Friday, September 16, 2011

Farmland Investment: Is UK Farmland Overvalued?

Most important for investors considering farmland investments, is to purchase assets at a price that truly reflects the assets real value as a farming asset. We are able to calculate true and proper value of farmland as an investment asset using a simple economic model taking into account farm revenues and capitalisation rates as follows:

Farmland values = Future revenues ÷ Capitalisation rate.

Future Revenues

Future revenues are considered to be only the revenue received by the landowning investor, which has historically remained at around 25% of total revenue. USDA figures for cost of production taken from the past three years show that landowners have received 25% of total farm revenues in U.S.

Therefore we are able to calculate future revenues once we know current yield and crop prices. For example; according to DFERA, the 5 year average yield per hectare including wheat, barley and oilseed rape to 2010 is 5.65/ha. And the average crop price as a weighted 26 month average is approximately £95.78 So total revenue per hectare is £541.16 therefore future revenues for landowners amount to £135.29

Capitalisation

Capitalisation can be proxied with historical cash rent-to land value ratios and figures from DEFRA, the average rent for one hectare of general cropping or cereal producing land in 2009 was £195 per hectare under a Farm Business Tenancy, which equates to 1.32% of the Q1 value of UK farmland according to the Knight Frank Farmland Index which indicates a national average of £14,797 per hectare.

So, according to this model, current true value of farmland can be calculated as:

Farmland values = £135.29 ÷ 0.0132

Farmland values = £10,249 per hectare

This model indicates that farmland in the UK is overvalued when compared to other global regions, and rising interest rates pushing up rentals combined with a drop in commodity prices could cause value to fall back sharply.

Realistically, farmland values are supported more by long term trends of increasing demand for food, feed and fuel, and Investors able to take a long tern view when choosing to investment in UK farmland are likely to do very well.

Those investors seeking growth and enhanced income in the short term are likely to find better value in developing economies where land values are lower, labour and inputs are cheaper and yields can be increased substantially through the application of new technologies and up to date farming techniques.

UK farmland investment remains a good investment opportunity for those happy to take lower return in exchange for investing onshore.

Provided the right data is available, this model can be applied to farmland in any part of the world, providing a good rule of thumb guide to investors considering investing in farmland as part of a diversified portfolio of alternative investments.

Download your complimentary copy of the DGC Asset Management Farmland Investment Report at the DGC Asset Management Website


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