Closing Grain Futures

Just real quick I thought you would be interested in the closing grain futures from March 17th, 2014.

• May corn closed at $4.79, down 7 cents
• May soybeans closed at $13.91 and 3/4, up 3 and 1/4 cents.
• May soybean meal closed at $446.60, up $2.60.
• May soybean oil closed at $41.89, down 40 points.
• May wheat closed at $6.74 and 1/2, down 12 and 3/4 cents.
• April crude oil closed at $98.08, down 81 cents.
• May cotton closed at $92.03, down 16 points.
• April gold closed at $1,372.90, down $6.10.
• Dow Jones Industrial Average: 16,247.22, up 181.55 points.

1031 Exchange Under Attack

Proposed Tax Reforms Includes Ending 1031 Exchange

The ninety two year old 1031 tax exchange is once again up for abolishment in current tax reform proposals.  Congressman Dave Camp, Chair of the US House or Representatives Committee on Ways and Means, has a bipartisan tax reform group tasked with identifying eleven subjects including real estate tax matters as potential revenue raisers.  Senator Max Baucus, Chair of the Senate Finance Committee has targeted the elimination of the 1031 exchange as one of many means of tax reform.

Section 1031 "like-kind" exchanges is estimated to cost of $42 billion over the five year period 2012-2016 by the Joint Committee on Taxation (JCT).  Estimated by the JCT in prior years estimated the tax deferral to be $16.2 billion over the five year period 2010-2014.  The two fold difference is attributed to a change in accounting methodology.

The Treasury Department 1031 Regulation is enforced by the Internal Revenue Service in Section 1.1031 stating that "no gain or loss shall be recognized on the exchange of property held for productive use in trade business or investment, if such property is exchange solely for property of like ind which is to be held for productive use in trade or business or for investment."  Individuals, married partnerships, trusts, corporations use 1031 exchanges when selling and replacing real and personal property to defer federal and state capital gain and recaptured depreciation taxes.  The taxes are deferred until the replacement property is sold and not replaced, effectively cashing out.  The economic position of the taxpayer does not change in a 1031 exchange; they have the same amount of cash and debt if not more.  If the taxpayer receives cash or reduction in debt, then a tax is due.

Sixty percent of 1031 exchanges involve properties for sales of less than one million dollars with a third for less than $300,000 owned by small investors and businesses.  The majority of investors are individuals and small businesses with exchange proceedings of less than $300,000.  Corporate entities do utilize 1031 exchanges to replace worn equipment and reposition low income producing properties with higher income producing properties.  In the Florida Panhandle, from Perdido Key West of Pensacola, Florida to Panama City Beach, Florida, investment properties saturate the real estate market with the local counties benefiting from the country bed taxes on properties held for short term rentals.  Titleholders are individuals, husbands and wives, trust and small limited liability companies generating business for Realtors, lenders, contractors, title companies, attorneys, CPAs, appraisal, pest and survey companies.

Positive Impact of 1031 Exchanges

• Encourages the rate by which money is move from one transaction to another; otherwise, known as the velocity of money.
• Property located in the US must be exchanged with property located in the US requiring reinvestment in the US rather than overseas.
• Stimulates taxpayers to acquire properties of equal or greater value often times greater including improvements in real estate.

What a 1031 is Not

• A tax loop hole for the rich.  Ninety percent of investors are individuals, families and trusts within a seven hour driving distance to their investments.
• A tax scheme robbing US taxpayers and government, rather a temporary tax deferral with the tax due when replacement property is cashed out or due upon decedent's taxable estate.

Negative Impact of 1031 Exchange Elimination

• Fewer real estate transactions, real and personal property will be held longer with many families electing to hold until death.
• Increase in depreciation deductions offsetting income tax revenue.
• Businesses will downsize due to no longer having access to or qualify for loans and paying tax on the gain or depreciation recapture of relinquished or old asset.

1031 exchange provide significant benefits to the taxpayer and local economies where the asset is located encouraging reinvestment versus the hoarding of cash and removing those dollars from the economy.  The 1031 exchange allows many others to benefit in the transaction before ultimately deposited with the US Treasury.

Farmland Values Cooling Off

It's upon us!  That long stretch of a dramatic rise in land values is finally slowing down.  According to the Federal Reserve Bank of Kansas City land in Nebraska, Kansas, Wyoming, Montana, Colorado, Oklahoma and Western Missouri have all cooled off.  This could trigger what I believe is a farmland gold rush for buyers. 

How's That? 

