The Kansas City Federal Reserve just released a workpaper entitled “Farm Investment and Leverage Cycle: Will This Time Be Different?”. 

The article describes the four major farm cycles that have occurred since 1900.  The first cycle begin in 1910 and ended in 1940.  The First World War caused farm prices to rise dramatically which led to an increase in farmland prices.  Once the great depression started, this increase in farm land prices was mostly wiped out and many farms went bankrupt.

The second cycle began in 1940 with the start of World War II and continued to until 1960.  Real farm income tripled from 1940 to 1943 causing a resulting increase in land prices.  However, unlike any other farm boom cycles of the last 100+ years, this cycle did not end in any type of bust.

The third cycle started in the early 1970s and ended in the late 1980s.  With the rapid increase in crop prices due primarily to the US-Russia grain pact, farmland prices started to rise dramatically.  There were other inflation pressures during this period that also help cause the increase.  As prices rose, farmers continued to expand with more debt than was proved prudent.  This led to the crash of the 1980s that really took at least 15 years or more to recover from.

This brings us to the latest cycle that started in 2005.  Many factors led to increased crop prices (ethanol, China, etc.) and this cycle is still in process.  The authors indicate that things still look good, but if there is a dramatic drop in land prices and if the debt to asset ratio crosses over 20% again (like the 1980′s), then we will have a bust to end the cycle.  However, if this ratio stays at 17% or lower, then we will not have a bust (similar to the 1940-60 cycle).  The ratio (using their definition) is currently at 10% which is the lowest it has been since the mid 1950s.

The authors are not predicting a bust but are letting us know the parameters that may cause one.  It will be important to watch these signals and be ready to respond accordingly.

Paul Neiffer, CPA

There is a provision in the Income Tax Code that disallows certain farm losses that are in excess of $300,000 (or the aggregate farm income for the last 5 years).  This excess amount is not allowed in the current year, but is carried forward and allowed as a deduction in the next tax year (assuming you still meet the requirement in that year).

This provision only applies if the farmer is receiving any direct or counter cyclical payments under Title I of the 2008 Farm Bill (as extended last year).  The proposed 2013 farm bills by both the Senate and Congress eliminates these payments, so there is a strong chance that after passage of this farm bill and full implementation that this provision will no longer apply.

We have seen several of our clients that were unable to fully deduct their current farm loss even though they had received less than $5,000 in direct payments.  The farmer does not lose this deduction, but simply carries it forward.

Also, with the drought last year, any expenses that are a direct result of the drought are not included in the calculations for this limitation.

We will keep you posted if this provision no longer applies.

Paul Neiffer, CPA

Gladstone Land Corporation (LAND) just recently raised $50 million in their IPO at a $15.50 price to invest solely in farmland.  To date, they have purchased acreage in California and Florida (primarily berry related) and just closed on a blueberry farm in Michigan.  Since its IPO, the price has increased almost 10% to close at $16.80 on May 20, 2013.

The company intends to elect Real Estate Investment Trust (REIT) status which allows the company to pay no income taxes assuming at least 90% of its taxable income is distributed as dividends each year.  In reviewing their balance sheet, it does appear their farmland purchases to date are fairly leveraged.  As of March 31, 2013, they have incurred total purchases of about $40 million with almost $30 million of long-term debt.  Their current long-term debt bears interest at 3.5%, but is scheduled to reset in another year or so.

Their margin is in good shape now, however, if rates rise a couple of points, it may be difficult for them to maintain their expected dividend payout.

I have seen many private farmland investment funds get capitalized over the last few years, but this is the first publicly traded farmland REIT in the US that I am aware of.  There are many similar companies in Europe and Asia.  Normally, if we see a flood of these type investments on the public market, a top in the market may not be far off.  We shall see.

