Land price increases raise fears of bubble
Posted: Thursday, March 10, 2011 9:00 AM
Federal regulators worry price surge is repeat of 1980s
By MATEUSZ PERKOWSKI
Capital Press
Bank regulators are keeping a close eye on rising farmland values to ensure growers and ag lenders don't get in over their heads with overpriced real estate.
"When you see prices jump by 20-25 percent from where they were 12 months ago, it should raise a red flag," said Hal Derrick, chief appraisal specialist at the Farm Credit Administration.
Regulators from FCA and other agencies recently met to discuss the "collateral risk" that rapidly appreciating farmland poses to the agricultural banking system.
Their apprehension stems from the volatility of the 1970s and '80s, when farmland values soared and then crashed, leading to foreclosures and financial distress among farmers and lenders alike.
Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., has raised the possibility of an emerging "asset bubble" in agriculture.
After taking a dip in 2008, U.S. farmland prices are experiencing a surge similar to the one seen before the financial crisis hit the global economy, said John Moore, chief economist for the FCA.
"We're trying to be prudent regulators and get on top of this situation," he said. "It is true that some farmers are making purchases at higher prices than the income-producing potential of the land would support."
Value, dangers
In 2011, the collective value of farmland in the U.S. is projected to top $2 trillion, up about $80 billion from last year and $70 billion from the previous peak in 2007, said Mitch Morehart, an economist at USDA's Economic Research Service.
Though farmland in some areas is selling for more than could be supported by agricultural operations, the nationwide increase is generally in line with the rising value of commodity prices, he said.
For that reason, Morehart said he wouldn't characterize the overall growth as a bubble -- but that doesn't mean real estate values aren't prone to significant turbulence.
"The land is susceptible to sudden changes in commodity prices, oil prices, interest rates or inflation," he said.
The current boom has been spurred by historically strong commodity prices, so if those suddenly sank, so would demand -- and prices -- for farmland.
Similarly, low interest rates have equipped farmers with more buying power. Depending on the speed at which they increase, higher interest rates could undermine that power and reduce the allure of buying farmland.
"If they rose rapidly, that would create an imbalance," said Morehart. "That demand goes away if interest rates change."
Predicting the effect of fluctuations in oil prices is trickier.
On one hand, rising oil prices spur demand for ethanol, boosting the fortunes of corn growers.
On the other hand, higher oil prices are associated with more expensive inputs, like fuel and fertilizer, that can wipe out farmer profits.
Inflation's impact will depend on the interplay between interest rates and commodity prices -- if interest rates inflate faster than commodities, that hurts farmland values.
Even if there isn't a bubble in farmland prices, some farmers are nonetheless making bets that could be dangerous if the agricultural industry's prospects darken.
"They're projecting earnings potential that may or may not exist," Morehart said.
Jim Farrell, president and CEO of the Farmers National Co., likened the current market for farmland to a pot of water heating on a stove.
There are bubbles rising to the surface, primarily in the Midwest and other corn and soybean states in the central U.S., he said.
"We're seeing bubbles in certain locations," said Farrell, whose company manages farm sales and auctions, among other ventures.
In parts of Iowa, for example, high-grade farmland sold for more than $7,000 per acre, according to a state survey. Average prices increased by more than 21 percent in some areas compared to the prior year.
Farrell attributes the hike in farmland values in part to disappointed returns from alternate investments, like stocks and bonds. He estimates roughly a fourth of the land sold in recent years went to nonfarmer investors.
"There have been outside influences," he said.
Buyers use cash
Farmland owners are also aware of the dearth of profitable investment options, which has limited the availability of properties on the market and driven up prices.
"We have more people trying to buy than are willing to sell," Farrell said. "If I sell it and take the cash, what am I going to do with the cash?"
The strength in commodity crops has provided many growers with more cash, which they're plowing right back into farmland.
That's a positive factor for lenders and bank regulators worried about a repeat of the 1980s collapse in farmland prices.
Since growers are relying more on their own money, they're taking out less debt to pay for the properties. That helps alleviate the risk that farmers will default on loans if commodity prices fall or another shock befalls the industry.
"At the moment, it does not seem we are leveraging up as rapidly or nearly as rapidly as before the last farm crisis," said Farrell.
Whereas bankers typically only required farmers to make a 20 to 25 percent down payment in the 1970s and 80s, these days down payments are commonly 35 to 40 percent of the farmland's price, said Hal Derrick of FCA.
"They're requiring greater equity positions," he said.
In contrast to the residential real estate boom that later melted down, bankers are not aggravating the rise in property value with easy credit, Derrick said.
"We're seeing people tightening standards rather than loosening," he said.
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