'U.S crop land investors at risk of overpaying'

CHICAGO: The value of top-tier cropland across the U.S. Corn Belt hit all-time highs this year as crop prices scaled multiyear or record high levels and investors poured funds into an array of assets tied to commodity markets.

But while rising global populations and a growing need for sharp increases in food output make investments in the factors of food production highly tempting, the fact that land price appreciation has clearly outstripped productivity growth in the United States in recent years suggests investors may be at risk of overpaying for land in the U.S. relative to other countries.

BETTING THE FARM

The average price for U.S. cropland topped $3,000 per acre for the first time this year, marking a 100 percent increase in 10 years and placing U.S. agricultural soils among the most costly on the planet for crop production.

But in terms of crop yields -- especially for the most widely planted crop, corn -- the U.S.'s yield advantage over other nations clearly justifies a higher per-acre price than other regions.

Thanks to a combination of higher soil fertility levels, regular rainfall patterns and more advanced farm management practices, U.S. corn growers handily outperform their counterparts from all other regions when it comes to maximizing corn output per acre of land.

This yield advantage seems to be behind the higher land valuations seen in top corn producing states such as Iowa and Illinois compared to areas such as Kansas that are more traditionally suited to other crops like wheat.

That said, the yield differential for soybeans, which is the second most widely planted crop in the areas concerned and competes with corn for the same acre, is far less dramatic between the U.S. and elsewhere, bringing to light an important aspect of land investment decisions -- comparative advantage.

While U.S. crop growers enjoy a distinct advantage relative to their international peers in corn production, they enjoy no such competitive edge when it comes to soybeans. Indeed, in recent years U.S. soybean yields have underperformed those seen in Brazil, and are only marginally better than those of Argentine producers.

CORN-DEPENDENT

The significance of this corn yield advantage lies in the fact that in order for high land valuations to be justified farmers must remain committed to planting corn on the most expensive soils. This is because land valuations are based on assumptions of a continued stream of income stemming from the parcel of land concerned, and corn remains by far the most economically attractive crop for such revenue-focused producers.

Yet a key tenet of sustainable farm management is crop rotation, which involves switching up the crops inhabiting those acres on a regular basis to allow for soils to replenish critical nutrients and for crop diseases to be eradicated or controlled.

A typical crop rotation practice in the Corn Belt is for farmers to follow up two or more years of straight corn production with a season of soybeans on every acre of land. Such practices serve to extend the life span of the soils in question as well as help improve the quality of the crops grown upon them, but may also be in conflict with one of the key tenets of economics and return-focused investment – maximum value extraction.

Further, as the gap between the price paid for an acre of cropland in a top corn state and an acre of cropland elsewhere in the country continues to widen, it is likely to become increasingly difficult for farmers of the more expensive soils to resist the temptation to ignore rotation practices in favour of continued intensive corn production.

A look at how the price differential between an acre of land in Iowa -- the number one U.S. corn state -- and the price of an acre in Kansas -- a top six corn producing state with a long tradition of wheat production in more arid areas – has widened in recent years reveals that the owners and managers of Iowa acres have an increasing incentive to remain intensive corn producers relative to their Kansas counterparts.

Naturally, Iowa corn growers can expect to significantly outperform Kansas growers in terms of corn yields, which should go a long way toward quashing any buyer's remorse an Iowa land buyer may feel.

But the fact remains that Iowa's land values remain almost entirely defined by that state's corn producing capability, and can only be justified in a corn-on-corn production environment and not during periods when other crops on grown on the land instead.

Also, while Iowa's per acre land value has increased by nearly 60 percent over the past five years as the corn market pushed higher, its per acre corn yield has climbed by only 3.5 percent, revealing a dramatic productivity-growth lag in recent years.

The state's average corn yield is up by more than 20 percent since 2001, but land values are up by more than 187 percent over the same period, indicating that land value appreciation has handily outstripped productivity over the longer haul as well.

FARTHER AFIELD

Investors committed to putting money into farmland may be better served by looking beyond U.S. shores for their opportunities, especially to regions where crop productivity growth is expected to outperform that of the U.S.

One potential destination is Argentina, which is a top-five corn grower globally and has seen corn yields climb by roughly 40 percent since 2000. (U.S. corn yield grew by roughly 16 percent over the same period).

Per-acre cropland prices are roughly one-third of those seen in the top U.S. states at around $1,500-$2,000 per acre in some areas, while national corn yields are roughly two-thirds of those seen in the U.S.

Given that average soybean yields in Argentina are roughly on a par with those expected in the U.S., the country's corn yield potential may prove enticing for investors looking for opportunities in the arena.

Of course, political and production risks are notably higher in Argentina than in the U.S., so part of the lower per acre price reflects a higher level of riskiness of such an investment.

But for those willing to stomach that risk and take into account the productivity potential evident in areas such as South America, their investment dollars will likely go further there than within the U.S.

Copyright Reuters, 2011