Paul Neiffer, CPA

After the House passed their Farm Bill today, it appears that their version on the Senate version are not too far apart.  The key points for both are:

• An elimination of all direct farm payments
• A reduction in CRP acreage to either 24 or 25 million acres
• Consolidation of many farm programs
• A Price Support program that guarantees a farmer a minimum price for their crop, or
• A Revenue Program that a farmer can elect (they have to elect one or the other).

The Price Support program is either based on a price set by Congress (the House version) or based on the average Olympic average of the prior 5 years of prices (the Senate version).  If a farmer elects the Price program, they cannot participate in the Revenue program and vice versus.

A couple of key differences is a payment limitation in the Senate of $50,000 per person for the Senate and $125,000 for the House.

The Senate also eliminates these payments if your adjusted gross income is over $750,000 while the house boosts this to $950,000.  This will most likely make the accounting simpler than it is now since you will most likely only need to look at the bottom line income shown on the bottom of your Form 1040 page 1.

We would guess that a final farm bill will be ready for a vote in the  next week or so, but with Memorial Day only a week from Monday, who knows long Congress will take off for that Holiday.

We will keep you informed.

Paul Neiffer, CPA

I was doing a google search on the House Farm Bill today and the 10th item that showed up in my search was this article.  With a title of “House Ready to Make Draconian Cuts to Food Stamps in House Bill” I was interested in what these “draconian” cuts were.  As you read the article, you will note that the author point out that the House Farm Bill is proposing cutting “Food Stamps” by about $2.5 billion per year or $25 billion over the 10 years.  This compares to the Senate Bill which calls for lower cuts of about $4.1 billion in total over 10 years.

On the face of it, $2.5 billion might be a lot of money, however, the total “Food Stamp” portion of the Farm Bill is close to $60 billion per year.  The proposed $2.5 billion cut equates to a 4% reduction.  I would normally not consider that to be “Draconian”.  The House is most likely battling this issue as I write this post and it will be interesting to see what final number they pass onto the floor for a vote.

It also appears that the Dairy margin management program is still part of the Bill, but this may get eliminated or changed in the committee between the House and Senate.  We will keep you posted on any material changes in both versions.  So far, the Senate Bill appears to mostly follow the bill passed last summer.

Paul Neiffer, CPA

The University of Illinois puts out a great daily email called the “Farm Doc Daily”.  In today’s email, they summarized the debt to asset ratio from 2005 through 2011.  The lower this ratio goes, the better.  Their database showed that the average farmer in Illinois for 2005 had total assets per acre of $1,267 and related debt of $365.  This resulted in a debt to asset ratio of 29%.  For 2011, the total assets had increased to $2,385 while related debt increased but by a lower % to $500.  This resulted in the debt to asset ratio declining from 29% to 21% in 2011.

Farmers have done a great job over the last few years in keeping this ratio low, however, you can note that total debt has increased from $365 to $500 per acre.  I wondered how this ratio would change if we assumed that the three major asset categories used (crop and feed inventories, machinery and farm land) would each decrease by 10% or 20%.  A 10% reduction would lower total assets from $2,385 to about $2,150 and would increase the ratio from 21% to 23%.  A drop of 20% would put total assets at about $1,900 resulting in a ratio of 26%.

As you can see, even if all asset values decrease by 20%, farmers are still better off (using this ratio) than they would have been in 2005.  To get to the same 2005 29% ratio would require an almost 28% drop in asset values.

Keep up the good work.

Paul Neiffer, CPA

The Kansas City Federal Reserve 4th quarter survey of Ag conditions spotlighted an ever upward trend in farm land prices.  On a year-over-year basis, irrigiated farmland in Kansas, Nebraska and the Mountain states all saw increases over 30% and non-irrigated land increased by more than 20% in all states.

For the last two plus years, land prices on a year-over-year basis in most corn belt states have increased 15% or more.  We are starting to see the Federal Reserve discuss how to reduce and then eliminate the fiscal stimulas (QE 1, 2, 3 …..).  Once this stimulas is removed, interest rates should start to revert to their norm.  The question is what the norm will be.  If we end up like Japan, we may still have very low interest rates.  If we end up like previous recoveries from recessions, long-term interest rates should range around 3% plus inflation.  Currently, this would suggest rates in the 5-6% range.  How would this effect farm land prices.

