ESTABLISHING A FARMLAND CASH RENTAL RATE
Originally published on January 27, 2005
Farming is and will remain a volume business.
While technological changes have enabled us to farm more acres with fewer people, the small per-acre profit margin has forced farmers to expand their land base to spread their fixed costs over more acres. The grain farm appears to be going through the same transformation that the pork industry has done in the last 10 years. Grain farms are getting bigger.
One of the quickest ways to increase your farm size is to rent more land. In our office we have several large farm clients that rent up to 70 percent or more of their land.
The cash lease remains the most common rental arrangement. In a cash lease, the tenant pays a fixed cash payment to the landlord for the use of the land and buildings. The tenant receives all the income. He supplies labor and machinery and pays all the expenses except for the property taxes, building insurance and repairs.
How do you establish a cash rental rate? There are four common methods: landlord’s cost; tenant’s residual method; crop share equivalent and market approach.
While economists use such terms as economic value in their efforts to establish a cash rental rate, our office has found that two specific measurements are particularly useful to farmers and landowners when negotiating their cash lease amounts: the percent of land plus property tax calculation and the rent-to-value indicator.
In the first method, we determine a cash rental rate by applying a return on investment of six to eight percent to the current land value. We then add to this amount the current year’s property tax expense to arrive at a cash rental rate.
Rent-to-value indicators are used to characterize the relationship between rents and land values. While Canadians are not too familiar with the term rent-to-value, in the United States, it is a common statistical standard that has been directly reported by the United States Department of Agriculture for each class of land including non-irrigated cropland, irrigated cropland and pasture since 1976.
U.S. farmers negotiate their cash rent by applying USDA published percentages to the market value of their land. For example, assuming 10 percent is the typical rent-to-value in the district and a farmer has land worth $300 per acre, then the cash lease amount would be $30 per acre. These indicators are often used by appraisers to determine if the land is over or undervalued.
Tenant’s residual method
The inverse to landlord’s cost method is the tenant’s residual method. From gross income expected from the crop, the tenant subtracts his production costs, including purchased inputs, machinery and labor to find the amount available for paying rent.
Some tenants justify paying more than their calculated residual if machinery ownership and labor costs will not increase if additional land is farmed.
Crop share equivalent
The crop share equivalent approach is a method where the cash rental is calculated as an amount equal to a projected crop share rent, but rather than pay the landlord in crop, the tenant pays an equal amount in cash less a calculated risk factor of 10-20 percent.
In a cash lease, the landlord assumes no risk. The rent is agreed before seeding and the price and production risk is passed on to the tenant. This is the main reason why we deduct the risk factor.
According to Saskatchewan Agriculture’s cash lease agreement guide, some common examples for risk factor discounts are:
■ Up to 10 percent if the landlord assumes no price and production risk.
■ An additional five percent reduction if half of the rent is paid in advance of seeding.
■ An additional 10 percent reduction if full rent is paid in advance of seeding.
The final method used in determining a cash rental rate is the market-based approach. This simply involves knowing the existing cash lease agreements in your community.
This is not always readily available and as an alternative, landlords occasionally advertise in their local market or call for tenders.
While some argue that landlords drive cash rents, I beg to differ. It’s been my experience that aggressive bidding for farmland is done by the farmers and not the landlords. In some areas, it is not a question of “what is fair” but rather a question of “what it is”.
If farm incomes are down then why is the price of land and cash rent still holding firm or rising? More than one farmer has asked me that one. In my mind, as long as there are farm operators who want or need to expand, the demand for rented land and the accompanying cash rents being paid will remain firm or even increase.
While no one knows the future, a person once told me that trends typically continue. With that in mind, grain farmers wanting or needing to expand will be doing it by cash leasing more land.
Allyn Tastad, chartered professional accountant, is a partner in the accounting firm of Hounjet Tastad Harpham in Saskatoon at 306-653-5100, e-mail at email@example.com or website www.hth-accountants.ca. All data and information provided is for informational purposes only. Readers are cautioned that laws and regulations are subject to change. Consult your accountant for current professional advice tailored to your situation.