Farmland as an Alternative Investment

Farmland as an Alternative Investment

Using Farmland as an Alternative Investment Class

 

The idea behind alternative investing: own assets not correlated with your other investments. When the stock market crashes, your overall portfolio may be sheltered through alternative investments. Or, maybe the market has a bad decade… wouldn’t it be nice to own something not linked to market returns?

Alternative investments have a different risk-return profile and might provide an improved risk-adjusted return. As they say, don’t put all your eggs in one basket.

Agriculture is a massive industry in the United States, and there are ways to use farmland as an alternative investment.

Let’s look at agricultural farmland investing and see how you might consider diversifying your portfolio. But first, let’s remember why you invest in the first place.

 

Reason Why You Invest in the First Place

What is your reason for investing in anything? The main idea: your money needs to work for you. If you leave it under the mattress money becomes worthless over time as it loses purchasing power.

Some say the first rule of investing is not to lose money. Well, if you don’t invest, you actually lose money, too! Of course, don’t have all of your money at risk. But you do need to take some risk, as the reason you get any return is because you took risk.

Some assets have better risk-return profiles than others. Unfortunately, you can only look to history as a guide. If all of your assets are tied up in paper assets (such as stocks and bonds), chances are you will be fine. But there are times that are, historically at least, worse than other to be all paper assets. Is now one of those times given low interest rates low and low future expected returns on equities?

So, what else is there aside from paper assets? There are real assets and businesses. If you are not going to start your own business, you are mostly stuck with real assets. Real assets include real estate: a large “alternative” class of investment.

Usually when folks thing about alternative investments beyond real estate, they think of hedge funds and private equity. Hedge funds did great for a while, but private equity is the current darling for many. But everyone knows that! Might cash flows into private equity to dampen returns for the near future?

So, what’s someone to do when their mattress becomes uncomfortable with all the cash stuffed in it? What about Farmland as an alternative investment?

 

Farmland as an Alternative Investment

After all, they are not making any more productive land!

The main problem I see, is that corporations have taken everything that it makes sense for them to take, and only in the margins might you have a competitive edge. Do you have an edge with farmland?

Here in Montana, for instance, there are still quite a few cow/calf operators who may make money two out of five years if they are lucky and prices behave. Over time, they might be able to deduct large machinery and maybe even pay off the grazing land. But many ranchers fail. And the reason why producing calves has not been taken over by the mega corporations (such as you see with poultry and hogs): because they can’t make money doing it!

With farming, you often produce commodities at low margins. If corporations could buy all the land and do it themselves, and make a profit at it, they would have done so already. So, it must be a risk proposition, and one of which it isn’t easy to make a go.

Compare farmland with local real estate.

 

Comparison with Real Estate

It is said real estate has made more millionaires than any other asset class. There is no doubt that is true, but since real estate often involves leverage, there have also been more bankruptcies cause by real estate than any other asset class. Risk seems lower as you are making such great rewards. Again, though, if it was all a reward story, money would have flowed in and reduced the risk/reward ratio, reducing payouts.

But even though real estate increases over time just with the rate of inflation, the return is lumpy. Your timing must be right in the real estate game. Fortunately, most of the time, it is fine. But as we saw in 2008, there are dire times as well.

Let’s look at some of the pros and cons of farmland as an alternative investment.

 

Pros and Cons for Farmland Investing

  • Pro:

Farmland is in Limited Supply. People always (for the most part, anyway) use land for its best value. Ever wonder why there is so much grazing land in some states? Well, because it doesn’t make sense to grow crops on it… you just can’t make the finances work. Land always finds it best use. Its best use is always to subdivide and put big buildings on. That is in direct contradiction to the fact that there is a limit on good crop land in the world, and the world will need fed.

Productivity Increases with Time. Technology is coming to Agriculture just like in every other industry. Automation will improve profit margins.

The world will always need food.

