mortgages today have negative

equity. Housing prices fell 17% in last twelve months. Bottom of housing market not yet in sight.

40 percent of mortgages made in last two years were sub-prime loans.

117 banks on FDIC trouble list in 2nd quarter.

Uncertainty in Real EconomyUncertainty in Real Economy

Institute of Supply Management business activity index fell to lowest level (43.5) since October 2001. Value below 50 signals business contraction.

Real wages sliding since November 2003; down sharply since August 2007.

Contagious effects on client nations for agricultural products, leading to declining exports.

Incomes declined for first time since August 2005.Consumer spending adjusted for inflation at the

lowest level in four years.

Recession ProspectsRecession Prospects

There can be no doubt that the U.S. economy is in a recession.

The question is how long it will last and how deep it will be.

I think it will be 1-2 years given passage of the bailout package passed and signed.

May look much like the 1981-1982 recession that lasted 16 months.

We know what that agriculture looked like during that recession.

Future Unit Cost and Future Unit Cost and Commodity Price TrendsCommodity Price Trends

Percentage Change in Corn Disappearance

0%

10%

20%

30%

40%

50%

60%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Per

cen

tag

e C

han

ge

Exports Feed Seed Ethanol Food Ending Stocks

Source: Various WASDE Reports, USDA.

Expansion of corn use in manufacturing ethanol comes

at expense of feed use and has driven up corn prices.

Expansion of corn use in manufacturing ethanol comes

at expense of feed use and has driven up corn prices.

USDA Reported Monthly US Corn Price

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

$5.50

$6.00

$6.50

Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug

Do

llars

/Bu

sh

el

2004/05 MY 2005/06 MY 2006/07 MY 2007/08 MY

Source: Agricultural Prices, USDA.

Source: CBOT Corn Futures Contract Prices.

Weekly Closing Settle Price Volitility

$3.75$4.25$4.75$5.25$5.75$6.25$6.75$7.25$7.75$8.25

7-D

ec14

-Dec

21-D

ec28

-Dec

4-Ja

n11

-Jan

18-J

an25

-Jan

1-F

eb8-

Feb

15-F

eb22

-Feb

29-F

eb7-

Mar

14-M

ar20

-Mar

30-M

ar4-

Ap

r11

-Ap

r18

-Ap

r25

-Ap

r2-

May

9-M

ay16

-May

23-M

ay30

-May

6-Ju

n13

-Ju

n20

-Ju

n27

-Ju

n3-

Jul

11-J

ul

18-J

ul

25-J

ul

1-A

ug

8-A

ug

15-A

ug

22-A

ug

29-A

ug

5-S

ep12

-Sep

19-S

ep26

-Sep

December 2008 Contract March 2009 Contract

Percentage Change in Prices Paid Indices

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Per

cen

tag

e C

han

ge

Seed Fertilizer Chemicals Fuel

Source: Agricultural Prices, NASS-USDA.

Instability in input prices as wellInstability in input prices as well

Looking ForwardLooking Forward

Source: 2007 expenses derived from published state crop production budgets. Projections over the 2008-2014 period based upon the rate of increase in FAPRI-Missouri projections updated in August 2008 extrapolated to 2017.

Projected Commodity Operating Expenses

$0

$100

$200

$300

$400

$500

$600

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Do

llars

pe

r A

cre

Kansas Wheat Iowa Corn Illinois Corn

Source: Historical data for 1987-2007 provided by NASS-USDA. Projections for the 2008-2017 obtained from FAPRI-Missouri (2008-2013) updated in August 2008 and FAPRI-Iowa State (2014-2017).

Historical and Projected Commodity Prices

$0

$1

$2

$3

$4

$5

$6

$7

$8

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

08

20

11

20

13

20

15

20

17

Do

llars

pe

r B

us

he

l

Price of Wheat Price of Corn

Cropland Price Cropland Price AssessmentAssessment

Simulation AssumptionsSimulation Assumptions

Land values are local; reflect expected returns.Focus on the capitalized agricultural value.Net present value of future values over the

2008-2017 period; solution for maximum bid price or where price results in NPV=0.

Three crop situations examined: Northern Central Kansas 65 bushel wheat Iowa 170 bushel continuous corn Central Illinois 182 bushel continuous corn

Scenario DesignScenario Design1. Baseline – FAPRI commodity price and expense

trends.2. 15% higher commodity prices with baseline expenses

and existing interest rates (HP-BEXP). This is the Best Case Scenario.

