Earlier this year I blogged about why I was interested about farmland investing. And earlier this month I posted about how I was really close to buying my first farm. Well drum roll please because earlier this week I officially became a farm owner 😉 That doesn’t mean I’m a farmer though. I still live in the city, but I’m the landlord of a farm in eastern Saskatchewan. With farmland prices growing at double digit rates in the United States, Australia, United Kingdom, and pretty much all over the world, Canada is certainly no exception to the global trend :0) Buying farmland as a long term investment is not for everyone, but if you’re interested to learn more about the business, please read on (*^_^*)
About my Farm
Saskatchewan is divided up into small squares called rural municipalities (RMs) Each RM has a number and a name. My farm is in the RM of Sliding Hills (RM #273) Below is a map of Saskatchewan.
And here’s a close up shot of the RM
My farm is used for agricultural purposes to grow grains (wheat, barley, canola, etc) There are no buildings on the land. It’s in the black soil territory of Saskatchewan, the best kind 🙂 Total area of the land I bought is 160 acres, or 1 quarter section. That’s about 7 million square feet. 135 acres is cultivated, and the remaining 25 are bush or slough.
Buying farmland is similar to buying a house. I get emails from my realtor periodically about new listings. I also went to the mls.ca website and filtered for “Agriculture” and searched for listings based on my price range. Super easy to do. Eventually I came across the following listing. Except it wasn’t sold at that time yet.
The seller wanted $167,000. I offered $145,000, to which he counter offered with $150,000. And that’s the final price we agreed on. I think it was a pretty good deal (works out to $937.50 per acre) because when my bank did their own assessment of the land they valued it at $154,500 so according to my bank, technically I’ve made $4,500 on my investment already :0) The crop insurance rating of my farm is an “F” meaning it’s Fantastic 😀 Haha. Just kidding. All farmland has a letter grade based on it’s soil quality, ability to hold water, etc. The better the land the better the grade. F is pretty high up there 😀 You might see a C or E but they are super rare and go for a much higher premium 🙂
After I removed my subjects on the purchase agreement I found a lawyer in Saskatchewan for all the legal stuff, and went to my bank to get financing. TD requires a 25% down payment and lent me 75% at 3.89% fixed rate for a 1 year term. Took a Prt Scr of my account details below. Total lawyer and bank fees: about $2,500.
Luckily there was already someone renting the land from the seller when I bought it. I talked with this farmer and he said he is interested to continue farming there. So we signed a 2 year agreement where he pays me $37.50 per cultivated acre of land every year. Right now there is 135 cultivated acres so I will be paid $5062.50 per year. That represents about 3.4% return on the value of the land with no operational risk to me 😉 Payment is to be made twice a year, half of it when he seeds in spring and the remaining half is paid when he harvests in the fall. Pretty typical rental agreement. Anyone can download these lease templates from the government of Saskatchewan website.
Behind the Numbers
Now to tackle the ultimate question. Does this investment make sense from a financial point of view? Let’s go through the numbers.
First, breaking down the cost of $150,000. As mentioned earlier, I needed to come up with a 25% down payment, or $37,500. Notice how I haven’t been blogging about the stock market much lately? That’s because I didn’t buy any new stocks since July. I started researching about farmland back in the summer and decided to start saving as much as possible. I had saved $10,000 in my bank account by the time I bought this farm. I had also mentioned I sold about $10,000 worth of stocks in September. So that’s $20,000. The remaining $17,500 I borrowed from my line of credit.
- $10,000 Savings
- $10,000 Procedes from selling stocks
- $17,500 Line of Credit at 5.25% floating
- Total = $37,500
- $112,500 loan amortized over 25 years, currently at 3.89%
- Total = $112,500
Total purchase price = ($37,500 + $112,500) = $150,000
Next, let’s compare the income vs cost of owning. This will tell us whether I’m making money or losing money.
- Rent = $37.5 x 135 acres = $5062.50
- Total Revenues = $5062.50 / yr
- TD Farm Loan: $112,500 at 3.89% interest rate = $4376.25
- Line of Credit: $17,500 at 5.25% interest rate = $918.75
- Property Tax: $475
- Total Expenses: $5770 / yr
- Net Loss = $707.50
Not sure if that’s the proper way to do a balance sheet. Lol, I’m obviously not an accountant 😛 But basically I’m paying more than $700 out of my own pocket every year. I’m not surprised though. If you think about it, I’m really only putting down $20,000 of my own hard earned money which is about 13% of the land’s entire value. The remaining balance is financed one way or another, we’re talking about serious leverage here. This is what’s known in the mortgage industry as a high ratio loan, lol. Some readers might think I must be high on paint thinner. What kind of loony investor would put $20,000 of his own money into something that clearly will give him a negative return! He would be better off putting that money under his bed. He should at least save enough for a proper down payment like 20% or higher, and not rely on his credit line.
