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Investing in farmland: Reaping returns

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Farmland is becoming an increasingly attractive investment as an asset class that tends to buck the trend of the rest of the market.

InvestorWise | 01 May 2012

Investing In farmland: Reaping Returns

A global food crisis and rapid population growth are making farmland an increasingly attractive investment. Holly Black looks at the options

By Holly Black | Published Apr 19, 2012

“Invest in land. They’re not making any more of it,” said Mark Twain. Though he was factually correct in his statement, farmland has never been the darling asset of an investor’s portfolio.

Many factors go against investing in farmland. It is a costly asset and one that requires specialist knowledge in order to manage it properly. That means an investor either needs to lease the property out to a farmer, or down tools in the city and head out to the country for the good life. Add to this the fact that UK land in particular is not widely available and things start to get complicated.

That said, farmland is becoming an increasingly attractive investment as an asset class that tends to buck the trend of the rest of the market; it has flourished in the last few years.

Market trends

The Royal Institute of Chartered Surveyors (RICS) says in its annual Rural Land Market Survey that the price of agricultural land is increasing for four main reasons: speculation, lifestyle buyers, foreign farmers buying UK land and the inheritance tax benefits. This interest is certainly benefiting the market; farmland has almost doubled in value in the last five years with the average price per acre in the second half of 2011 up to £6,514. RICS says that an imbalance in supply and demand means that surveyors are predicting this trend to continue through 2012.

Chief economist for the National Farmer’s Union (NFU), Phil Bicknell, agrees that this upward trend will continue. He says that this market is notoriously counter-cyclical and has gone against the recession.

Knight Frank estate agents, which produces a quarterly review of farmland performance, says that growth is starting to plateau though, despite strong growth overall. Its report shows that over a 10-year period the value of farmland has increased by 188%, over five years it has increased by 76% and in the last year it had increased by just 1.4% after a poor fourth quarter of 2011, which saw growth of just 0.4%.

“There is a greater appetite for what is quite a rare, tangible commodity, with 50% less land coming to market now than 10 years ago,” says Clive Hopkins, head of farms and estates. He says that the sudden halt in growth of last year is down to investor’s reining back after a very active market period of record high prices, saying that many wanted to take a step back and see how the market panned out.

Farming funds

Certainly commentators appear to have high hopes for the market for the forthcoming year but the trouble with farmland as a specific asset is that it is part of a much wider chain.

Table 1shows the list of available retail agricultural funds along with the discrete and cumulative returns as well as their three-year volatility and risk adjusted return (RAR). While they are an easy way for an investor to gain exposure to agriculture as a whole, they will tend to contain little or no actual land within their holdings and so are peripheral to the main focus here. An investor concerned with farmland only will have to look elsewhere.

Within the portfolios of these funds there is a much heavier focus on other aspects of the sector such as fertiliser, machinery and crop protection. While this does provide diversification, it leaves them open to volatility, which can be seen in the returns of the funds. Over a three-year period performance has been relatively strong, with the best result from the Allianz RCM Global Agricultural fund, which returned £1,792 on an initial investment of £1,000. However, the volatility of the sector can be seen in the vast difference in performance between years, with just one fund producing a positive return in the last year. The Allianz fund showed growth of 1.1%.

The UK itself features very little among these portfolios, not least because there is not actually much land available. Figures from the Department for Environmental, Food and Rural Affairs (DEFRA) show that the amount of agricultural area in the UK is actually decreasing. The most recent figures show that at the end of 2010 the total agricultural area in the UK stood at 18,282 hectares, down from 18,884 hectares in 1990.

The NFU’s Bicknell points out that farming tends to be a family business; a lot of land will not ever come to market because it is simply passed through the generations rather than put up for sale to investors.

Fund manager of the First State Global Agribusiness fund, Skye Macpherson, agrees saying that farmland tends to be under-represented because it is owned by individuals. Commenting on why there are so few companies offering the opportunity for investors to own a piece of land collectively, she says that it is an awkward asset to aggregate for investment. Its high price tends to mean it has to be listed at a discount, which is not an attractive proposition.

Manager of the Pictet Agriculture fund, Gerardus van de Geer, says that it is not an appealing asset to a fund manager because it is already high in price and so not where the greatest opportunities for growth are. “Investing in agriculture by owning different parts of the chain makes more sense and is more profitable,” he says.

The fact that none of the funds in the Table qualify for five-year data, and some not even for three, highlights that the fascination with agriculture by the investment world is a fairly recent phenomenon. Indeed, the BGF and First State funds only launched in 2010 and Pictet’s in 2009. But with holdings varying from bio-fuels and crop sciences to producers and processors, these funds have quite little to do with actual farmland. Investing purely into the actual land behind the crops is far more niche.

View from the top

While there are several companies that do cater to the retail client interested in farmland, because of the sums involved in owning such an asset, many are wholly directed at the institutional investor.

