Farmland vs. Commercial Real Estate

Picture a tangible investment that appreciates in value, generates operating income, and is being modernized in how you can invest in it. Whether you thought of farmland or commercial real estate, you’d be correct. These two well-rounded asset classes have a lot in common, yet slight differences ultimately distinguish the two.

Let’s take a look at how farmland and commercial real estate overlap and where their differences may lie.

CRE and Farmland: A Brief Overview

Plagued by unfavorable tax reform and the S&L crisis, commercial real estate’s modern resurgence as an investment didn’t hit its stride until the 1990s. Farmland has experienced a somewhat similar path of growth with institutional investors beginning to get involved in the late 1980s. Most recently, commercial real estate markets have reported their highest trading activity since 2007 while farmland reported record-breaking crowdfunding investments through FarmTogether earlier this year.

In addition to traditional means of directly owning real estate or farmland, there are now easier, more accessible ways to invest in both asset classes. Real estate investment trusts (REITs) pool capital from investors, self-select the underlying assets, and may distribute dividends to investors. REITs are known for having wide, diversified portfolios holding various types of real assets. Farmland ETFs traditionally hold stocks of agriculture businesses or futures contracts for commodities, while the largest commercial real estate ETF invests in REITs as well as companies that directly purchase real property. Mutual funds offer very similar pools of investments as ETFs, though they’re actively managed resulting in slightly higher fees and have different rules on the number of shares that can be issued.

Different from all these opportunities, another emerging investment opportunity is crowdfunding digital platforms like FarmTogether. Like the options above, investors pool funds to invest in real assets. These crowdfunding platforms focusing on real estate or farmland generally oversee the management of the site, provide investors regular updates regarding the property and operations, and distribute cash dividends in alignment with operating cycles. All of the opportunities above have helped real estate and farmland become more liquid markets. However, digital platforms like FarmTogether create a single all-encompassing portal for investors to view due diligence materials, browse investment opportunities, and monitor performance.

Investment Returns

Over the past 20 years, commercial real estate has produced average annual returns of roughly 9.5%, slightly higher than the S&P 500 over the same period. Residential property has traditionally outperformed other sectors of real estate, though REITs - averaging annual returns around 11.8% over the past two decades - are the top-performing traditional real estate class. Commercial real estate returns are highly contingent on physical location. Property in the northeast part of the United States has historically produced average returns above 13%, while property in the southwest averaged less than 7%. As the world transitions to its pre-pandemic state, commercial real estate has begun performing exceptionally well. In the third quarter of 2021, the NCREIF Index posted its highest quarterly return in over 15 years.

In many ways, farmland has traditionally outperformed real estate’s strong results. Since 2000, farmland’s average annual return is 11.98%. Since 1992, farmland outperformed U.S. stocks, U.S. bonds, and real estate investments; of these four asset classes, farmland was the only one to average double-digit returns over the past three decades. Agricultural investments have also been one of the top performers so far this year. From January 2021 to June 2021, commodities generated an average return of 21% - tied for the highest return during this period across all asset classes. Also, from 2020 to 2021, farmland property values increased an average of 8%.

Investment Volatility

Commercial real estate and farmland have had similar volatility profiles. In a Fall 2020 study published in The Journal of Alternative Investments, the average standard deviation of commercial real estate’s total returns from 1991 to 2018 was 7.8%. Over the same period, farmland’s total return standard deviation was 6.8%. This study found that during this time, the volatility of either asset was less than large-cap stocks, micro-cap stocks, corporate bonds, US Treasury bonds, and gold. Both asset classes also have a history of continually generating periods of positive returns; in the past, commercial real estate infrequently experienced total negative annual returns when factoring in both land valuation and income streams. Meanwhile, between 2000 and 2018, farmland produced only one-quarter of negative results (a 0.01% loss to start 2002). Most recently, commercial real estate was directly and materially impacted by the pandemic, while farmland was a much more stable investment.

There are several reasons why the volatility profiles of both asset classes are similar. Commercial real estate is generally held between 3 to 10 years, while investments on FarmTogether typically have holding periods between 5 and 12 years. Both also have different risk profiles within their product offerings. The average standard deviation of institutional-grade commercial real estate is less than 6%, while lower-rated properties hold standard deviations up to 13%. Similarly, commodities are dependent on consumer demand, weather conditions, or macroeconomic factors such as regulation or economic policy.