Many farmers have been holding on to their land in hopes to selling it at it's highest value well beyond the normal age a farmer does.  Well, those values have peaked, leveled out and are now starting to come back down a bit.  As of now, there are fewer farms for sale on the market.  I expect a dramatic increase here quickly with farms selling at a dramatic pace.  So if you're an investor looking to get in, now is an excellent time to be brushing up and learning about the cropland business.

Where Should I Go?

There are many websites you can go to to learn.  My favorite is Brownfield Ag News.  This is where you can keep up with all things agricultural.  I especially like it has a spot where the commodity prices are constantly up to date.  You can also download and app for your smart phone as well.

Another good place is Farmers National Company.  Here is a one stop shop for all things agricultural and they do an excellent job spelling things out in laymen's terms to better help you understand.  Also, they are the largest farm management company in the United States.  So, find a local manager in your area using there site and sit down and talk with him.  That the best way to learn.

And then finally, talk to a local real estate agent to help you look and make decisions.  Farmers National Company also does this.  Depending on where you're looking I highly suggest Farmers National Kansas City.  If anything, they can help point you in the right direction.

What About a Bubble?

This is a common fear people have.  While it is a possibility it's highly unlikely.  Most farms were bought by cash buyers.  It was rare someone bought a farm with loaned money.  The reason is farmland prices always go up and rarely fall back.  Now we are experiencing a slow down and may experience a lowering in price, but that won't be the trend for long.  As a matter of fact, what will most likely happen is instead of farm prices rising at a clip of 25% per year.  They are more likely to rise at 5% per year.  So there won't be any collapse like the housing market which was primarily driven by debt.

If you wish to read the complete survey by the Federal Reserve Bank of Kansas City just click on the link below.

Fed Reserve of KC Survey

Types of Property Ownership

Tenancy in Common

Tenancy in common is another commonly seen type of farmland ownership we see.  Tenancy in common is where a property is held by two or more persons with only the unity of possession.  There may hold a varying size of interest in the property.  The owners may take the title at different times.  The owners may also have different deeds.

Possible Issues

The owners will share an undivided possession.  So upon the death of one owner there is no right of survivorship.  The other owner can't take the passed owners shares unless stated so in a will.  Decedent's interest passes to his or her will.  Or, it passes to the state law of distribution.

Fundamental Puzzle Pieces In The Market

What Are The Fundamental Players In The Commodity Market?

There are three things to think about when look at the commodity prices when it comes to farmland.  US supply, US demand and the US economy.

US Supply

This is production and potential production.  Both have an affect on the market.

US Demand

A good example of this is ethanol.  That has become a very popular source of fuel recently and has really driven then corn demand in this country.

US Economy

As long as the U.S. dollar is strong so will the marketplace for US crops abroad.

Corn is the Market Leader!

With the strong push for ethanol corn has exploded on the US market recently.  It should continue to do so for the foreseeable future.

Weather Will Always Trump!

With all these things that go into what affects commodities, nothing affects it more than the weather.  Keep an eye on the forecasts in the area of your farm.  If you truly want to know what the future of commodity prices are just look to the sky.

Piecing Together a Commodity Marketing Plan

What Affects The Market?

A handful of things really affect the commodity market.  

USDA Reports

USDA reports can really dictate what the next year or so could look like for the farming business.

Foreign Economies

For example, what happens in say Greece with all their economic woes can affect commodities we export out.  Also, China is a big exporter for us.  If that economy falls apart we would feel it as well.

Managed Commodity Funds

The market will react to these as well.  These are really where we see the numbers and how the prices in the market will be adjusted.

World Events

To really truly hurt the farming market a global event has to take place.  Such as an embargo or a third world war.  But little ones like economic woes of Europe can be felt here.

Weather

A few years ago we went through a pretty long drought.  It was actually getting scary.  But like most things the weather came back to the median.  However, that drought really affected prices.  Drove them through the roof.  So weather is something to keep an eye on when thinking about the market.

Predictions For 2014

Cropland Predictions For 2014

What does the next year hold for the cropland business?  I expect demand to remain strong.  At some point in the next handful of years I expect a cropland gold rush.  A lot of aging farmers who own land are hanging on and waiting to see if they can't sell at the top.  Usually these farmers would've sold by now but they are patiently waiting to see where the prices will hit there peak.  When we start getting close to that expect the market to flood with cropland.

Rents will be tied to crop prices.  Whether they go up or down that's what you should expect cash rent to follow suit.  This isn't any amazing revelation I know but it's something to not forget while going forward.