If cash rents are at $350 per acre and land is trading for $15,000, then the cash return is about 2.3%.  In today’s very low interest rate environment, this may be acceptable.  But if rates rise to 5% and a farm investor wants a cash rate of return of 4% on their land, this suggests a value of $8,750 per acre.  Also, there are certain expectations built into land right now (the price is going up, I need to grab that quarter section before the neighbor does) that “gooses” land values.

What happens when these “gooses” fly away.  Does the mentality revert back to the 1980s or will we see something in between. 

We shall see.

Paul Neiffer, CPA

Creighton University produces a monthly index called the Rural Mainsteet Index (RMI) indicating the overall economy for several rural states in the Midwest and Mountain states.  The May Index was recently released and I thought this month I would recap the index for each of the states covered.

Any value greater than 50 indicates economic growth.  The Index values by state are as follows:

• Colorado – 73.1 down from a strong 75.2 in the previous month
• Illinois – 56.7 down slightly from 56.9
• Iowa – 62.3 an almost 3 point dip from 65.2
• Kansas – 61.8 a full 9 points higher than an almost neutral 52.8 reading
• Minnesota – 66.7 almost no change from 66.8
• Missouri – 71.7 a substantial increase from 56.3
• Nebraska – 57.3 up from 54.9.  In January the index was actually under 50
• North Dakota – 78.8, as would be expected this state has the highest index reading (shale oil and low unemployment will do that)
• South Dakota – 57.2 a small decrease from 58.8
• Wyoming – 55.1 a good increase from 52.8

Many of the states farmland indexes appear to be having more swings both up and down versus a more sustained increase in several previous months.  Are we seeing a crest in land prices (leading to a dip) or is this just the start of the next wave.  We shall see.

Paul Neiffer, CPA

At the Northwest Ag Bankers conference yesterday Corey Brock a local attorney spoke on various issues related to estate and tax planning for farmers.

In most parts of the Columbia Basin water project a farmer is limited to owning 960 acres. If you go over this limit certain penalties will apply including possible loss of water to the excess land which can quickly destroy the value of the land. Current values for irrigated land might approach $12,000 while non-irrigated land might only fetch $500.

In his case, grandparents had set up a trust calling for land to be distributed to their heirs at a certain point in time. One of the heirs already owned 960 acres so any additional acres distributed to them would cause this penalty to apply. They are working to resolve the issue, but the point is that care must be taken to make sure that any estate documents created such as a trust is designed and reviewed for local Ag laws and rules.

Without this review nasty non-tax costs can arise.

I spent today in Spokane attending the Washington Bankers Association agriculture conference. I gave an update on the possible new farm bill provisions along with an update on the new tax laws.

After I spoke (never a good thing to give the farm bill and tax update right after lunch) Alex McGregor of The McGregor Company gave a talk entitled “Good Times, Tenacity and Teamwork”. The McGregor company started as a farm raising sheep over 100 years ago and is now one of the largest distributors of fertilizers and chemicals in the northwest.

He indicated what worked for our farmers three generations ago will work now. This is comprised of their work ethic, tenacity and character. But he reinforced that we need to get your message out to the general public about the vital function we perform.

After that message Brian Hefty of Hefty Seed Company in South Dakota gave a similar message. He told a story about a water issue that came up in his county that required public hearings. At the meeting were close to 200 or more people. About 4 people spoke in support and four spoke against the issue. Brian at the end of the meeting asked the audience to indicate whether they supported the issue or not. All of the people there were against the issue other than the four that spoke in favor. Without asking the question most people would have thought the support was about equal based on the numbers speaking.

This is why these people against Ag are called activists. They are Active. The question is: Are we just as active in telling our message.