The Federal Reserve Bank of Richmond, which covers the District of Columbia, Maryland, the Carolinas, Virginia, and most of West Virginia, published some noteworthy observations this summer about businesses’ capital expenditures, or CapEx.
According to the Fed, companies in those states are taking on fewer capital expenditures and are either slowing the pace of existing CapEx projects or delaying the start of pending projects due to economic uncertainty.
Why does that matter? Because CapEx is a category of expenses used to improve a business’ physical assets and add value by boosting efficiency or capacity. This kind of spending can provide insight into long-term business growth and economic health.
CapEx is especially prevalent in traditional real estate, which consists of buildings that are depreciating and must be improved to guard against age and rent erosion, as well as the land on which those buildings sit. The value of the buildings and their improvements typically far outstrips the value of the land.
Farmland is a bit different when it comes to CapEx, as Green Street Advisors explained in its 2021 report about farmland investing.
“Farmland as an asset class for the most part does not depreciate, and improvements in certain crops can be minimal and may require relatively low capital expenditures by the landowner,” they explained.
That’s because land, which doesn’t historically depreciate, dominates farmland investments and is responsible for the lion’s share of the value.
In agriculture, a farmer’s biggest costs are in equipment and technology, which are not tied to the real estate. Furthermore, many row crop farmers outsource grain handling, storage, and processing to local cooperatives and privately owned businesses, thus minimizing real-estate related capital costs that would be associated with on-farm structures.
That doesn’t mean farmland is CapEx-free.
Trees and bushes that produce crops year after year – like nuts and fruit – are capitalized and depreciated and require investment to maintain productivity. These permanent crop farms can be CapEx intensive while waiting for trees and bushes to mature.
And in row crops – such as corn, soybean, and wheat – capital investment in the long-term improvement and productivity of land can be a big differentiator between institutional land investors like Farmland Partners (FPI) and individual farmland owners who may have inherited property from a spouse or previous generation.
“When we buy a farm, we do so with the intention of holding it for a long time. We aren’t speculating on development potential or looking for a quick profit,” explained Luca Fabbri, the President and CEO of Farmland Partners. “In fact, we like to purchase farms that can be improved with a capital project. Improvements like irrigation systems, drainage tile, land leveling, and grain storage can generate positive returns for FPI, our tenants, and contribute to a stronger food supply system.”
Fabbri said that these kinds of investments are well understood by FPI’s farmer tenants and are often misunderstood by smaller landlords who may have little agricultural background.
“We have found that our long-term focus and capital resources can provide a competitive advantage in the farmland market,” he noted. “These projects are costly and take time to complete and show return. Not a lot of individual farmland investors have the patience, expertise, or capital to accomplish it.”
FPI’s portfolio in the Carolinas is a perfect example of its approach to CapEx improvements. The company purchased more than a dozen farms spanning thousands of acres there in 2014 and 2015. But the farms’ potentials were not being maximized.
FPI installed pivot irrigation systems and upgraded the drainage infrastructure on many of the farms to improve water management, which is essential for farming success. Additions of on-farm grain storage also aided the harvest and marketing capabilities for tenants.
“We added a lot of value to those farms, which has paid off throughout the years in asset appreciation and additional rent income,” Fabbri concluded.
And that’s the whole point of CapEx – to add long-term value for businesses and its investors.