One such company is Agro Ecological Investment Management. Its approach is to jointly own the land with the farmer, who becomes a shareholder of the business. For example, Agro Ecological may own 85% of the assets and the farmer will own 15%. Managing director Geoff Burke says that the reason he does not deal with private investors, despite many enquiries, is because the assets are big and illiquid. Because of that it is hard to make it a viable proposition for retail clients.

Land Commodities has a similar outlook, creating bespoke investment packages for institutional investors. Head of product development Pax Zoega says that private investor enquiries have picked up in the last year and there are plans in motion to introduce a retail fund by the end of 2012. “Private investors are lacking access to a low risk, stable income stream and the ability to get involved in the ownership of farms. That is a hole in the market right now,” he says.

And it is one that affects farmers as much as investors, says Hopkins of Knight Frank. He believes farm purchases by asset management companies can provide opportunities to farmers who are looking to either start or expand a business but are lacking the capital to do so. managing director of DGC Asset Management David Garner agrees, “You have to be talking about scale with these investments; an acre is no use to anyone, but investors do not have £5m to buy a farm.”

DGC is one of the few companies that does target the private investor, another is Brooks Macdonald. Working on slightly smaller scale sale and lease back projects, their approach enables them to work on a more personal level with investors and farmers. DGC currently has three ongoing projects, two purchase leaseback agreements in the UK and in Australia, and a development in Latin America while Brooks Macdonald owns four farms in the UK.

Rules and regs

Of course, with so much of farmland investing being involved in emerging markets and elsewhere across the globe, several bodies are keen that a culture of responsible investment is instilled. The World Bank is currently leading an initiative to establish a set of principles of responsible agricultural investment; so is global organisation Principles for Responsible Investment (PRI). A group of signatories from the latter has come up with its own set of Principles too, although they are aimed more towards institutional investors. These can be seen in Figure 1 .

PRI currently has a farmland working group and is working with a network of around 1,000 investors globally, looking at the various environmental, social and financial implications of the asset class. Rob Lake, director of strategic development, says that it is looking to produce the final best practice outline later this year. “Investors are recognising the importance of these issues but do not necessarily know how to deal with them. Awareness is growing that there are risks associated with these opportunities,” he says.

Where other investment types often have recognised certification schemes these Principles aim to help to fill that void says Jos Lemmens, senior portfolio manager commodities at All Pensions Group (APG), which was part of the group of signatories to come up with the Principles. He says that sustainability is an important factor with this type of investment, “Lots of farmland has been marginalised and over used; we need new investments in what has been a neglected sector for many years.”

Benefits

The argument that the planet will be feeding nine billion people by 2050 may be somewhat overstated, but it does help to raise interest in the sector, along with the fact that globally diets are changing and many countries are more dependent on grain supply. “Countries like China are very influential in the demand of commodities,” says Macpherson, “in the past they have been very self-sufficient but they are becoming more reliant on being supplied.”

And while this creates a good argument for commodities, the fact that the success of actual land is so interlinked with the crops it produces means that it could see benefits for farmland as well. And, points out Macpherson, while emerging economies are implementing infrastructure to benefit from this, established farmers are experiencing record margins.

DGC’s Garner warns that this is not an investment for the short term, but for anyone able to lock up capital for a minimum of 10 years it can provide portfolio insurance and generate revenue as well as offering an inflation hedge.

As always, the gains to be had depend upon the risk the investor is willing to take. The UK presents great advantages with its political stability and a good infrastructure, buts this comes at a cost of high prices and a lower profit margin. For superior returns, says Garner, investors need to look at the emerging markets where he cites his Latin American project, which has returned between 9% and 14% for each of the last four years.

For those less keen on risk, there is still the security of a stable, steady income stream in the UK-based sale and lease back arrangements, such as Brooks Macdonald’s. Chairman Martin Robinson says the route it takes is to look at how to add value to any new acquisition. Draining land for example, which must be done at an initial outlay, can increase rent from around £60 to £220 per acre.

“Knight Frank runs indices of various sectors to track performance against the FTSE and currently the only thing outperforming farmland is gold,” says Knight Frank’s Hopkins.

He says that, although some commentators fear that the market could be in danger of over-frothing as land value reaches record highs, he would be unsurprised if costs reached £10,000 per acre by 2015, up from just over £6,500 currently. Robinson is also positive, saying that despite a possibility of a market correction, there is a still a huge demand and low supply. And there will always be the need to produce and to feed people, so there will always be a market.

The UK’s appeal comes in the fact that it is both a safe and tradeable area in which to own land. “It is a safe haven. It cannot disappear, the land will always be there,” says Robinson.

Risky business

It is not all plain sailing, of course. There are many risks attached to this type of investment.

The inherent attachment that farmland has to the rest of the agricultural supply chain can be a benefit or a burden to its success. Price volatility is a widely acknowledged risk in this sector and the value of land can suffer if its crop does too. Table 1 is evidence enough of the volatility of the associated funds, with an average volatility of over 5% and discrete performance falling from 47.1% in 2010 to -2.7% just two years later.

