Farmland Prices: Is the Bubble About to Burst?

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Record-high prices for corn, soybeans, wheat and other commodities have left growers flush with cash to purchase more land. And what the farmers don't pay for out of their own pockets, historically low interest rates provide them with easy and cheap access to money to close the deal.

The favorable mix of both cash and credit has provided fuel to drive up land values across the Midwest, stoking fears of a bubble ready to burst.

In Iowa, where rich soil, favorable weather and ethanol and livestock production help foster demand for limited growing space, farmland values have soared 90 percent since 2009. An acre of farmland that a decade ago sold for an average of $2,275 now goes for $8,700, according to Mike Duffy, an economist at Iowa State University who watches land prices.

It culminated last October when an 80-acre parcel near Boyden in Sioux County, some of the most fertile ground in the Corn Belt, sold for a record $21,900 per acre.

"The concern clearly is not so much how much higher are they going to go, but when this bubble breaks, how low will they go and what will the aftermath of that be?" said Michael Hein, vice president of the Liberty Trust and Savings Bank in the southeast Iowa town of Durant. "If profits start to diminish, there will be an impact on land values as well." Hein called the recent increase in land values "not sustainable" and said if they do rise in 2013, it will be at a more moderate pace.

Colin Johnson, a fourth-generation farmer, who rents land from a dozen different property owners in and around Wapello County, has been careful not to get swept up in the bidding frenzy.

He was approached in 2012 by two who were looking to sell, giving the 36-year-old corn and soybean farmer the first chance to make an offer.

Each time, Johnson lost out to a competitive market with buyers willing to pay far more than he could afford.

"The (landowners) went the route of 'I'm going to take the high dollar,' and I don't blame any of them for doing that," said Johnson, a husband and the father of three children. "Land is just bringing such a premium, and I believe it is highly inflated right now. I can't take that risk as a person with a young family."

The inevitable drop in land prices is unlikely to be as sharp as in the early 1980s, when new purchases were financed largely with debt and less with farmers' own capital, say economists and bankers who work in the agricultural industry.

When interest rates on their loans soared and crop prices declined, many farmers no longer had the income they needed to pay the bank. They had no choice but to unload their real estate, contributing to the sharp downdraft in land values.

The crash was especially severe in Iowa, where the value of the state's farmland plunged from $2,147 an acre in 1981 to a low of $787 five years later, a drop of 63 percent. A third of the state's farms went out of business.

Since then, farmers have become more financially conservative, leaving them in a better position to weather a downturn.

Land purchases during the last few years have been made with growers regularly using 50 percent to 75 percent of their own cash. And the finances of the farm are stronger than ever with the debt-to-asset ratio expected to be the lowest level on record in 2013, according to the U.S. Department of Agriculture.

A drop in land prices now means farmers are losing the investment of their own cash rather than being left in a lurch with the local bank. It doesn't mean they won't feel the heat financially, but it's likely to prevent as many farmers from getting irreversibly harmed and, at the same time, limit the severity of a drop in land prices.

"The shock absorber is the enormous amount of farmer capital that they have invested in real estate," said John Blanchfield, a senior vice president and director of American Bankers Association's Center for Agricultural and Rural Banking.

"The cautionary tale is this: Farmers hate liquidity. They just can't stand to have money in the bank, and so an enormous amount of farmer liquidity has been invested in real estate. If there is a rapid correction in commodity prices ... the liquidity that farmers should have had to tide them over in a poor cash flow period" has been invested in land, he said.

Banks such as Liberty Trust and Savings have responded by becoming more conservative in their loans as farmland values ascend. Hein said the bank has been cautious about financing too much debt-per-acre in a land purchase because of concerns that a sustained drop in crop prices could reduce a farmer's income and increase the chance of default on the loan.

"We're here to make loans, but the undertone is still one with a lot of caution," Hein said.

Last month, the USDA predicted more typical weather conditions in 2013 would generate a record corn and soybean harvest, which it forecast would push the average crop prices for corn to $4.80 per bushel, down a third from the prior year, and $10.50 per bushel for soybeans, a drop of 27 percent.

Ultimately, how land prices react hinges largely on the weather and if the water-starved Midwest receives enough moisture this year to help it rebound from the 2012 drought—the worst since the Dust Bowl of the 1930s.

Here is a rough outline of how the commodity price-land value equation works: A retreat in commodity prices would mean farmers stand to receive less money for their crops. Meanwhile, an increase in interest rates would make it more costly for farmers to borrow money from a bank to help finance a purchase. At the same time, farm operations are likely to continue to be squeezed by higher costs for items such as seed, fuel and fertilizer. The result is that farmers are willing to pay less for a parcel of land or they forgo the purchase altogether.

Some farmers, such as Joe Heinrich, vice president of the Iowa Farm Bureau Federation, are content to stand idle as the land-buying frenzy unfolds.

Heinrich, who hasn't purchased new land since 2005, hasn't ruled out making a purchase if the location is close to his current operation and the quality of the farmland is right.

"There is land that's in the area that if it did come up for sale, yeah, we would be interested. But we're not going out there to buy land just for the sake of buying land," said Heinrich, 52. "You want to save for the things you want to buy. We know there are those situations in the area that at some point" the land will be available for sale, he said.

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