Farmland Price-to-Rent Ratio and Interest Rates – AgFax

Corn field in the spring. ©Debra L Ferguson

The ratio of price per acre of farmland to rent paid per acre for farmland has increased over the past 50 years and particularly since 2000. This increase is conceptually and statistically associated with falling rates of interest.

The Federal Reserve has indicated that it is committed to raising interest rates to curb inflation. As interest rates rise, the ratio of farmland price to rent is likely to decline unless offset by other factors.

Land price/rent ratio

The ratio of farmland price to farmland rent is an example of a general type of ratio that relates the value of an asset to the income it generates. A ratio of farmland price to farmland rent for the United States can be calculated from 1971. The specific ratio is [(average US per acre price of agricultural land and buildings) divided by (price index of agricultural services and rents)].

The values ​​of these variables are contained in the US Department of Agriculture’s (USDA) Quick Stats database. This ratio has followed an upward trend, increasing by 122%, from 7.22 in 1971 to 16.01 in 2021 (see Figure 1). The upward trend accelerated after 2000, with the ratio increasing to 69%.

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A potential concern with this ratio is that the numerator includes buildings as well as land while the denominator includes agricultural services as well as rent. The ratio may therefore change even if the farmland price/rent ratio does not change. However, variable control exists.

The USDA has published the US price of cropland and the US cash rent paid for cropland since 1997 and 1998, respectively. These variables are also available in Quick Stats. Since 1998, the two land price/rent ratios have evolved together (see Figure 1). Their correlation is +0.93 (1.00 is a perfect correlation).

Moreover, the year-over-year changes of the two ratios have a correlation of +0.81, which is a strong relationship between the year-over-year changes. This comparison suggests that the ratio of farmland and buildings to farm services and rents is a reasonable measure of the relationship between the price of farmland and the rent of farmland.

Land price to rent ratio and interest rate

A basic model of asset pricing is that the price of an asset equals its discounted stream of future net returns. The rent is a net yield of the land. A conventional measure of the discount rate is an interest rate. Figure 2 shows the relationship between the farmland price-to-rent ratio and the interest rate on 10-year US Treasury bills, a commonly observed and market-determined interest rate.

Between 1971 and 2021, the interest rate on 10-year US Treasury bills (constant maturity) averaged 6.1% with a range of 0.9% to 13.9%. For 2021, it was 1.5%.

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The change in the 10-year Treasury rate explains 53% of the change in the farmland price-to-rent ratio. As expected, the relationship is negative. Higher interest rates are associated with lower land price-to-rent ratios. A 1 percentage point (ie 1%) increase in the interest rate reduces the farmland-to-rent ratio by -0.683 (0.01 * -68.3). The relationship is significant with a statistical confidence of 99%.

Summary observations

The ratio of the price per acre of US farmland to the rent per acre paid for farmland has tended to increase over the past 50 years.

This ratio is negatively related to interest rates with a statistical confidence of 99%. For a given level of rent, the price of land increases (decreases) with the decrease (increase) of the interest rate.

The US Federal Reserve began raising interest rates to control inflation.

To give an idea of ​​what higher interest rates may mean for farmland prices and assuming no other variable changes initially, an increase in the Treasury bill rate to 10 years at its average value of 6.1% would result in a 20% drop in the price of farmland.

The drop could be greater. The previous calculation does not take into account the fact that higher interest rates may increase interest charges and therefore lower the rent. Interest charges are dealt with in the article from the daily farmdoc of March 21, 2022.

The analysis found that the change in the 10-year US Treasury rate explains 53% of the change in the farmland price-to-rent ratio. In other words, 47% of the variation is unexplained. Given the magnitude of unexplained variation, identifying other factors associated with variation in the farmland price-to-rent ratio would be a useful area of ​​research.

Carl Zulauf, Gary Schnitkey, Krista Swansonand Nick Paulson

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