The Wealth Paradigm – How Land Costs and Finance Have Become the New Risk Factors
Overnight, land and finance costs have overtaken machinery and labour as a differentiator in management on farms.
I grew up as an accountant during an era when machinery costs were escalating. During my time in public accounting, I saw the industry take a strong turn away from just analyzing gross margin, and into the discussion on “management techniques” on farms. Through the early part of this century (mainly 2005 to 2010) we saw a large shift in the way accountants presented and discussed financial measures. The new buzzwords at our firm became “LPM (Labour, Power, and Machinery)” and my favourite “Iron Disease”.
Now, don’t get me wrong, this is still a large issue on farms today – especially progressive grain operations. The cost of machinery continues to compound each year and competition in labour has forced these costs even higher. However, in the last twelve months I can unequivocally state that the new leading risk on farms is land and finance costs.
Historically, the term LBF (Land, Building, and Finance), was used to describe the multi-generational wealth in a farm. Those farms with longevity and whose grandfather built a solid foundation, had much lower costs per acre than the new farmer with high debt loads and rental acres. But, this was not a true measure of management because living off the past generation’s profits did not make you a strong entrepreneur.
Now to describe the shift…
When I started Maverick Ag with my business partner Kristjan, it was to take on the role of Chief Financial Officer at Hebert Grain Ventures. The farm was just starting its lofty expansion goals in 2019 going from 14,000 to over 20,000 acres (little did we know that would be 32,000 by 2023!). The concept was that the financial planning and debt management around this type of growth was getting harder and needed more supervision. It also helped that we were in what was likely the best interest rate period we will see in my lifetime.
Look ahead four years and I have been part of debt restructuring on more primary producer operations than I can count on my hands. The theory as an accountant was that we could not manipulate LBF costs in the short-term because it took years of management. However, on many farms, through restructures and interest rate drops, we saw significant lowering of risk through locking in rates. The term ‘interest rate risk’ used to be a fancy dictionary term that most farms ignored – if you didn’t manage it over the past five years you lost out on the largest opportunity available in ag.
Let me elaborate.
The difference between a 2% interest rate and a 7% interest rate on $1M dollars is $50,000 per year; on $10M it is $500,000 per year. The majority of farms we manage through strong debt restructures and available lending tools (interest rates swaps, bankers’ acceptances, longer term amortization periods) were able to lower their finance costs considerably. For those that are highly progressive, we even restructure lines of credit for future purchases.
So, in today’s environment you may be competing against one of our farms that already has a 2% rate locked in. This is a big advantage when buying land in today’s environment. To be frank, this opportunity was large and those that capitalized will do so for the next ten years (which is the majority of locked in swaps we did).
In the past I have written numerous blogs on land (it is obviously the hot topic these days with the rising appreciation). But I’ve never dug deeper into the management of land costs and how progressive operations have been able to gain advantages. And yes, there is more than just wealth behind these large land deals occurring lately.
When it comes to rental, how does one gain an advantage? My answer is usually simple, think outside the box. Our farm has grown exponentially over the past five years and the majority has been through rent, not ownership. I prefer long-term rental deals with strong landlords over the high price per acre that ownership requires these days.
You just need to remember that the farm needs to actually make money farming, not just on land appreciation (which sounds weird to read, but it’s true that the majority of farms in Saskatchewan would make more money renting land out than farming – don’t hate the comment, hate the data).
So, how do you structure a rent deal? My top advantages are as follows:
- Tax – I don’t like to praise our government, but one of the largest advantages we have gained has been in regards to tax on rental acres in a company. When the government increased the rates on passive income in a corporation (to over 50%), it allowed farms to get creative on rental structures.
This is when joint ventures really caught steam, and this created a large gap between management techniques of farms. Take home cash on $100 per acre land rent in a corporation is relatively close to $50 per acre. Take home cash on $60 per acre of “active business income” in a corporation is around $53 per acre. It has allowed many farms to offer significantly less rent per acre and provide higher take home cash for the landlords.
- Cash Flow – As a public accountant I used to laugh when the biggest issue most ageing farms had was if they could collect their “old age security” cheques. Many tax planning mechanisms were built around not costing the farms this monthly payment. The funny part is, a decade later, we now employ this same discussion in land rental agreements.
Monthly payments have become one of our top competitive advantages. It acts like a steady income and the risk of non-payment by a farm in a bad year is reduced as three-quarters of the money has been collected before the crop comes off. This is an easy way to increase your advantage on rent.
- Transparency – This last one is an anomaly and I give the credit to my partners at HGV for this. A main concern from landlords, especially those that are former producers, is pillaging of the land and its nutrients. This is where getting creative became an advantage.
How about a land guarantee that the soil samples from the first year must be equal or have less nutrients than the soil samples in the final lease year? A guarantee that we will “farm your land like we own it”, with a penalty of a per acre fee if we don’t. This provides a lot of trust factors from landlords in the long run.
As I have begun to see LBF costs start escalating from old benchmarks of $70 per acre to well above $100 per acre, I have also begun to see management techniques come out of the woodwork. This category of fixed costs has become another subset of good managers distancing themselves from the rest of the pack. And I truly believe that this will continue to show progressive strong growers and the large disparity from most of the industry.
In closing, a story that sums up all the items discussed:
Farmer: I just sold my farm and want to invest my money.
Financial Advisor: Buy Land.