Thesis Driven dives deep into emerging themes and real estate operating models. This week’s letter digs into farmland as a real estate investment asset class: major players, typical returns, and the future outlook of the sector. It also features the return of the Thesis Driven Buy Box.
Of all the alternative real estate investment sectors, farmland is among least appreciated and understood. Loved by billionaires, inflation hawks, and doomsday preppers alike, farmland is in the midst of a renaissance as an investment category. Today, we’ll study farmland as an investment and meet a few of the firms helping investors—institutional and retail—access it.
The USDA estimates that US farmland is a $3.4 trillion asset class—approximately the size of the US multifamily sector—yet it sees a tiny fraction of the transaction volume and institutional interest of other real estate food groups. A majority of US farmland is held by long-term family owners, many of whom have held the land for generations with very low (or zero) leverage. Over 60% of US farmland is held by owner-operators, and far less than 1% of it trades every year.
For a number of reasons—shrinking inventory, loose capital markets, and increasing investor interest—farmland prices have increased dramatically in recent years after decades of stability. According to the USDA, average farm prices have risen more than 20% over the past two years to $3,800 per acre, proving its worth as an inflation hedge and drawing further investor interest.
Today’s letter will dig into farmland as an investment sector, specifically covering:
Macro trends drawing investor interest to the sector;
Interviews with operators taking varying approaches on the sector;
Typical farmland investment profiles including target yields, IRRs, leverage, and deal sizes;
Forward-looking analysis including potential headwinds.
Why Farmland ?
Farmland is increasingly attractive to investors for a few reasons. One, the supply of it has been steadily declining for decades. Since 2000, the US has lost almost 50 million acres of farmland—5.3% of the nation’s total—an amount of land equivalent to the State of Nebraska in size. Greenfield development is a major driver of farmland loss; suburban housing developments, retail centers, and Amazon distribution facilities all occupy previously agricultural land. Marginal farmland has also been allowed to re-wild and return to forest, a trend that is seen most strongly in the northeastern US and even more dramatically in Europe.
The re-forestation of Europe from 1900 to 2010. Animation via the Washington Post.
Furthermore, the amount of farmland is practically limited. While farmland is easily lost to development, it is very expensive—and often environmentally discouraged if not prohibited—to convert non-farmland into net new farms. While some new farmland was created in the 2008-16 period in response to investment in biofuels and ethanol subsidies, it did little to reverse a multi-decade trend of farmland loss.
Farms have also benefitted from advances in technology—which have increased productivity and driven down operating costs—without facing existential, disruptive threats from new models. While we’ll discuss headwinds later in the letter, potentially disruptive innovations such as vertical farms, hydroponics, and lab-grown meat haven’t yet come close to competing against traditional farming methods in the largest product categories such as corn, soybeans, wheat, beef, and chicken.
The net result of these trends over the past 50 years have been very positive for farmland owners; the asset class has seen solid returns without strong correlation to other investment categories or significant volatility. Since 1970, US farmland returns have exceeded the S&P 500 while exhibiting little correlation to other major sectors.
Not all farmland is the same, and farmland returns are driven by a variety of factors. At the highest level, farmland’s return profile is driven by two big things: (a) the productivity of the land and (b) the potential to turn the land into something else in the future; e.g., a housing development.
It’s impossible to divorce farmland returns from the underlying productivity and profitability of the land. The quality and fertility of the soil, availability of water resources, climate, and suitability for specific crops or livestock are primary determinants of productivity. The geography of the land, including its topography and size, also matter, as does its proximity to markets and infrastructure such as roads and utilities. And regulatory factors like environmental regulations and agricultural subsidies can play a big role in determining yield and profitability.
Like other real estate food groups, farmland is divided into classes that roughly correspond to the area’s productivity and reliability as a farming area. Prime corn-growing land in Iowa or Indiana, for example, would be considered Class A (or "core") farmland. Cold, dry land suitable for wheat or grazing in Montana or the Dakotas, on the other hand, would be considered Class B (or "value-add") land. In general, value-add farmland trades at a much higher cap rate—around 200 basis points—than core land.
Farmland investment also varies based on the types of crops that are grown on a given piece of land. In general, there are two types of crops: row crops—which are planted anew every year—and permanent crops like trees and bushes that persist year-over-year. While row crops are fairly straightforward from an underwriting perspective, permanent crops add complexity as they take several years to mature and must be replaced on a regular basis, so they depreciate over time. This depreciation impacts the farm’s value but can also provide tax benefits.
