Download Risk and Return for Farmland Today

Risk and Return for Farmland Today
Michael Langemeier and Tim Baker
Purdue University
Outline of Topics
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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.
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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
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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
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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!