Income Stream/Passive Income

Both commercial real estate and farmland generate operating cash flow. It’s common to see commercial office leases locked into periods greater than 10 years. Pre-negotiated rent escalation clauses also cause cash flow to increase over time, keeping up with inflation as well as increasing the commercial property’s value. Indirect investments in real estate can still produce passive income, as some REITs issue periodic dividends based on net cash operations collected. During 2020, the average capitalization rate was around 6.0%.

Farmland’s income stream is a little different. Cash flow from farmland can be generated either from leased land agreements or operating income from crop yields. With FarmTogether, the annual payout is divided by the initial equity of the investment. Each investor then receives cash distributions on a quarterly or annual basis depending on that specific investment’s harvest sales schedule. Despite economic uncertainty and supply chain constraints due to the pandemic, farmland’s average operating income return last year across the United States was 3.4%.

Asset Valuation/Appreciation

In addition to operating income, both real estate and farmland have underlying real assets that have appreciated in value in the past. From 2010 to 2020, nationwide commercial real estate index prices doubled, though specific locations like San Francisco or Manhattan posted much greater growth. However, since 2005, commercial real estate valuations have experienced 12 quarters of negative growth including the historic 29.8% drop during Q3 2009. Most recently, commercial real estate prices are up about 1.3% from April 2020 to April 2021. Industrial properties - having posted positive annual returns for the first time since the beginning of the pandemic - have produced the highest year-over-year returns.

Farmland valuations have been much more stable over the past few decades. Agricultural land prices reported twenty consecutive years of positive price growth before falling 3.2% in response to the Great Recession in 2008. Since then, farmland has experienced only one year of negative price growth (in 2016). However, this stability is offset with lower valuation returns though farmland prices still rose in value 50% from 2010 to 2020. Like commercial real estate, land valuation is highly dependent on geographical location. The year-over-year change in farmland prices between 2020 and 2021 is 7.0%, though certain markets like Massachusetts are experiencing year-over-year price increases greater than 20%.

Domestic and International Market Size

Professionally managed global commercial real estate grew from $9.6 trillion in 2019 to $10.5 trillion in 2020. Approximately $3.6 trillion of this market value resides within the United States. On the other hand, farmland’s global market valuation is estimated to be around $9 trillion. Similar to commercial real estate, approximately ⅓ of the industry’s market share resides within the United states. In 2020, farmland in the United States topped $3.1 trillion, up 1.5% from 2019.

Unsurprisingly, the top cities in the United States for commercial real estate are all developed markets experiencing population growth and net positive migration. For farmland, the average farm real estate value across the United States is $3,380. However, states in the Pacific region (California, Oregon, and Washington) have a regional average price per acre of $6,420. Meanwhile, Northern Plain states like Nebraska experienced greater year-over-year price increases from 2020 to 2021 than the nationwide average.

How To Evaluate Opportunities

When evaluating opportunities between these two investment options, there are several similarities. Both investment options have a land component and an operating income component. Therefore, both use similar financial metrics to evaluate performance including NOI, cash-on-cash yield, cap rate, or IRR. Also, the operating cycle of both industries has been cyclical in the past. Commercial real estate has previously operated with four phases: recovery, expansion, hyper supply, and recession, while the agricultural industry has a history of repetition.

Each investment option is also highly dependent on the underlying asset. Commercial real estate is assigned a property class to easily designate the quality, age, and location of the investment. Higher grade properties in premium locations with Class A ratings generally have lower, more stable returns than riskier properties. For example, from 1995 to 2019, permanent crops like almonds, apples, or grapes generated higher returns than row crops like corn, soybeans, or cotton.

Farmland vs. Commercial Real Estate

Both farmland and commercial real estate hold the same underlying investment principles. These long-term hold, income-generating real assets are highly dependent on their physical location and associated operations. As the NCREIF Farmland Index’s total value of $12 billion pales in comparison to NCREIF’s National Property Index of $768 billion, farmland appears to be the more overlooked investment opportunity.