Land prices—and the prospect for land price appreciation—also must take a farm’s future development potential into account. Buying farmland near growing cities or major distribution corridors (like interstate highways) can be viewed as a form of covered land investing. That is, the farmland is being used for agriculture now, but due to urban sprawl or changes in zoning laws, the land may be more valuable in the future for non-agricultural uses. In these scenarios, the land’s value is some combination of its current yield and its future value as a development site; these farms tend to trade at lower cap rates.
But for most investors—institutional allocators as well as families and individuals without Gates’s resources—buying farms outright requires a tremendous amount of commitment and experience, especially given the scarcity of large, profitable farms sold through a public process. These investors are looking for a more accessible route to gain exposure to farmland, and a new cohort of companies are helping them find it.
Trevor Hightower of Macfarlan Capital Partners is part of this new generation of firms helping high net worth individuals and institutional investors purchase farmland. An Air Force veteran with a background in multifamily and retail, Hightower spoke with me about his firm’s approach to farmland as an investable asset.
"Farmland is the OG of real estate," said Hightower. "It’s a non-correlated asset that’s an inflation hedge, and it tends to weather economic storms well. The more you look at farmland, the more it’s obvious why [investors] are looking at it."
The Macfarlan Buy Box:
Market: Secondary agricultural regions, currently Montana & South Dakota
Individual Asset Size: $15 to $30M total deal size
Target UYOC: 6-8%
Target Leverage: 50% LTV
Target Hold Period: 10 years
Target IRR: 13-15%
Macfarlan’s primarily clients are wealthy individuals and family offices. They target the "middle market" of farmland assets; large enough to be worth their time but too small to attract institutional interest. This strategy has been helpful in maintaining their target yields as more institutional investors have begun competing over larger farm assets.
The farm operator is a critical part of Macfarlan’s investment process. "We find farms with help of the operator," says Hightower. "And the operator invests in the farm alongside us, aligning interests." In one of Macfarlan’s recent acquisitions, the farm operator put in 17% of the total equity required to purchase the farm. In addition to capital, Macfarlan provides farmers with shared services and back-office support.
Retail investors also have a path to invest in farmland assets. Carter Malloy runs AcreTrader, a fractional ownership platform for farmland that has raised over $330 million to purchase 135 farms since its founding in 2018. While retail investors—some investing as little as $20,000—form the backbone of AcreTrader’s buyer pool, Malloy has seen increasing institutional interest in the category.
The AcreTrader Buy Box:
Market: Variety of US agricultural regions
Individual Asset Size: $1 to $5M total deal size
Target UYOC: 3-4%
Target Leverage: 0%
Target IRR: 11% (unlevered)
Unlike Macfarlan, AcreTrader avoids leverage on its purchases. "Our pitch is to be boring and conservative, so we don’t usually take debt," says Malloy. Given that many of the properties offered on AcreTrader are high-quality, Class A farmland, unlevered cash-on-cash yields can be as low as 3%.
In Malloy’s model, sponsors are typically farmers themselves, operators looking to expand their farming footprint with additional land purchases. "For farmers, we are an equity finance tool," explains Malloy. "The farmers are mini-GPs, and we work with thousands of farmers looking to source land." The farmers sign an operating agreement with AcreTrader; we’ll cover the different types of operating agreements at work in the next section.
AcreTrader is supported by a proprietary farmland underwriting tool, a simplified version of which can be found on Acres.com. Malloy toured me through the tool, demonstrating how it uses historical satellite data as well as other information—the presence of standing water, topography, soil composition, and historical yield data—to help the AcreTrader team underwrite farms and identify potential risks.
Acres, AcreTrader’s farmland underwriting and analysis tool
REITs also offer an opportunity for individual investors to access farmland. There are two major farmland REITs in the US. Gladstone Land (NYSE:LAND) primarily owns California farmland producing berries, fruit, nuts, and other "permanent" crops. On the other hand, Farmland Partners (NYSE:FPI) primarily focuses on commodity row crops like corn, soybeans and wheat with properties across the US heartland. Both earn a majority of their revenue by net leasing land to farm operators.
Structuring Farm Operations
Financially, farmland operations tend to follow a few structures that will should be familiar to regular Thesis Driven readers.
In the direct farming model, the farm is owned and operated by one entity. While this is how the majority of farms operate in the US today—with one farming family or organization both owning the land and operating the fam—it is relatively rare in the world of farmland investing in which the real estate and the operator are separate entities. Unlike (say) the hospitality industry, agriculture hasn’t yet gone through the widespread disaggregation of operations and ownership, so direct farming models are still commonplace.
