What is in this article?:
- Three factors fueling interest in farmland purchases
- Seeking long-term returns
- One example
• Strong demand for land, low interest rates and low income tax rates can be beneficial for buyers and sellers of agricultural land.
Seeking long-term returns
Institutional investors seek long-term stable returns of 6-8 percent and that can be done with agricultural land. Since 1970 farmland averaged returns of 12 percent annually, better than the S&P 500, but with the risk of corporate bonds. The only investment that has shown less volatility than farmland long-term returns has been U.S. Treasuries.
Investors have historically done their best to avoid overpaying for agricultural land. They are looking for a 5-6 percent gross cash return, so if land is priced at $3,000 per acre, a cash rent of at least $150 per acre is necessary.
Recent weather events, increasing demand for food, fiber and protein brought on by higher incomes in developing countries and population growth, have contributed to a significant increase in commodity prices.
This in turn, has increased net income levels for farmers, providing the additional cash flows that have contributed to increase the demand for farmland.
Interest rates: According to Federal Reserve Board statistics that began in 1930, the prime rate (what commercial banks charge their best customers) did not exceed 2 percent until after 1950. Since then, it has fluctuated from 3 percent to 20 percent.
The prime rate has been declining since 1980 and during the first week of May 2011, it was 3.25 percent. This current historically low prime rate has translated into low mortgage rates that began around 2004.
Are we taking these low rates for granted? It is easy to forget historical trends. Between 1976 and 1981, mortgage interest rates ranged from 11 percent to in the 21 percent range. That was a doubling of rates in 5 years.
My wife and I bought our first home as a couple in 1986 and we were tickled to death to obtain a 13 percent mortgage rate! It had gone down from 15 percent!
No one knows how long these low rates will last, but some experts sense we are close to a bottom. Many feel there is a greater chance of rates going up than going down, particularly after 2012, when the economy is predicted to have recovered more from the current recession.
Taxes from income: We are in a period of historically low long-term federal capital gains tax rates. Rates have historically been at least 20 percent. The period from 1922 to 1933 is the only period that rates were 12.5 percent or lower.
From 1934 to 1996 the maximum capital gains tax rate exceeded 25 percent and was in excess of 32 percent from 1970 to 1978. This increased to as high as 39.9 percent in 1976-78.
For a married couple filing jointly with $69,000 or less of taxable income, the capital gains tax rate will be 0 percent in 2011.
Capital gain is the profit you make from holding a capital investment such as land. It is also the price received from the sale of farm-raised cull cows.