December 21, 2021
Understanding Liquidity & Liquid Assets
In June 2021, the world’s most valuable postage stamp sold for over $8.3 million, marking only the third time the British Guiana One-Cent Magenta stamp had been sold since 1980. Then, in the fall of 2021, this one-of-a-kind collectible was digitally fractionalized, allowing investors to buy shares of equity in the stamp for as little as $132. This situation exemplifies the recent digital transformation of farmland. What used to be a highly illiquid investment has evolved into a more dynamic, flexible opportunity that is now easier to buy and sell.
Let’s define what liquidity is and take a look at how varying degrees of liquidity provide investors with different benefits.
Liquid Assets vs. Illiquid Assets
The liquidity of an investment refers to how easily the asset can be converted to cash. A liquid asset can quickly be sold, while an illiquid asset typically takes longer to trade. Because of broader accessibility, publicly-traded marketable securities like stocks or bonds are more liquid than private assets. An asset’s liquidity is dictated by a number of factors including the number of buyers, the number of sellers, industry regulations, transaction fees, or restrictions on that specific asset.
Liquid assets are often spoken of more favorably. They're easier to convert to cash for emergencies or exchange for other investments. Liquid assets are often listed on public exchanges with a high degree of transparency in their price. Assets with higher liquidity may have low or no barriers to entry with no net worth requirements to invest or no investment minimums. Some of the most liquid investments including money market accounts are insured by the FDIC.
There are still plenty of reasons to hold illiquid assets in your portfolio as well. Since 1992, traditionally illiquid assets like commercial real estate or farmland have been less volatile than public equities. In addition, illiquid assets have historically responded better to inflation than liquid assets. Private assets have also generated higher returns, as a study of 234 hedge funds found the return on illiquid assets was 20 basis points higher per month simply because of their illiquidity. In the past, investors willing to hold their assets long-term have had their patience rewarded with favorable investment performance.
Are liquid assets better than illiquid assets, or vice versa? There are benefits to both, but to say one is better than the other is incorrect. What is ideal for one portfolio may not be the same for another. An investor demanding immediate access to cash at all times may be better suited with liquid assets, while investors seeking less-volatile assets with higher returns may favor illiquid holdings. Similar to how investors diversify across asset classes, investors may consider diversifying their portfolios across levels of liquidity.
Farmland’s History of Illiquidity
Why has farmland been historically illiquid? For starters, there’s a high capital requirement in outright purchasing your own farm. With the average farm size in the United States 444 acres and the average price per acre $4,420 in 2021, there’s been a substantial cost barrier to entry for those looking to directly hold their own land. Investors choosing to leverage their investment are still faced with loan closing costs for land ranging between 2% and 5%. Farmland’s value is also highly dependent on geographical locations and underlying crops. Though it has made great strides to increase transparency on these valuations over the past several decades, farmland valuations had traditionally been more difficult to gauge due to a lack of benchmarking and public data.
Farmland’s illiquidity is also largely driven by how difficult it can be to buy or sell the property. Similar to other types of real estate, the acquisition and disposition of farmland includes conducting private research of property valuations, reviewing existing liens, working with lawyers or brokers, and determining your sale terms. Documentation for the sale may include existing lease substantiation, recent soil test results, maps, yield history, insurance statements, and third-party agreements. If farmland is sold during auction, there’s often a commission fee; if it is sold on market, standard real estate broker fees may apply. Compared to public equities that can be bought and sold instantly, farmland has been tougher to trade.
Reaping The Benefits of Farmland’s Illiquidity
Investors who have navigated this illiquid environment have experienced very favorable rewards in the past especially when holding farmland for long periods of time. Farmland generated competitive returns over the past few decades with specific permanent crops like pistachio trees capable of generating profit for up to four decades. Because investors are less inclined to panic sell or emotionally dissolve their positions, farmland returns had lower volatility than the U.S. stocks, U.S. bonds, and commercial real estate over the past 30 years. Arable farmland continues to become more scarce every year with permanent crops making up only 2.4% of all farmland in the United States. There are also tax incentives encouraging long-term holding of farmland; several soil and water conservation tax deductions are maximized if the property is held by the landowner for at least 10 years.
There’s also an inherently long-term approach to sustainable agriculture. Environmentally-friendly farmland takes a strategic, forward-thinking approach that balances long-term profitability with impacts on the environment. Certain sustainability practices like renewable energy, protection of water resources, or soil health conservation require more upfront costs but still yield profits in the long term. In fact, organic crops have been historically more profitable to cultivate than conventional crops, and farms that move away from less sustainable practices have historically fared better financially. All offerings through FarmTogether are enrolled in the Leading Harvest Sustainability Standard, and FarmTogether strives to achieve financial and environmental success.
The Introduction of Liquidity
In response to investor demand and innovation, there’s now a number of easier ways to invest in farmland. The largest agriculture exchange-traded fund just topped $1 billion assets under management. The NCREIF Farmland Index, debuting in 1995, now holds over 1,200 properties and provides a transparent, reliable benchmark for investors. Some of the largest farmland REITS all began trading within the past decade with the largest REIT currently exceeding a $1 billion market cap.
The modernization of digital platforms has also provided tremendous accessibility. Fractional or tokenized assets have substantially shorter settlement times while eliminating high capital requirements. For example, while the average farm in the United States would sell for millions of dollars, FarmTogether’s investment minimum on select offerings is only $15,000. These digital platforms also allow companies to more easily fractionalize equity ownership stakes in LLCs that directly own farmland. This technology recently led to a record-setting $22 million equity crowdfunded farmland investment organized by FarmTogether.
More Investor Demand, Innovation, and Liquidity
As the appetite for farmland continues to grow, innovation continues to foster newer ways to transact with agriculture investments. While farmland investments are intended to be held to reap long-term benefits, FarmTogether realizes the importance of portfolio flexibility and understands unforeseeable circumstances arise. For this reason, FarmTogether’s secondary market pilot is currently underway having already completed three secondary market exchanges.
FarmTogether aims to offer liquidation opportunities for each deal, depending on the deal structure, within 366 days after an investment’s closing date. For investors needing to secure liquidity, FarmTogether is rolling out programs to make farmland even easier to convert to cash.
Farmland: The Best of Both Worlds
Both liquid and illiquid assets have a part to play in a balanced, diversified portfolio. While farmland hasn’t always been easy to buy or sell, the introduction of invest-tech solutions and digital platforms continues to increase the liquidity of the asset class.
Now, with innovative solutions driven by retail and institutional demand, FarmTogether continues to promote industry liquidity with the introduction of a secondary market. If you’re looking for long-term opportunities that still provide some flexibility, offerings of farmland on FarmTogether may be the perfect fit for your portfolio.
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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