Is Farmland a Good Fit For Pensions?

Michel Leduc, senior managing director of public affairs at CPPIB, wrote a comment for the Leader-Post, Saskatchewan farmland a good fit for CPP (h/t, Pension360):

A little more than a year ago the Canada Pension Plan Investment Board (CPPIB) bought 115,000 acres of Saskatchewan farmland from Assiniboia Farmland LP. Some misinformation has been circulating about this and I want to set the record straight.

CPPIB exists to help provide a foundation upon which Canadians build their financial security in retirement. The assets we manage belong to over 18 million contributors and beneficiaries who participate in the Canada Pension Plan (CPP), including more than 700,000 Saskatchewanians.

CPPIB believes farmland is a good investment because well-run farms that have been properly maintained provide stable returns over the long term and add diversity to our investment portfolio.

CPPIB has the ability to spend money on improvements to the farms, and to own the land for decades. During that time many emerging countries will see rapid increases in population and wealth, increasing the demand for food. Saskatchewan has the potential to be a big beneficiary of this global trend.

We spent a long time studying farming dynamics before we bought this land. And we're proud to own it.

Assiniboia Farmland is an agriculture investment company founded and based in Regina. It had previously bought the 115,000 acres, much of which grows wheat, barley and canola, and we liked its business model, which supports family farms in Saskatchewan.

It helps farmers to cash in on their land while still allowing them to run, and even expand, their farms if they choose. Assiniboia is now doing that on CPPIB's behalf and with our financial backing. It's playing an important role in a market where many young farmers don't have the money to buy their parents' farms, and loans can be hard to secure.

For a long time now roughly 40 per cent of Saskatchewan's farmland has been rented, rather than owned, by the farmers who farm it.

Within about six months of owning the land we ensured that 18 abandoned buildings were demolished, seven old storage and fuel tanks were removed, and three yard sites were cleared up.

In addition, two ponds that were being used to dump waste were cleaned out. An abandoned water well was capped. We are working on improvements to irrigation, storage and drainage.

We want to partner with local farmers to improve production techniques - and the livelihoods of those working in the sector.

Premier Brad Wall's government has made clear its desire to foster a competitive, strong and vibrant economy. The long-term vision that he laid out in 2012 included increasing crop production by 10-million tonnes by 2020 and boosting exports of agriculture and food products to $15-billion. We want to contribute to those goals through our investment.

CPPIB is a patient, responsible, long-term investor. We do not plan to amass huge individual holdings of farmland, or to squeeze out returns. We will make reasonable investments to improve farms and help those farmers who choose to partner with us to compete.

CPPIB paid Assiniboia about $120 million for the land. If we bring our investments in Saskatchewan farmland up to $500 million over the next five or six years, we would still constitute less than one per cent of the market. Large investors make up a tiny sliver of Saskatchewan farmland transactions.

We did this deal in full daylight, following all the rules, trusting in Saskatchewan's stable regulatory environment and its desire to foster a thriving economy.

Contrary to what's been alleged, CPPIB did not make use of any loophole. The Saskatchewan Farmland Security Act (SFSA) allows CPPIB to buy farmland because we're Canadian. CPPIB was created for Canadians by an Act of Parliament, the Canada Pension Plan Investment Board Act. Any changes to that Act require approval from twothirds of the provinces representing two-thirds of the country's population.

The SFSA was updated in 2002 to allow both Canadian individuals and Canadian entities to own farmland. It says that foreigners and publicly-traded companies are restricted.

CPPIB is quintessentially Canadian. We work for the millions of Canadians who have contributed hard-earned dollars to the CPP and want to see that money put to work in investments like Saskatchewan farmland.

Other than the traditional family farm, it is hard to imagine another owner that better represents both the interests of Saskatchewan residents and the province's own goals.

That article elicited a critical response from Dan Patterson who ranches south of Moose Jaw and was general manager of the Farm Land Security Board for 20 years. He wrote an article, Valid concerns about CPP land venture:

Two recent articles regarding Saskatchewan's farm land ownership legislation ("Leduc: Saskatchewan farmland a good fit for CPP" and Bruce Johnstone's "Gov't eyes farmland Act changes") contribute some confusion to the issues involved.

