July 30, 2020

Demystifying the Relationship Between Farm Owners and Operators

by Sara Wensley

Director, Growth and Marketing

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Demystifying the Relationship Between Farm Owners and Operators
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As a farmland investor, understanding the relationship between farmland owners and operators is key, both for monitoring the health of your investment, as well as evaluating an opportunity before buying in.

If you’re new to farmland investing or new to agriculture entirely, you might assume that a farm’s “owner” and “operator” are one and the same. For much of US history, they essentially were: The farm, and all of its land, belonged to the family who had settled there or purchased the land in the first place.

Nowadays, though, this relationship is much more complex. Farmland ownership in the US has become increasingly fragmented over the last several decades. The landowner and farm operator are often not the same person. Of all land that he or she cultivates, the proportion of that land that the farm operator actually owns can vary according to many factors, including region, farming type, the farmer’s age and size of operations, and more.

As a farmland investor, understanding this relationship is key, both for monitoring the health of your investment, as well as evaluating an opportunity before buying in.

What are your responsibilities as a farmland owner? What will be your relationship to the operator and how will the success of the farm itself relate to the value of your land?

We’ll dive into these questions below, and provide some helpful context for how these dynamics have evolved over time in US agriculture.

For farmland operators (i.e. farmers), how does renting land work? Why rent, rather than buy?

A variety of factors have driven rental of farmland to become more and more common since the mid-20th century. We’ve written before, for example, about how technological change to agriculture has increasingly aligned economies of scale with profitability. In other words, the larger the area you farm, the more you’ll be able to offset the costs of production.

Still, land alone represents roughly 80% of the total estimated asset value across the entire US farming sector, and weighs particularly heavily in cost considerations for farmers as they manage their businesses. Buying more land is often the highest cost barrier to entry for farmers looking to expand operations. Conversely, for farmers who already own land and are looking to retire, the land itself can be an attractive source of stable income throughout retirement.

Renting farmland, therefore, can be an attractive option for both farmers looking to add acres to their operation, and farmland owners looking to continue benefiting from their land assets without being involved directly in production. In fact, it is a particularly good option for young and beginning farmers who are looking to build experience and improve their credit without incurring high costs. National-level statistics paint this picture clearly: Recent USDA surveys have revealed a strong inverse relationship between the size of a farm and the proportion of rented acres operated, and have also indicated that younger farm operators tend to rent a much greater share of the acres that they farm.

By now, roughly 40% of farmland in the contiguous 48 states is rented, and non-operator landlords – people who own farmland but aren’t directly involved in agriculture – account for 80% of all rented acres. Many of those non-operator landlords are retired farmers, who will eventually either put their land on the market or transfer it to their next of kin via wills, trusts or gifts. Some of that land will soon appear on the market for sale, when those who inherit farmland decide they would rather liquidate then remain involved in farming as a landlord.

How do farmland rental agreements usually look? How might tenants and landlords find one another?

Land rental agreements in farming usually fall into one of four categories: Fixed-cash rent, share-based agreements, hybrid cash/share rent, or “free rentals” between relatives. Cash rentals are by far the most prevalent, representing roughly 70% of farmland rental contracts in the US. Still, the use of share-based rent, either in part or in full, is common throughout different types of farming in the US. Share-based agreements can be defined as either a share of costs or a share of value of production as payment of rent, and are involved in up to 25% of farmland rental agreements nationwide.

As a farmer looking to rent, how you might find new land depends a lot on your specific situation and context. Nationally, the picture is extremely varied. Some tenants simply rent land from relatives, others from neighbors or friends. Many tenants will end up renting land from multiple landlords, even utilizing different agreement types between them. Additionally, farmers who already own land may still decide to rent more in the interest of scaling up operations.

For those who are completely new to farming, accessing farmland to rent can be more of a challenge – but this is beginning to change with new innovations in the farmland real estate business.

Crucially, the interests of farmland tenants and farm landlords are aligned around two key objectives, regardless of the nature of their agreements. The value of the land will increase when the farm operation can produce consistent favorable cash flow, and the long-term stability of the cash flow from farmland depends directly on how the land is managed. Though clearly related, these two objectives don’t always perfectly align in terms of actions or decisions for managing the farm, making the dynamic of the landowner-operator relationship critical to ensuring favorable returns on farmland assets.

How do farmland owners and farm operators share responsibilities for managing the farm? As a farmland investor, what should I be conscious of?

To understand how a tenant operator’s, and a farmland owner’s, decisions each impact the future value of the land, it is important to understand their incentives for earning an income from the farm. Namely, the landowner makes money from rent and from the land itself, as its value increases. Meanwhile, the tenant farmer makes money exclusively from the sale of farm produce – be it cereal grains, fruits, vegetables, or livestock products.

The combination of these incentives means that farmland owners and tenants will experience the greatest mutual benefit if they can work together, specifically on balancing profitability of day-to-day operations with longer-term drivers of production value, such as soil health and water availability.

One key driver of farmland values is “cash returns to farmland”, or the gross cash income per acre of cultivated land. As cash returns to farmland increase, indicating high production potential, the value of the land itself will generally increase as well. However, this effect is usually delayed, and can even be compromised depending on how the farm is managed. For example, if the operator decides to implement practices that maximize short-run yield, but compromise soil health, any immediate increases in returns to farmland might never capitalize into the value of the land. Landlords may decide to weigh in on certain aspects of farm management-decision making in order to avoid scenarios like this.

Depending on their situation, farmland owners might specifically look to work with their tenant operators on deciding to implement regenerative tillage practices or crop rotations. They also might take an interest in implementing systems for irrigation that require initial investment, but that conserve the health of the aquifer feeding the farm.

Exactly how these decisions play out in any landlord-tenant relationship in farming depends heavily on context. Livestock operations differ substantially, for example, from crop farming. Even within crop farming, row crop operations and permanent crop operations have their own distinct management needs which may engage the landowner differently from the operator. While USDA research has shown that tenants’ decision-making processes are relatively more “nearsighted” than that of landlords, evidence remains heavily mixed on how this difference in time horizon manifests in specific management decisions.

Still, it is clear overall that engaged landlords will see greater return on their investments in farmland if they can align well with their operators on how their land is managed. While it is the operator’s responsibility to manage day-to-day production, including everything from fertilization to variety selection to grazing to irrigation and pest management, it is ultimately the farmland owner’s responsibility to verify that these things are done responsibly. Both landlords and tenants in farming are stewards of the land, and their shared decisions will influence the productivity, versatility, and resiliency of the land into the future.

Interested in Learning More About Farmland as an Asset Class?

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Disclaimer: FarmTogether is not a registered broker-dealer, investment adviser or investment manager. FarmTogether does not provide tax, legal or investment advice. This material has been prepared for informational and educational purposes only. You should consult your own tax, legal and investment advisors before engaging in any transaction.

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