Net leases are the simplest type of structure out there. In this model, the farmland owner will sign a net lease with the farm operator, ensuring a steady cash flow for real estate investors while giving the farmer the upside (and downside) of variations in productivity and yield.
This structure is not as risky for the farmer as it may seem; the Federal Crop Insurance Program has protected farmers from losses since the 1930s and currently covers 74% of all potential output liabilities of US farmers. So even a particularly bad harvest would be unlikely to cause a farmer to default on their lease obligations.
Federal crop insurance now protects a significant majority of all planted acres in the US. Chart from EveryCRSReport.
Other farmers prefer to sign operating agreement structures similar to management agreements in the commercial real estate market. In this model, the farm manager charges a percentage management fee usually between 5 and 10% of total net crop proceeds. In this model, the farm owner takes all of the productivity risk—federal crop insurance aside—but outsources operations to a third party.
Often, the owner and farmer choose to combine the net lease and operating agreement models into a blended structure in which the farmer pays a lower base rent plus a share of upside to the farm owner. This blended model is AcreTrader’s favored structure. "If we were otherwise going rent a farm for $300 per acre, we’ll instead rent it for $200 per acre base rent," says Malloy. "Then the farmer will pay us another $50 to $200 based on a formula considering commodity prices and yields. This helps the farmer offset risk while giving [the investor] some upside."
Risks and Future Outlook
Farmland has a number of structural tailwinds: there is a dwindling supply of viable farmland, the category is not particularly sensitive to economic cycles, and farmland has historically produced strong investment returns. But trends change, and it’s worth taking a look at the threats facing farmland investments on the horizon.
As we mentioned earlier, farmland investments have two primary return drivers: the operating cash flow produced by farm operations and appreciation of the underlying land. Each driver its own opportunities and threats.
On the surface, the cash flow coming from farm operations seems like as sure of a bet as any: the amount of farmland is decreasing, human population is increasing, and humans require food. But a Malthusian future in which these forces push food prices ever-higher seems increasingly unlikely: while technology continues to improve the efficiency and quality of food production per acre, global populations are widely expected to peak in the next 50 to 75 years before beginning to decline as more countries go through demographic transition. Many large countries have already turned this corner; China’s birth rate fell below replacement rate in 1991 and India passed that threshold in 2020.
Climate change represents another risk for farmland owners. While changes in weather patterns may radically shift the number and location of farmable acres over the remainder of the 21st century, the United States is relatively well-positioned among global food producers. "Advances in plant genetics are way faster than changes in climate," notes Malloy. "The crops themselves will be okay. What’s problematic is water and volatility in weather patterns." Malloy offers the example of almonds in California as a crop that is exposed to significant climate risk due to water shortages in the coming years and decades. But he notes that the US agricultural industry is relatively well-positioned to handle climate threats. "[We] have great distribution, water, soil, waterways, technology, and government programs" relative to other countries with major farming industries.
Land appreciation has also been a major driver of farmland returns over the past 50 years. Suburban sprawl has created the opportunity for thousands of farm owners to cash out, driving overall returns in the category higher.
But it may be tougher for farmland investors to rely on this tailwind going forward. In a sense, many farm buyers are making real estate bets in places that are rapidly depopulating and have few economic drivers beyond the farmland itself. And land within an obvious path of urban development comes with a significant price premium and is best viewed as covered land—not farmland—investing.
This is not to say that land price appreciation won’t be a factor; rather, it will impact owners differently depending on where they own. Remote work may bring more relatively well-off people to certain rural areas, reversing negative population trends in specific areas. Colorado, Washington, Vermont, parts of Montana, and southern Appalachia all benefitted from these trends over the past 10 years and saw their populations grow and diversify. But farmland investors that are betting on land appreciation as a return driver must be intentional about the underlying demand that will drive any price appreciation.
In aggregate, it’s tough to argue with advocates like Hightower and Malloy who believe that farmland is one of the better bets in real estate today. Strong historical returns and a lack of correlation with the broader market have made it a favorite of billionaires and wealthy families for good reason.
There’s also something buried deep in our lizard brains that makes it compelling to own farmland. Even when structured and sold in increments on a website, owning a piece of American farmland feels like powerful insurance against something Very Bad happening. We discussed these human motivations when we covered Terranos Houston a few weeks ago, and they are no less true in this case.
Sometimes, it’s just nice to own a small piece of land.
— Brad Hargreaves
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