Firstly, is the assertion by Michel Leduc of the Canada Pension Plan Investment Board (CPPIB), and by the minister of agriculture as quoted by Johnstone, that the farmland purchases by the CPPIB are beyond the regulatory scope of the Farm Land Security Board.

For complex regulatory reasons, the special status claimed by the CPPIB can be legitimately questioned. Clearly, though, the existing situation creates untenable inequity among Canada's largest pension plans, which have similar aspirations to invest billions of dollars in Saskatchewan farmland.

Examples are the BC Public Service Pension Plan, the Quebec Pension Plan, the Federal Public Employees Pension Plan and the Ontario Teacher's Pension Plan.

Leduc describes the CPPIB in terms that depict his organization as a developmental institution motivated to improve the prospects of young Saskatchewan farmers. This is entirely contradictory to the CPPIB Act. It explicitly requires the board to maximize its return on investments.

Similarly, Assiniboia Farmland LLP claimed its establishment would also foster and support young farmers by encouraging farm parents to liquidate their land holdings to an investment firm leaving their children as tenants.

Meanwhile its private advice to prospective investors was that the land would be managed to extract maximum rental income and would be blocked into "efficiently managed units".

Managing 500,000 acres of farmland with the objective of maximizing profits both for itself and for its client will logically lead over time to a reduction of renters to achieve management efficiencies. This result will be contrary to the benevolent assertions of Mr. Leduc.

As to the question of who will ultimately profit most from this transfer of land ownership from farmers to investors, recent history has shown the significant increase in value of farmland over the last decade would have been better left with multi-generational farmers to enhance their financial capacity to invest in new technology and the risk management benefit that growing equity creates.

The proposition put by the CPPIB is that its planned acquisition of 500,000 acres is such a low percentage of Saskatchewan's total farm land that it will have little effect on individual farmers or their communities.

This is facile. All farmers, whether established or beginning, know that competing in the land market with a $200-billion pension plan is an uneven competition.

Furthermore, its intended acquisitions will not be spread evenly over the province, but will create serious local impacts. Land values will be artificially inflated by such funds, which are external to the normal agricultural economy. The historic pattern where land that comes on the market is distributed to farmers within target communities will be destroyed.

The farmland ownership rules of Canada's three Prairie provinces are actually very similar. Instead of depicting this common regulatory environment as the world's most restrictive, the message should be that they are the most forward-looking.

The majority of the world's farmers wish their legislators had the same foresight.

I have to admit, Mr. Patterson raises some excellent points that need to be properly addressed by CPPIB. In particular, how is CPPIB going to "maximize returns" without hurting the livelihood of local farmers and squeezing them out of owning farmland?

Let me discuss some other concerns I have with pensions investing in farmland. Jesse Newman of the Wall Street Journal recently reported, Farmland Values in Parts of Midwest Fall for First Time in Decades:

Farmland values declined in parts of the Midwest for the first time in decades last year, reflecting a cooling in the market driven by two years of bumper crops and sharply lower grain prices, according to Federal Reserve reports on Thursday.

The average price of farmland in the Federal Reserve Bank of Chicago’s district, which includes Illinois, Iowa and other big farm states, fell 3% in 2014, marking the first annual decline since 1986, the Chicago Fed said. Prices for cropland during the fourth quarter remained steady compared with the previous quarter, according to the bank’s survey of agricultural lenders, though half of all respondents said they expect farmland values to decline further in the current quarter.

In the St. Louis Fed’s district, which includes parts of Illinois, Kentucky and Arkansas, prices for “quality” farmland gained 0.8% in the fourth quarter compared with year-ago levels, despite lower crop prices and farm incomes in the region. A majority of lenders in the district expect values to cool in the current quarter compared with the first quarter of last year, reflecting reduced demand for land amid tighter profit margins for farmers.

The reports spotlight an overall slowdown in the U.S. farm economy and in the appreciation of farmland prices. Crop prices had soared for much of the past decade, fueled by drought and rising demand for corn from ethanol processors and foreign importers. The gains pushed agricultural land values so high that some analysts warned of a bubble.