Profitability here is dependent on what the land is used for and how it is used. Land is lost every year with water stress, soil degradation and building all contributing factors, and the UK is not the worse case. Take the situation abroad and political factors start to come into play, with land grabbing commonplace in many countries and land acquisition rules varying vastly. In some countries it is not possible to ever actually own land outright, investors will have to settle for a long-term lease.

But where the UK offers stability it throws up other obstacles. It is a lot more difficult to pull together large areas of land here than in places such as Russia or Eastern Europe. A lot of land is available in the emerging markets but with this comes climate and currency risks, as well as political ones. Garner says that farmland is one of the few assets where there is specific risk for each individual asset and due diligence must be carried out effectively.

With UK-based land the main risk, according to Robinson, is the farmer’s ability to pay the rent. The land rented will not be the farmer’s only source of income but rather an addition to the land he already has, and besides, the level of demand means that there will always be other tenants.

Throw into the mix that this is a large, expensive and illiquid asset that needs to be a long-term investment and there is certainly a lot of food for thought. Farmland is an asset that will be passed down through generations or held on to for long period of time All things considered, the lack of supply in this sector starts to become less of a mystery.

Scams

What may also deter the smaller investor is the historically bad reputation that many illegitimate firms have given this sector. It was only at the end of March 2012 that a high court judgement resulted in fines amounting to £32m for three firms accused of land-banking.

For the uninitiated, land-banking is name given to the practice where firms offered individuals deals to buy undeveloped land on the expectation that it would be sold on to a major supermarket or similar company at a much higher rate. In reality the plots of land sold, which were generally too small to warrant any attention anyway, were usually worthless and liable to multiple building restrictions that meant they would never gain the planning permission buyers were promised. And, as some victims have experienced in a more rare form of the practice, sometimes the plot does not even exist.

Judge Pelling banned one individual, who was operating two of the firms in question, from selling land in the UK and ordered him to pay £31.89m to the FSA. The other individual was ordered to pay just over £1m.

While the regulator is attempting to deal with these scams, they are still prevalent in the sector and have sullied its reputation somewhat. Robinson of Brooks Macdonald admits that, when starting a new fund, many potential investors were cautious and drew comparison with land-banking schemes. This is something the company has had to shake off.

Tax and pensions

Further advantages to agricultural property come in the form of an IHT exemption. Although to benefit from this an individual needs to personally own the land, rather than be invested in a relevant fund.

HMRC states that if you own agricultural property that is part of a working farm then it may be passed on free of IHT either in a will or before death. The land must be located in the UK, Channel Islands, Isle of Man or the European economic area and must have been owned for two years before death, or seven years if it is leased out.

Farmland is eligible to be put into a SIPP but this will negate any tax exemption. The reason for this is that the asset is sold into a SIPP, which upon payout is not concerned with the type of asset but simply the value of it. “Having farmland in a SIPP is great for the yield income while you are alive, but to benefit from any IHT exemption you would have to sell it out of the SIPP before death,” says Martin Tilley, business development manager at Dentons Pension Management.

Who’s it for?

Talk to many of the asset management groups and they will say farmland investment is appropriate for institutional investors only. But these companies are receiving more and more enquiries from retail investors and there is a gap in the market where they are not being catered for. But maybe there is just cause for that.

“A lot of people are touting this asset class for smaller investors that do not really understand it,” says Garner of DGC. He says that it is not something for everyone because, although farmland is in itself a stable asset with a high value, it is part of a much wider chain that is vulnerable to price volatility; if the price of fertiliser and fuel rises and the price of crops falls it is simply tough luck.

Capital is obviously a big factor with this type of investment with so few funds catering for the retail client. And if an individual has the capital to directly invest then he will also need the knowledge.

Scale is also important, as those affected by land banking will now know, an acre is of no use to anyone. “You don’t want just one farm in Brazil, you need to be diversified,” says APG’s Lemmens. But, as well as adding to the cost, diversification can introduce risk. Emerging markets may be alluring to those seeking higher yields but there are drawbacks, “People want the security of a stable country – no one wants to invest in a farm where you need machine guns to run it,” says Burke of Agro Ecological.

The farmer wants a fund

Although currently there is not a plethora of opportunities for the retail client, asset management companies are starting to realise there is enough demand to consider opening up the market.

Research needs to be done on both parts of course, how to make it a viable and financially accessible asset for investors, who in turn need to make sure they fully understand the risks attached to what is historically a volatile sector. In terms of revenue, farmland may be a stable asset but it part of a much wider entity with a multitude of risks and variables.

“There is a growing interest and people are flirting with this sector but there is a lack of understanding of the asset class and it is a big learning curve,” says Burke.

Some are put off investment by the fact that prices are already at record levels and therefore argue that land itself does not represent the greatest opportunity. But space is scarce and priced at a premium and many of the figures suggest that the boom is not over yet.

Source: FT Advisor, originally published 19 April 2012

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