From WILL - Ag Notes -

Controlling Costs with Lower Crop Revenue: Cash Rents

Current projections put corn and soybean prices at much lower levels compared to prices between 2010 and 2012. Non-land costs are not projected to come down by the same amounts as revenues have declined. Current projections place operator and farmland returns below average cash rents, leading to the need to adjust cash rents down.

Operator & Land Returns 

Operator and land returns equals gross revenue minus non-land costs, and represent a return to both the farmer and the land owner. To illustrate, take a situation where the operator and land return equals $320 per acre and farmland is cash rented for $280 per acre. In this case, the land owner receives $280 per acre in cash rent and the farmer has a return of $40 per acre ($320 operator and land return - $280 cash rent).

As a result of higher corn and soybean prices, operator and farmland returns increased in 2007 and 2008. In northern Illinois, operator and farmland returns were $428 in 2007 and $364 in 2008. Operator and farmland returns then fell in 2009 as a result of lower commodity prices and higher costs. In northern Illinois, operator and farmland returns averaged $172 per acre in 2009. Higher levels of returns were occurred in 2010, 2011, and 2012. In northern Illinois, operator and farmland returns were $425 per acre in 2010, $540 per acre in 2011, and $490 per acre in 2012. Overall, returns have been higher between 2006 and 2012 then they were in the period prior to 2006.

Operator and farmland returns are projected to be lower in 2013 and 2014 as a result of much lower commodity prices. Returns in 2013 are projected at $284 per acre. Prices of $4.00 per bushel for corn and $11.00 per bushel for soybeans are used in 2014 return projections. Given trend yields, operator and farmland returns are projected at $245 per acre.

Cash Rents

Since 2006, cash rents have increased dramatically in Illinois, primarily because of higher commodity prices leading to higher operator and land returns. In 2006, cash rents across Illinois average $132 per acre. In 2013, cash rents average $223 per acre, an increase of $91 per acre. Between 2006 and 2013, cash rents increased an average of 7.8% in Illinois. To a large extent, the cash rent increases during the 2006 through 2012 period were justified. Revenues had grown and returns in agriculture were high. A portion of the higher returns needed to accrue to farmland, leading to higher cash rents.

The Current Situation: A Dilemma

Average cash rents now have reached the point where they are higher than projected operator and land returns. Take northern Illinois as an example. Operator and land returns averaged $486 per acre between 2010 through 2012, well above average cash rents. Operator and land returns are projected at $245 per acre in 2014. Northern Illinois farmland has a 190 expected corn yield. NASS county cash rent data is used to project an average cash rent for different expected yields (see details here). The average cash rent for a 190 expected corn yield is $286 per acre. There is little reason to expect decreases in cash rents in 2014. Therefore, the 2013 cash rent is treated as the 2014 cash rent. The $286 cash rent is $41 higher than the $245 operator and land return, leading to a $41 loss to the farmer.

Projected 2014 operator and land returns are lower than average cash rents in all regions of Illinois. In central Illinois, high-productivity farmland has a $261 projected return, $42 less than the $302 cash rent. For low-productivity farmland in central Illinois, the $227 per acre return is $43 less than the $270 per acre cash rent. In Southern Illinois, the $154 per acre return is $48 less than the $202 cash rent.

The 2014 projections are based on trend yields and a $4.00 per bushel corn price and an $11 per bushel soybean price. Obviously, yields and prices can change between now and harvest. All else being equal, higher prices would increase returns and lower prices would lower returns. If prices are near those levels used here for 2014 projections; however, losses will be incurred on farmland with average cash rents.

Commentary

Many cash rents are set during the fall prior to the year of production. A critical time period will be this fall when 2015 cash rent levels are set. If commodity prices are near those projected above, it will be likely that 2015 commodity prices will be projected at similar levels near $4 per bushel for corn and $11 per bushel for soybeans. In this case, there will be a need to adjust cash rents down for the 2015 production year.

There has been considerable debate on the speed with which cash rents will decrease. The general expectation is for a long adjustment process. While rate adjustments are lagged in the farmland rental markets, there are several reasons to expect downward cash rental rates in 2015. First, there will be two years of marginal returns at average cash rents. These marginal returns will have reduced liquidity postions on many farms, leading to the need for reductions in cash rents. Second, guarantees on crop insurance products will be lower, leading to a higher risk position. Third, non-land costs likely will continue to be high, placing farms in a continuing high risk position. For these three reasons, the downward adjustments could occur more quickly than expected.

In this post, a $4.00 corn price is used in making projections. This is near the $3.95 price projected by the USDA at its Agricultural Outlook Forum; hence, the price expectations used here are near projections made by others. Changes in commodity prices could change projections. For example, a $4.50 corn price and similar increase in soybean price would result in an increase of $70 per acre in operator and land returns. This $70 increase would change the cash rent outlook.

A large range in farmland returns is a characteristic of the current environment. As corn prices from $3.50 and $5.50 per bushel are possible, swings of $200 or more in operator and land returns over the next several years are possible. In this environment, it will be difficult for land owners not to bear some of the return declines. This will require adjusting cash rents up or down based on price, cost, and yield expectations. Those land owners willing to bear this risk likely will be rewarded with higher returns over time.

Summary

Lower commodity prices lead to lower operator and land returns. Cash rents need to adjust to projected levels of returns. Current price projections suggest that cash rents need to adjust downward.

Categories: Agriculture