On Tuesday, the U.S. Department of Agriculture projected net U.S. farm income this year would fall to $73.6 billion, the lowest since 2009, from $108 billion in 2014.

Prices for corn, the biggest U.S. crop by value, have tumbled more than 50% since the summer of 2012, when they soared to record highs amid a severe U.S. drought. Growers produced the nation’s largest corn and soybeans harvests ever last autumn, helped by nearly flawless weather over much of the growing season.

In the Chicago Fed district, farmland values in the latest quarter dropped in major corn-producing states like Illinois, Iowa and Indiana compared with year-ago levels, while land values in Wisconsin increased slightly and were unchanged in Michigan. The fourth quarter of 2014 marked the first time since the third quarter of 2009 that cropland values in the district dropped overall compared with a year earlier.

“Lower corn and soybean prices have been primary factors contributing to the drop in farmland values,” David Oppedahl, senior business economist at the Chicago Fed, wrote in Thursday’s report, adding that for 2015, “district farmland values seem to be headed lower.”

While exceptional returns for livestock producers in 2014 helped blunt the impact of falling crop prices on land values, Mr. Oppedahl said, the trend may come to a halt if prices for animal feed grains stabilize somewhat this year.

Meanwhile, the St. Louis Fed said farm income, household spending by farms and expenditures on farm equipment declined in its region. Midwestern bankers expect a continued slowdown in the current quarter in those three categories.

“It is very difficult for farmers to buy farmland and new equipment with corn prices in the $3.50 range,” said one Missouri lender in the St. Louis Fed report.

Bankers in the Midwest also noted a rise in financial strain for crop farmers in the latest quarter. Lenders in the Chicago region reported a dramatic increase in demand for farm loans compared with year-ago levels, with an index of loan-demand reaching the highest level since 1994. Farm loan repayment rates also were “much weaker,” in the fourth quarter of 2014 compared with the same period a year earlier, the bank said, with an index of loan-repayment falling to the lowest level since 2002.

As if that's not bad enough, just yesterday, Joe Winterbottom and P.J. Huffstutter of Reuters reported, Rent walkouts point to strains in U.S. farm economy:

Across the U.S. Midwest, the plunge in grain prices to near four-year lows is pitting landowners determined to sustain rental incomes against farmer tenants worried about making rent payments because their revenues are squeezed.

Some grain farmers already see the burden as too big. They are taking an extreme step, one not widely seen since the 1980s: breaching lease contracts, reducing how much land they will sow this spring and risking years-long legal battles with landlords.

The tensions add to other signs the agricultural boom that the U.S. grain farming sector has enjoyed for a decade is over. On Friday, tractor maker John Deere cut its profit forecast citing falling sales caused by lower farm income and grain prices.

Many rent payments – which vary from a few thousand dollars for a tiny farm to millions for a major operation – are due on March 1, just weeks after the U.S. Department of Agriculture (USDA) estimated net farm income, which peaked at $129 billion in 2013, could slide by almost a third this year to $74 billion.

The costs of inputs, such as fertilizer and seeds, are remaining stubbornly high, the strong dollar is souring exports and grain prices are expected to stay low.

How many people are walking away from leases they had committed to is not known. In Iowa, the nation's top corn and soybean producer, one real estate expert says that out of the estimated 100,000 farmland leases in the state, 1,000 or more could be breached by this spring.

The stakes are high because huge swaths of agricultural land are leased: As of 2012, in the majority of counties in the Midwest Corn Belt and the grain-growing Plains, at least 40 percent of farmland was leased or rented out, USDA data shows.

"It's hard to know where the bottom is on this," said David Miller, Iowa Farm Bureau's director of research and commodity services.

SIGNS OF TROUBLE

Grain production is, however, unlikely to be affected in any major way yet as landowners will rather have someone working their land, even at reduced rates, than let it lie fallow.

But prolonged weakness in the farm economy could send ripples far and wide: as farms consolidate, "there would be fewer machinery dealers, fewer elevators, and so-on through the rural economy," said Craig Dobbins, professor of agricultural economics at Purdue University.

