Pesticide sprayer in corn field. Photo: Michelle Wiesbrook, University of Illinois
Farmland prices have increased by large amounts over last year’s prices. Even with these increases, farmland prices are still close to the levels suggested by the historical relationship between farmland prices, farmland yields, and interest rates.
Significant declines in farmland prices could occur if 1) commodity prices deviate from current expectations, or 2) interest rates rise due to Federal Reserve Bank (FED) measures to combat inflation.
Farmland price increases in 2022
The National Agricultural Statistics Service published land values and cash rents for states in the US. For 2022, average Illinois farmland prices are estimated at $8,950 per acre, a record level that is 13% above 2021’s level of $7,900 per acre (see Figure 1).
The last time land values in Illinois increased by more than 13% was in consecutive years 2011 (16% increase), 2012 (15%) and 2013 (14%). Since 1970, land values have increased more than in 2022 19% of the years, suggesting that the increase in 2022 is large but also not a one-off event.
Other studies confirm rising real estate prices in the Midwest. The Chicago Fed Ag letter indicates that land values in northern 2/3 counties of Illinois increased 18% between Q2 2021 and Q2 2022. A Purdue Agricultural Economics Report indicates Indiana property values increased by over 30% from June 2021 to June 2022.
A Farmland Value Benchmark Study prepared by assessors at Farm Credit Illinois evaluated 20 benchmark farms in Illinois’ southern 60 counties. From July 2021 to July 2022, soil values on Farm Credit Illinois’ benchmark farms increased an average of 28%.
Overall, much of the land price hike seems to have happened before April 1st. For example, the Chicago Fed reported that property values in Illinois did not change between April 1 and July 1, 2022. Likewise, the country’s largest increase in Indiana occurred in the latter half of 2021 and not the first six months of 2022.
Factors affecting farmland prices
Most economists believe that the price of farmland should equal the discounted sum of all future returns from farmland. Obviously future yields and discount rates are not known with certainty. Expected future returns are approximated by cash rents, assuming current rent levels are indicative of future rent levels.
Current interest rates are often used to measure discount factors, including under the assumption that they represent market expectations for the future. Cash rent amounts and interest rates are discussed in the following two sections. The combined effects of the two factors are then assessed in the Capitalized Values and Farmland Values section.
Higher cash rents usually result in higher farmland prices. NASS estimated the average Illinois bar rent for 2022 at $243 per acre, a 7% increase from the 2021 level of $227 per acre (see Figure 1). The $243 rent for 2022 was the highest rent level in Illinois history.
Overall, rising and high cash rents in 2022 are the result of high yields for farmland caused by:
- high commodity prices in recent years (see farmdoc Daily, August 2, 2022) and
- Ad hoc federal payments from the Market Facilitation Program (MFP), the Coronavirus Food Assistance Program (CFAP), the Wildfire Hurricane Indemnity Program-Plus (WHIP+), and the Economic Relief Program (ERP).
Higher non-land costs have also occurred, but not at levels that offset higher commodity prices and ad hoc federal payments. 2023 returns are likely to be positive if corn prices are in the mid-$5 range and soybean prices are in the high-$12 range. At this point, fall 2023 bids are at these levels, suggesting there will be no downward pressure on cash rents.
A rise in interest rates generally lowers asset prices, particularly long-lived non-depreciable assets such as farmland. In addition, higher interest rates increase farm mortgage costs, increasing the cost of acquiring farmland. And higher interest rates correlate with higher alternative asset returns, making farmland less attractive as an investment.
The 10-year Constant Maturity Treasury (CMT) rate is a reasonable proxy for the farmland capitalization rate. The CMT rate has been low since the 2008 financial crisis. From August 2013 to date, 10-year CMT rates have averaged 2.07% (see Figure 2).
2020 saw very low interest rates as the Federal Reserve Bank (FED) implemented rate cut measures to mitigate the economic impact of the Covid pandemic. Ten-year CMT rates were below 1.5% for a few days in June 2020.
