Institutional investors usually refer to farmland as a better investment than commercial real estate. The major challenge, though, is that the historical performance of farmland as a real estate investment trust has been limited. Both farmland REITs we track, Farmland Partners and American Farmland Company, have been public for less than two years. The former distributed first dividend in June 2014, while the latter did the same last December.
All the same, investors usually consider how farmland is performing based on its National Council of Real Estates Investment Fiduciaries’ index (NCREIF Farmland Index). NCREIF was established to provide the institutional real estate investment community with real estate performance information.
However, the NCREIF Farmland returns do not necessarily match the REIT return. In 2015, NCREIF Farmland had positive total return of 10.4 percent whereas American Farmland showed a total return of -16 percent and Farmland Partners 5.6 percent.
NCREIF returns stem from appraisals which can happen once in a year and do not take into account the fluctuations in the financial markets. Also, the appraisal of all the assets in the index does not take place simultaneously. Moreover, appraisal results are generally smoothed out. As an example, the evaluators sometimes do not capture changes in pricing entirely until a pattern is well defined.
The farmland REIT environment is structured as farm rentals where the REITs typically pay for the property insurance, taxes and maintenance. The tenant is responsible for input costs, labor and fuel. The tenant can either be under a participating or fixed lease depending on the types of risks the company chooses to take.
The shareholders in farmland REITs do not have as much information about their tenants as those in regular REITs. Some of the decisions the tenants make are subjective and can affect the overall performance of the crop. Also, crops are subject to external factors such as natural disasters (hail, drought, floods, and so on). But, in bad years, crop insurance is an important mitigant and helps curb the losses.
Farmland business has its own advantages despite being a tough business. In the long run, there are bound to be benefits from this investment. The downside of farmland is its reliance on weather conditions which may either diminish the crop or lead to oversupply. Additionally, crop prices (particularly corn) have been dropping in the market, and this has been a setback.
However, factors such as growth in population, especially in the middle class population, will push the demand for food upwards. There are also other imminent factors such as desertification and urbanization that are eating up productive land. The resulting effect will be a rise in value of farmland.
Source: NCREIF, Yahoo!Finance, American Farmland Company(AMEX:AFCO), Farmland Partners Inc.(NYSE:FPI)
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