 

  • Con:

Weather. Floods, droughts, pests, anything can go wrong. There is crop insurance, but no one in Ag thinks they will make a nice steady profit year after year. Hence the complicated commodities and futures market.

Cost of Doing Business. Tractors, fertilizer, and everything associated with farming is going up faster than profits. And land is getting more expensive, too. As I mentioned earlier, land will always find its best use, which usually isn’t growing crops.

Politics. A trade policy change can affect prices.

 

How Agricultural Farmland Makes Money

  • Crops Yield
  • Land Appreciation
  • Forced Equity
  • Principal Pay Down

 

The idea of forced equity is interesting in farmland investing, so let’s dig deeper.

Much like in real estate, you can add value to land through improvements. In agriculture, you can improve on raw land, or plant higher end (or organic) crops. There are buildings, infrastructure and irrigation systems that can also force equity.

Let’s not explore some ways you can invest in farmland.

 

Agricultural ETFs

There are a few ETFs you might invest in if you want farmland exposure. These area above and beyond commodity exposure, or, say, exposure to industrial stocks in companies that build large tractors.

ETF have the advantage of being tax-efficient, but don’t participate in depreciation to any degree.

FPI, DBA, COW, MOO and LAND are ETFs to consider. Nice Names!

Other advantages include diversification, liquidity, and low expense ratios. To me, this feels a bit like tactical investing through factor exposure, and I’m not a big fan.

 

Individual Stocks

Let’s not even talk about commodity investing.

Of course, you could buy John Deere or large seed or fertilizer companies or the like, but I don’t encourage betting in individual equities.

 

Crowdfunding in Farmland

There are a couple ways to crowdfund into farmland. Generally, crowdfunding platforms have lower minimums to get involved. Farmers submit deals which are reviewed by the site owners. Buyer beware. You must know what you are doing to get involved in these types of deals. With these deals, you buy “shares” of farmland. There may be access to a secondary market, but you should consider these investments as illiquid.

Some of these are LLCs where you will be Limited Partners, which are quite different than crowdfunding. Minimum investments are higher. Don’t expect liquidity.

Options to consider: AcreTrader, FarmTogether, FarmFundr, Farmland LP and Harvest Returns.

For me, this is what I plan to explore. I’m signed up on the above sites and will monitor the deals for a couple months as I learn more. Farmland LP seems the most interesting.

 

Tax Benefits of Farmland as an Alternative Investment

You cannot depreciate land. But some crops like nuts and fruits do have trees or vines that can be depreciated. There are also capital improvements such as irrigation systems. Depreciation is note the primary driver for agricultural investing in funds.

 

Conclusion

Farmland is a lower risk investment that should be considered as an alternative investment. It tends to increase in value over the long-term, and is a real asset that they are not making more of.

As you are investing in vintages (that is, money from other illiquid investments comes back to you in lumps), it might be a good idea to keep a few farmland deals in the back of your mine.

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7 Comments

    • Really? If you are talking active management (i.e. farming) then yes! More effort and time… but why would passive investment be any different? All you have to do is vet the deal and then invest if you choose to do so.

  1. It’s nice to read a physician finance blog without an affiliate link to AcreTrader! Great to read an honest take on farmland investing without advertising. Excellent economic point re:corporations and ranching.

    Also, I really enjoyed reading your covid book!

    Stay safe!

    • Thanks for the compliment on the book, Mark. No affiliate links?? What was I thinking! I talk enough about always considering one’s incentive. My incentive was to start thinking about alternative assets. You know you can’t read about real estate on physician blogs without affiliate links, so maybe that will be next?

  2. I have actually owned a small farm (20 acres) and it was a lot of work for no money. Just my observation.

    • No doubt! That is why I think the forced appreciation idea is interesting. It takes a lot to improve farm land but it needs to be done!

  3. I loved this post. Made me think of how I could partner up with some local startup farms and invest with them – thank you for the idea.

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