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Transcript

Risk and Return for Farmland Today Michael Langemeier and Tim Baker Purdue University Outline of Topics • • • • • • Trends in Inflation Rates Trends in Interest Rates Land as an Inflation Hedge Sources of Land Earnings P/E and P/rent Ratios Summary and Implications Trends in Inflation Rates 5 6 Trends in Interest Rates 8 9 Ten-Year Treasury Interest Rate and Its Reciprocal, 1960 to 2012. 10-Year U.S. Treasury Reciprocal of 10-Year Treasury 20.00 60.0 50.0 16.00 40.0 12.00 30.0 8.00 20.0 4.00 10.0 0.00 0.0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 10 2004 2008 2012 Projections Survey of Professional Forecasters Period Real GDP Unemployment Rate PCE 10-Year T Bond 2013 1.9 7.7 1.8 2.1 2014 2.8 7.2 2.0 2.6 2015 2.9 6.7 2.0 3.3 2016 3.0 6.3 N/A 3.8 Source: Federal Reserve Bank of Philadelphia, First Quarter 2013. 11 Land as an Inflation Hedge Is Farmland a Good Inflation Hedge? • Over the long-run, farmland has been highly correlated with inflation – Correlation coefficient of 0.63 from 1914-2011 • Regression of nominal US Farmland against inflation using the CPI: – %∆𝐿𝑎𝑛𝑑𝑃𝑟𝑖𝑐𝑒 = 0.720 + 0.957(%∆𝐶𝑃𝐼) – R2 = 0.394 (a lot of the movement in land prices unexplained) • Farmland has moved close to 1 to 1 with the CPI. • However, the relationship is more complex than this model suggests, therefore we broke inflation into expected and unexpected components Inflation and Real Land Values • Regression of real U.S. farmland price against expected and unexpected inflation (19142011): – %∆𝐿𝑎𝑛𝑑𝑃𝑟𝑖𝑐𝑒 = a + b (expected inflation) + c (unexpected inflation) + – Expected and unexpected inflation were not significant Effect of High Inflation in the Current Environment? • Expected inflation is low • Effect of high unexpected inflation would depend on its effects on – Interest rates – The US and world economies – Exchange rates • Depending on how high unexpected inflation came about it could have a large negative impact on real farmland prices Sources of Land Earnings Sources of Land Earnings • Two Sources: – Rent – Change in Value • Figure on next page shows 10-year moving average rent and change in value for West Central Indiana. Sources of Land Earnings, 10-Year Moving Averages Rent Change in Value 0.150 0.100 0.050 0.000 -0.050 -0.100 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 18 P/E Ratios P/E and P/rent Ratios • P/E Ratio for Stock P/E = Market Value per Share / Earnings per Share A high P/E ratio indicates that investors anticipate higher growth of earnings in the future. • P/rent for Farmland P/rent = Farmland Price / Cash Rent West Central Indiana P/E and P/rent Ratio Graphs West Central Indiana Farmland Price, Cash Rent, and Owner Operator Returns Actual and Average P/rent Ratios Farmland P/rent Ratio and the Reciprocal of Ten-Year Treasuries West Central Indiana Farmland Price (left axis), Cash Rent (right axis), and Owner Operator Returns (right axis), 1960 to 2012. West Central Indiana Farmland Cash Rent Owner Operator Returns 8000 500 450 7000 400 6000 350 5000 300 4000 250 200 3000 150 2000 100 1000 50 0 0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 22 2004 2008 2012 Farmland Price to Cash Rent Multiple for West Central Indiana, 1960 to 2012. Actual P/rent Average P/rent 1980 1988 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 1960 1964 1968 1972 1976 1984 1992 1996 2000 23 2004 2008 2012 Farmland P/rent Ratio and the Reciprocal of Ten-Year Treasuries, 1960 to 2012. Farmland P/rent Ratio Reciprocal 10-Year Treasury 60.0 50.0 40.0 30.0 20.0 10.0 0.0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 24 2004 2008 2012 Cyclically Adjusted P/E and P/rent Ratios • P/E Ratios – Shiller uses a ten-year moving average for earnings (P/E10) to remove the effect of the economic cycle. – P and E are expressed in real dollars. • P/rent Ratios – Use real farmland price as numerator – Use five-year or ten-year moving average of real rent (P/rent5 or P/rent10) for denominator • P/OO Ratios – Use real farmland price as numerator – Use five-year or ten-year moving average of real owner operator returns (P/OO-5 or P/OO-10) for denominator P/E and P/rent Ratio Graphs Cyclically Adjusted P/rent10, P/OO-10, and P/E10 Ratios, 1960 to 2012 10-Year Rate of Return and P/rent10 at Time of Purchase, 1960 to 2002 Cyclically adjusted P/rent10 ratio, 1930 to 2012 10-Year Rate of Return and Cyclically Adjusted P/rent10 at Time of Purchase, 1930 to 2012 45 Ten-Year Moving Average of Cyclically Adjusted P/rent, P/OO, and P/E Ratios, 1960 to 2012. P/rent10 P/OO-10 P/E10 40 35 30 25 20 15 10 5 0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 27 2004 2008 2012 Ten-Year Rate of Return (left axis) and Cyclically Adjusted P/rent10 at the Time of Purchase, 1960 to 2002. 25% Note Negative Relationship! 20% 15% 10% 5% 0% 0.0 5.0 10.0 15.0 20.0 25.0 -5% 28 30.0 Cyclically Adjusted P/rent10, West Central Indiana, 1930 to 2012 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 29 2000 2005 2010 Ten-Year Rate of Return (left axis) and Cyclically Adjusted P/rent10 at the Time of Purchase (horizontal axis), 1930 to 2002. 1930-1959 1960-1979 1979-2002 15.0% 10.0% 5.0% 0.0% 0.0 5.0 10.0 15.0 20.0 25.0 -5.0% -10.0% 30 30.0 Summary and Implications Back of the Envelope Computations: Predicted Land Values • Scenario #1: Long-run averages • Scenario #2: Current cash rent; 2012 average rates • Scenario #3: Current cash rent; long-run average rates • Scenario #4: Current cash rent; 5-year average rates • Scenario #5: 5-year average operator returns and rates Back of the Envelope Computations: Predicted Land Values Scenario T-Rate (1) Risk Premium (2) Inflation Rate (3) Cap Rate (1+2-3) Cash Rent Land Value #1 0.0654 0.0199 0.0342 0.0511 200 3,914 #2 0.0180 0.0199 0.0200 0.0179 253 14,134 #3 0.0654 0.0199 0.0342 0.0511 253 4,951 #4 0.0325 0.0199 0.0200 0.0324 253 7,809 #5 0.0325 0.0199 0.0200 0.0324 282 8,704 Farmland Versus other Assets: Real Rates of Return Variable Mean % return 1911-2011 US farmland price 0.97772 IN farmland price 1.14426 IL farmland price 0.85505 IA farmland price 0.97168 Inflation (CPI) 3.07525 GOLD price 1.27822 S&P 500 return 6.33822 Case-Shiller housing prices 0.21782 Summary and Implications • Inflation and interest rates are likely to increase • Current P/rent ratio is relatively high • Negative relationship between rate of return on farmland and P/rent ratio at the time of purchase • Cyclically adjusted P/rent ratio is relatively high • Caution!