Acreage will be based on crop insurance.  We are seeing crop insurance more and more affecting the cropland market.  That mostly comes from the drought we had a few years ago.  I don't see this changing anytime soon.

Volatility will continue.  This is where you will decide what kind of operation you are going to run.  All depends on your personality.  Are you a risk taker or not.  It all depends on your comfort level how you want to run your operation.  Remember, it's your farm.  Run it how you want to.

Have a Happy New Years and let's look forward to 2014!

Analyzing Operating Alternatives

With all the information I've given you on the different ways to run your farm, the next question you should be asking yourself is what's the best way for me?  How should I run my farm operation?  You should use the market indicators to help you make an informed decision.

Actual Negotiated Cash Rent

You need to find out what land is going for in your farms area for cash rent.  If it's high maybe that's the way you want to go.  If it's low you may take an alternative such as share crop or custom farming.  You have to know what you're comfort level is.  That's the best way to get started.

Actual Production History

This is a valuable tool. This will tell you what the land has produced in the last handful of years.  You will know if it's good producing land or bad producing land.  This is an excellent tool when deciding what farmland to buy.  I highly suggest getting this before making a purchase or decision on how to run your land.  I would also suggest having a farm manager look over this for you.  Sometimes it's like reading a different language.

Guaranteed Revenue Protection

What kind of crop insurance do you have?  What's the protection you have against a bad crop year?  This will help you know if you can take a bigger risk in doing custom farming or if you need to play it safer and do cash rent.

Projections of Future Pricing

For this I would hire a farm manager or consult with a farm management company for.  They have employees that all they do is look at farm futures.  They are a good tool and can help you make better decisions on how you want to handle your farm going forward.

Need To Be Aware Of...

Start Simple

What is it you need to be aware of when thinking about your farm management plan?  While the first aspect is simple it's something some people make way more complected than it needs to be.  You need to think about the lands profit potential.  Basically, think of the income and expenses that go into the land.  You will also have to keep in mind your relationship with the farmer.  This will impact managing the farm as a valuable asset in one way or the other.  You don't want to hover over him constantly yet you can't be an absentee owner.  Absentee owners often get taken advantage of.  I heard a saying once from a farm manger that I love.  "What makes the crops grow the best?  My shadow."

Negotiation Skills

What are your negotiation skills?  Do you enjoy this part of the process?  Do you expect fair market value for your assets?  If you answered yes to this then you should consider custom farming.  I would highly suggest looking into hiring a farm manager to handle this.  They will get you the best deal you can for a small portion of the profits.

Written Lease

How would the farm manger work up a written lease?  I'll go over a quick standard way it's done.  While each deal is different this is the basic way it's written up.  First off he would negotiate a new lease every year.  This would insure that you get most out of the land year to year.  He would secure the cash rental payments or collect up front.  He would form a lease that would protect you and the farmer.  He would guard against any subleasing.  The lease would make sure you know your farm's production capability.  And they would use studies from local universities on cash rent.  However, take them with a grain of salt.  These studies tend to be out of date by the time they become public.

Cost of Management

This is simple much like the first step but often people don't think about it.  Basically this is the difference between what the owner/farm operator thinks might be fair vs analysis of value the land brings to farming operation.  Simply put, think of it like any other business.  Most first time investors forget that it's a business and treat it differently.

Solving The Leasing Puzzle

Leasing Formula

How do you go about putting a farm lease together?  Start with these four questions.  What are the commodity prices?  Will improvements need to be made?  How productive is the land?  Is there a demand for you land?

Other Factors

You need to get an idea of what the USDA net farm income would be.  That would give you a jump start on where to begin negotiating.  And lately they've been great.  In 2011 we had the second best year for record income.  And 2012 was the third best year in record income.  Farmers generally have cash on hand which is one of the reasons most deals are cash deals and not debt driven.  You no longer have to worry about a bubble for the cropland market.  Debt to asset ratio is 10.3%.

Weather Patterns

You know that old saying in housing and commercial real estate.  What's the three most important things?  Location, location, location.  Farmland falls right into that as well.  Depending on where you were located, yields from the drought were reduced from 0% to 80%.  So if you live in an area with warm days, cool nights and steady rainfall patterns, you're looking good.  Ever wonder why Iowa is the hot bed for cropland?  It's in the sweet spot of climate and rain fall.  No other state has what Iowa has.  However, this is also the reason Iowa land is by far the most expensive in the United States.