Possibly also fewer new farmers.

Jon Sparks farms about 1,400 acres of family land and rented ground in Indiana. His nephew wants to return to work on the farm but margins are tight and land rents high. Sparks cannot make it work financially.

"We can't grow without overextending ourselves," Sparks said. "I don't know what to do."

Landowners are reluctant to cut rents. Some are retirees who partly rely on the rental income from the land they once farmed, and the rising number of realty investors want to maintain returns. Landlords have also seen tenants spend on new machinery and buildings during the boom and feel renters should still be able to afford lease payments.

"As cash rent collections start this spring, I expect to see more farm operators who have had difficulty acquiring adequate financing either let leases go or try and renegotiate terms," said Jim Farrell, president of Farmers National Co, which manages about 4,900 farms across 24 states for land-owners.

Take an 80-acre (32 hectare) farm in Madison County, Iowa, owned by a client of Peoples Company, a farmland manager. The farmer who rented the land at $375 an acre last year offered $315 for this year, said Steve Bruere, president of the company. The owner turned him down, and rented it to a neighbor for $325 -- plus a hefty bonus if gross income tops $750.

There are growing numbers of other examples. Miller, of the Iowa Farm Bureau, said he learned about a farmer near Marshalltown, in central Iowa, who had walked away from 650 acres (263 hectares) of crop ground because he could not pay the rent. Just days later, he was told a north-central Iowa farmer breached his lease on 6,500 acres.

COURTS OR LOANS

Concern about broken leases has some landlords reviewing legal options, according to Roger A. McEowen, director of the Iowa State University Center for Agricultural Law and Taxation. His staff began fielding phone calls from nervous landowners last autumn.

One catch is that many landlords never thought to file the paperwork to put a lien on their tenants' assets. That means landowners "can't go grab anything off the farm if the tenant doesn't pay," McEowen said. "It also means that they're going to be behind the bank."

Still, farmers could have a tough time walking away from their leases, said Kelvin Leibold, a farm management specialist at Iowa State University extension.

"People want their money. They want to get paid. I expect we will see some cases going to court over this," he added.

To avoid such a scenario, farmers have begun turning to banks for loans that will help fund operations and conserve their cash. Operating loans for farmers jumped 37 percent in the fourth quarter of 2014 over a year ago to $54 billion, according to survey-based estimates in the Kansas City Federal Reserve bank's latest Agricultural Finance Databook.

Loans with an undefined purpose -- which might be used for rents, according to the bank's assistant vice-president Nathan Kauffman -- nearly doubled in the fourth quarter of 2014 from a year earlier to $25 billion.

Total non-real estate farm loan volumes jumped more than 50 percent for the quarter, to $112 billion.

"It's all about working capital and bankers are stressing working capital," said Sam Miller, managing director of agricultural banking at BMO Harris Bank. "Liquidity has tightened up considerably in the last year."

These articles highlight two things: First, the bubble in farmland is bursting and second, when it bursts and farmers walk away from their leases, it could potentially mean costly and lengthy court battles pitting landowners (ie. endowment funds and public pension funds like CPPIB and PSPIB which also invests in farmland) against farmers. That doesn't look good at all for pensions.

All this to say, while it's really cool following Harvard's mighty endowment into timberland and farmland, when you come down to it, managing and operating farmland is a lot harder than it seems on paper and the risks are greatly under-appreciated. Add the potential of global deflation wreaking havoc on all private market investments and you understand why I'm skeptical that farmland is a good fit for pensions, even if they invest for the long, long run.

Below, economist Ernie Goss says the steep rise in agricultural land prices in a short period of time has created a bubble, and there's no doubt that land price growth is coming down. He says it won't be like the farm crisis of the 1980s, because a lot of farmers have paid cash for purchases (December 2013). It wasn't just the Fed that led to the farmland bubble, endowments and pensions also contributed to it.

Also, an older WKBT TV report (March, 2013) where some agriculture experts warned the market for farmland could be headed toward a similar fate as the housing market bubble. I agree with Vance Haugen, farmers and investors should be very concerned about the bubble in farmland popping. It's going to get a lot worse.