There are numerous private equity funds, companies and even stock market listed companies, which offer the idea of farmland investments to the public or to high net worth investors. All of them operate farms or cattle stations themselves. One high gloss leaflet they claim superior performances due to all kind of special knowledge. Once it is the economy of scale or the transformation of land into a higher value land. On other occasions it is the very technological approach of GPS driven machineries with variable spreading or newer higher yielding crop.
Farmland Investment Vehicles
We have looked at many of these investment vehicles and compared the numbers. We concluded: The lessor beats the operator. Owning land and leasing it for a high yield generates usually a better outcome than starting a farming operation.
The average EBIT (earnings before interest and tax) is not very high in the farming business. The average EBIT margin in Australia is about 6.5%. The lowest quartile produces only around 2.5%, the most successful farmers in the highest quartile about 10.5%.
Everybody plans to be in the top quartile, but the reality is, the top quartile are usually Australian farming families with a father and one or two sons, who operate an efficient unit, meaning that they use their machinery to the maximum possible. Furthermore, the members of these families do not shy away from some extra work when it is needed in the evening or on a Sunday.
Farmland Investment Schemes
Investment schemes, who operate farms never reach this efficiency. They have employees, who only want to work 40 hours. The have a management board, which is usually fairly expensive, and they have significant other overheads like management fees and performance fees.
Farmland Investment Returns
We aim to lease out farmland for about 4.5% to 5% based on the purchasing price. One would conclude that at these levels it is difficult for the lessee to make any money, given the above EBIT number. But the reality is, the lessee achieves a very high marginal yield on the farmland leased from us. The lessee has usually a too small operation. The overhead of his machinery is too high, and the machinery is not fully utilized. On an additional leased plot of land, a lessee can produce certainly double-digit returns, especially if the farm he leases is next door to his home block.
Organic farmland investment
Since the green revolution the average yield per hectare has risen dramatically. One could conclude that this increase of production on the same area should lead to a higher margin for farmers. The fact points a different way. The average margin is not high and has not risen. All these efficiency gains actually accrue to the value of the land. Land values have gone up consistency even during the last 30 years during which real (price adjusted for inflation) price of food has been falling.
Farmland Investment – How farmers become rich
Farmers usually only become rich, when they exit the business and sell their land. As a lessor you have the benefit of a stable lease income, which does not fluctuate with seasonality and rises with inflation. And on top of this inflation protected income, which is higher than any inflation linked government bond, one participates in the continuous uptrend in farmland values.
We are convinced: The Lessor beats the Operator