Crop Insurance

The prices in the fall of 2012 will dictate what the prices of 2013 would be should a farmer have to use insurance.  For example, in 2012 corn was $7.50, soybeans were $15.39 and wheat was $8.78.  2013 farm finances are looking strong.  Crop Revenue Protection for 2013 is at profitable levels again.

What's Changed?

Late summer 2013 prices came in looking good.  Cash corn was $6.70 and new crop corn was $4.50.  Cash soybeans $13.30 and new crop soybeans was $11.60.  Cash wheat was $7.00.  This shows despite the rough last couple years farming is still very profitable.  Insurance prices as of July 24th of this year ar $4.80 and $12.55.  Farmland values are very strong and continue to rise as well as the return of investment.  Farmer's are sitting in a great strong cash position.  

So Now You're Ready

So Now You're Ready to Look

How much land is available?  Well, if you're related to a farmer or a friend of a farmer then a lot of land is available.  I'm going to assume most of you aren't related or a friend of a farmer.  So, what does that mean for you?

Only 1% of the total amount of cropland is sold each year.  Most of that land never makes it to the market.  Why?  It's sold to family or friends of the farmer.  People living in or associated with the community the farm is located tend to get first crack at it.

This puts non-local investors at a major disadvantage in acquiring the best farmland.  Less than 1/2 of 1% of all US cropland is available for public purchase.  Which should lead you to the next question.  How do you sort this all out?  How do you access the best farmland which usually never makes it to the public market?

There are three parties to the sale.  There is the seller which can be a farmer, investor or estate.  The investor which tends to be someone from out of town looking to expand their portfolio.  And the renter who is also the farmer.  The renter is what we need to help us out.  The right renter will help you balance out all these issues.

What can that farmer do for you specifically?  Look for that in my next post. :)

Farmland is a Better Investment

Farm Vs. Residential or Commercial

Some of you may be thinking, "This is all good information but I already have plenty of investments in commercial or residential.  What makes farmland a better investment?"  Let me break that down for you.

What are the down sides to investing in residential or commercial properties?  

Renters usually downgrade the property.  The property requires cash maintenance.  They are physical structures so they will decline in value.  Property taxes can be expensive.  You need liability insurance and that can be expensive.  And you have to collect monthly checks and that can be chore.  Who wants to do all that?

What makes farmland better?  

Renters will improve the property.  The farmers have a stake in the lands future.  The farmer will improve the property.  Land always rises in price thus it will physically improve over time.  Agriculture property taxes are low by law.  Liability insurance is very low too.  Finally, rent is collected once or twice a year.  No badgering and hunting down renters once a month.

How to Make Money Off Cropland

There are many ways people get revenue off of cropland.  The most traditional way is through the annual income, such as cash rent or share crop, and land appreciation.  

Annual income can come in various different ways.  One way is cash rent.  This is usually gain by receiving bids from farmers and they tend to be competitive.  This is the way most first time investors go.  It's the simplest way and has the least amount of risk to the investor.  The second way is share crop.  This tends to be done by more experienced investors.  They are typically 1/3 2/3 shares.  The positive is the investor usually makes more money this route.  However, they are usually more involved in the day to day decision making and if the crop fails or comes in poorly they take a hit along with the farmer.  And the final way to make income is through land appreciation.  I've gone over this a lot but to summarize it, cropland averages a 6% increase in appreciation annually over the last 40 years.  And we saw a massive jump in the last two years averaging 10% to 30%.

Now for the additional streams of revenue most people don't think of.

One additional source would be mineral rights.  This pertains to everything below ground of the property.  Things such as oil and gas leases and coal are the most common.  Another one is hunting leases.  The price of a hunting lease varies from property to property and how it's decided.  For example, you can decide the lease per acre, per hunter or, if it's a wetland, it could be a wetland lease.  Sub surface water rights is also another issue to think of.  Not too big of a deal in wet areas but places like western Kansas it can be an issue.  There are also government programs in place.  There is the conservation preserve program or CRP.  That is when the government pays the land owner a yearly amount to allow the land to grow naturally.  The is wildlife habitat incentive programs or WHIP.  It's similar to CRP but instead of just leaving it alone the government creates a habitat to promote wildlife growth.  There is also wetland reserve program or WRP.  Similar to CRP.  Allows a wetland to remain untouched and promote wildlife growth.  And finally there are wind leases.

Wind leases are becoming more and more common.  The issue is you have to have your land adjacent to other turbines to tap into a wind lease.  You have to think of it like an electric grid.  And it's expensive to put in so they will only add on to wind farms and rarely put up new ones.