3. Baseline commodity prices and 10% higher expenses, including higher interest rates (BP-HEXP).

4. Lower commodity prices and baseline expenses and interest rates (LP-BEXP).

5. 15% higher commodity prices and 10% higher expenses, including higher interest rates (HP-HEXP).

6. 15% lower commodity prices and 10% higher expenses and interest rates (LP-HEXP). This is the Worst Case Scenario.

The capitalization of future operations over a 10-year period approximates the 2007 land prices for continuous wheat in Kansas and continuous corn in both Iowa and Illinois.

Actual and Capitalized 2007 Value

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

$5,000

Kansas wheat Iowa corn Illinois corn

Do

llar

s p

er A

cre

Acutal Value Capitalized Value

HP-BEXP = 15% higher annual commodity prices; baseline expenses.BP-HEXP = baseline commodity prices; 10% higher expenses.LP-BEXP = 15% lower annual commodity prices; higher expenses.HP-HEXP = 15% higher commodity prices; 10% higher expenses.LP-HEXP = 15% lower commodity prices; 10% higher expenses.

Impact of Alternative Scenarios on Current Bid Price

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

Baseline HP-BEXP BP-HEXP LP-BEXP HP-HEXP LP-HEXP

Do

llars

/Ac

re

Kansas Wheat Iowa Corn Illinois Corn

HP-BEXP = 15% higher annual commodity prices; baseline expenses.BP-HEXP = baseline commodity prices; 10% higher expenses.LP-BEXP = 15% lower annual commodity prices; higher expenses.HP-HEXP = 15% higher commodity prices; 10% higher expenses.LP-HEXP = 15% lower commodity prices; 10% higher expenses.

Percentage Deviation from Baseline Bid Prices

-80%

-60%

-40%

-20%

0%

20%

40%

60%

HP-BEXP BP-HEXP LP-BEXP HP-HEXP LP-HEXP

Per

cen

tag

e C

han

ge

fro

m B

asel

ine

Kansas Wheat Iowa Corn Illinois Corn

Analysis of ResultsAnalysis of ResultsAddressing the title given to me for my paper, land prices

would increase markedly if higher commodity prices are expected over the next ten years, particularly in Kansas.

Conversely, land prices in Kansas are more vulnerable to lower commodity prices and higher expenses than observed in Iowa and Illinois.

Higher expenses can be tolerated ifif commodity prices rise simultaneously.

Higher expenses absent of higher commodity prices could cause land values to fall sharply.

The lower commodity price scenario still left prices above target price levels under the 2008 farm bill.

Some ThoughtsSome Thoughts If interest rates remained low, the dollar remained weak

and corn stocks remain at pipeline level, commodity prices for corn and wheat would remain strong in the 2008/09 marketing year.

Continued volatility likely going forward. Long run projections by those presented in a baseline never reflect potential volatility. FAPRI addresses this using stochastic simulation examining 500 alternative scenarios. Their CDF suggests, for example, that there is a 10% chance the price of corn would fall below $3.00.a 10% chance the price of corn would fall below $3.00.

Crude oil prices, value of the dollar, energy policy and growth in emerging economies are the major drivers going forward.

Downside RisksDownside RisksLower crude oil prices affecting demand

for corn as a feedstock.Higher unit costs of crop production. Higher interest rates.Stronger dollar. Slower economic growth in client nations

resulting from contagious financial crisis.Expanding production response in

competitor nations.

Financial ImplicationsFinancial ImplicationsReal estate values represent 85% of farm

balance sheets – represents a key factor to the financial health in the farm sector.

Farmers who refinanced debts with inflated land values as collateral in the 1970s faced severe problems when land values plummeted in the 1980s – surge in bankruptcies and rural bank closings.

Sales of 4-wheel tractors up 30% in 2008; farm debt expanding but not as fast as the 1970s.

Lenders will recognize weaknesses earlier due to less reliance on collateral lending.

Final ThoughtsFinal ThoughtsThe approach taken to assess today’s land

prices in the locations addressed validated published prices for the three locations studied.

These cropland bid prices are sensitive to future expectations for commodity prices, unit input costs and interest rates.

Locations chosen were based upon the availability of updated crop production budgets – higher yields, more efficient operations and marketing strategies not reliant on spot market prices can justify higher bid prices for cropland.

Thank youThank you