I agree that the conventional way of analyzing cashflow would label my farm purchase as a bad decision. However many of my investment ideas are anything but conventional, and this is yet another example 😛 Despite losing $707.50 a year, I still think this is a good investment. I have 4 reasons for this.
1) The bigger picture
In Chess we sometimes have to sacrifice pawns in order to win the game. In the game of investing, a short term loss is sometimes a necessary part of the longer term strategy. A lot of businesses are not solvent at first but over time they can grow to become very profitable. Farmland is such that investors need to have a long term view of the situation. You cannot buy and flip farms for a profit like you can with houses. I may be losing money now, but the entire loan is amortized over 25 years. And in the second year I will have paid off a portion of my principle, which means I’ll be paying less interest than today. I will probably break even some time in 2014. So for the majority of the amortization period I WILL be making a profit, just not right now.
2)Rent/Income to grow over time
This one is pretty self explanatory.
3) Capital Appreciation
Because farmland tends to hold its value over time we can assume with relative certainty that my farmland will grow in value over the next decade or so if we continue to have inflation. In fact, historically farmland prices have pretty much consistently beat inflation because the global farmland supply is shrinking, at the same time demand is growing. Just to be on the conservative side, let’s assume farmland prices in Canada will increase by only 1% to 2% on average over the next 10 years. Even so, that means by next year my farmland will be worth $1,500 to $3,000 more (1% to 2% of this year’s purchase price of $150,000) That is more than the $707.50 I lose in my first year of operations. Below are what returns will be given 3 likely scenarios of different appreciation amounts.
|Price of Farm||$150,000||$150,000||$150,000|
|If Farm Appreciates by||1.0%||1.5%||2.0%|
|Farm will be worth an additional||$1,500||$2,250||$3,000|
|Net loss from operations||$707.50||$707.50||$707.50|
|Net Return on Investment||4.0%||7.7%||11.5%|
Those returns aren’t great, but they’re not that bad either I think. A classic example of sacrificing income, for growth, which is good, because realized wealth (capital gain) is taxed less than realized income anyway 😀
4) Inflation Hedge
With all the money printed by the Fed, there are some people who think we might see inflation reaching 3% or higher in the future. Remember in 2011 when everything from food to gas appeared to have gotten really expensive? That’s because the inflation rate in 2011 was 2.9%. During that same year, the average price of farmland in Canada increased by 14.3%! I missed out that time but there is NO WAY I’m going to miss out on another opportunity like that (>_<)
Those are my 4 reasons why I purchase the farm despite being cash flow negative 🙂 I choose to assume a modest 1 to 2 percent growth rate so even if prices fall next year my long term view should give me plenty of time to recover. But what if we used some actual numbers, some real data! To the right is a chart that shows how much farmland prices have appreciated over the last 5 years. Source: FCC
Holy macaroni (o_o) those numbers are much higher than the 1%-2% annual growth rate I’ve predicted. Longer term data show similar results with farmland increasing double digits per yer on average over the last 10 or 20 years. If I make 4% return on my investment when my land goes up just 1 percent in value, imagine what my ROI will be if my farmland continues to appreciate next year like it has been doing in the last 5?
As with any investment, past performance is not an accurate indicator of future gains. The boom in global farmland prices will not last forever and there are many risks in the agricultural business. But I believe the potential for profit far outweighs those risks, especially if one has a long term investment view. According to a study by Enquirica Research, Canadian farmland has seen a 10.6% increase in returns over the past 10 years, compared with 3.8% for the Toronto Stock Exchange Index. I don’t believe farmland is a better investment than the stock market. The truth is nobody knows what the price of farmland will do next year. But I already have over $100,000 in stocks, so I’m just looking for ways to diversify my investments. Will my new farm be a good investment or did I just make a big mistake? We’ll just have to wait and find out (~_~)
Sorry for the long post 😛
[Edit June 2013] All information above was posted in December 2012. Months later the farmland value report came out and Canada’s farmland increased 19% in 2012 😀 Wow, the reality of land value appreciation turned out to be much better than the 1% or 2% I was expecting. See my post about how this investment has been paying off so far. This makes me want to buy another piece of farmland!
I also wrote a FAQ for how to draft up lease agreements, rental rates, free lease templates, etc [/edit]
[Edit June 2014] Okay. In 2013 I purchased another farm for $172,500 with a $20,000 down payment. Now I have 2 farms, yay! According to FCC during 2013 Saskatchewan farmland values increased 28.5%. That means my first farm purchased in 2012 for $150,000 is now worth more than $200,000! OMG! 😀 [/edit]