In recent months, the Fed has made efforts to bring down inflation by implementing measures to raise interest rates. As a result, 10-year CMT interest rates hit 3.31% on June 21st. Since June 21, the ten-year interest rate has declined and is now close to 2.70% in early August 2022.
capital values and farmland values
Over the past two years, increases in agricultural land yields are expected to increase agricultural land prices, while interest rate increases would have the opposite effect. Economists often use a capitalization formula to assess the combined effects of changes in yields and interest rates. A simple formula is often used to approximate the value of farmland:
Capitalized Value = Cash Rent / 10 Year CMT Rate
Again, this approximation assumes that current cash rents and interest rates represent longer-term expectations for the future. While this formula is simple, it has worked reasonably well in the past to point to times when farmland prices appear to be at odds with fundamental yield and interest rate drivers.
The orange line in Figure 3 shows historical capitalized values calculated using the formula above. The green line shows average Illinois farmland prices.
When farmland prices are above capitalized values, the fundamental yield and interest rate drivers of farmland prices suggest that farmland prices are too high.
In the late 1970s and early 1980s, before farmland prices fell during the agricultural financial crisis, there was an extended period of prices well above the implied capitalized values. Prices fell from their highs by the mid-1980s to levels suggested by the simple capitalization formula.
Between 1986 and 2006, farmland prices and capitalized values followed each other closely. However, since 2006, capitalized values have been higher than actual farmland prices. Early in this period, commodity prices rose due to the increased use of corn in ethanol.
Much of that time has also been associated with low and falling interest rates, which market participants may have thought would not last forever. The differences became particularly large in 2020, when the Fed pushed interest rates to very low levels. In 2020, the capitalized value was $24,966 per acre compared to an actual price of $7,300 per acre.
Land prices have increased since 2020, reaching $8,950 in 2022. Capitalized values are down to $9,720, with the decline being caused by higher interest rates. While the difference has narrowed significantly, capitalized values are still higher than farmland prices.
Current farmland price levels do not appear to deviate from historical relationships between farmland prices, farmland yields and interest rates. While there are concerns about overpriced farmland, farmland prices are unlikely to fall much unless yields fall or interest rates rise.
Cropland yields could fall, and corn and soybean prices are the most likely cause of these declines. Lower prices could materialize as official USDA and Congressional Budget Office (CBO) forecasts point to much lower prices in the coming years.
Still, prices on Chicago Mercantile Exchange (CME) contracts are not pointing to much lower commodity prices in 2023. Continued increases in nonland costs could also cause cropland yields to fall.
A more likely immediate cause of the pressure on farmland prices is higher interest rates. The Fed has announced that it will try to lower inflation by raising interest rates later this year. Any increase in 10-year CMT rates will bring capitalized values below farmland prices.
A 3% interest rate for 2022 results in a capitalized value of $8,100 ($243 cash rent / 3% CMT rate), which is $850 per acre below the 2022 price of $8,950. A 5% CMT rate has a capitalized value of $4,860 per acre, or almost 50% below the current price of $8,950.
It remains to be seen whether the Fed will hike interest rates. Even in the face of Fed policy, longer-term interest rates may not rise as expectations may be for a relatively short period of Fed action on inflation rates.
For example, the 10-year CMT fell in the first few weeks of August, even amid expectations of higher interest rates. Similarly, even if 10-year CMT rates rise on expectations of lower rates in the future, farmland prices may not react very much.
Farmland prices have risen sharply in the past year. Still, higher farmland prices appear consistent with current farmland yields and interest rate levels. Farmland prices could fall next year, likely due to either lower commodity prices or higher interest rates. Higher interest rates seem more likely at this point, but higher interest rates are not a matter of course.
Gary Schnitkey, Krista Swanson, Nick Paulson, Jim Baltz, Jonathan Coppess, and Carl Zulauf