Cash rents: A different approach may be necessary

SALEM, Ohio — It’s no secret that grain prices have fallen since the beginning of the year. The question is, should cash rents be following the same trend?

According to the USDA’s Economic Research Service, net farm income is forecast to be $113.2 billion in 2014, down 13.8 percent from 2013’s forecast of $131.3 billion.
If realized, the 2014 forecast would be the lowest since 2010, but would still remain more than $25 billion above the previous 10-year annual average.

Crop prices

With corn hovering at $3.30 and $10 soybeans for 2014 new crop and estimates not much higher for 2015, one has to wonder how long farmers can hold out paying rents that may have been set when corn was at $7 a bushel.

The returns projected for 2015 mean it’s time to renegotiate for lower cash rents.

According to the University of Illinois, cash rents increased in Illinois by an average of 7.7 percent per year and that number has been similar across Indiana and Ohio. And, since 2006, the average cash rent has increased over 65 percent.

According to Gary Schnitkey, ag economist at the University of Illinois writing in the university’s Farmdoc Daily, two factors will impact the need for adjusting rents. The first is the farm’s cash rent relative to the average rent for farmland.

There is a considerable range in cash rents for farmland of a similar type. Some rents are $100 per acre higher than the average  and some farms can be $100 lower than the average. This means that some farms will not be in consideration for renegotiation.

By the numbers

The USDA’s National Agricultural Statistics Service Great Lakes region report for Aug. 22 said Ohio’s cropland cash rent was $144 per acre in 2014, up $5 from the previous year.

Cropland cash rents in the Corn Belt region increased $3 from last year to $212 per acre.
The cropland cash rents in the states bordering Ohio were: Indiana, $193 per acre; Kentucky, $147 per acre; Michigan, $123 per acre; Pennsylvania, $78.50 per acre; and West Virginia, $40 per acre.

Barry Ward, Ohio State University ag economist, said the farming community is in a transition right now. Farmers are trying to figure out where the bottom line is and what the 2015 crop year may hold for them as far as future prices.
He said he expects a two- to three-year period of lower grain prices and, with that, a lower rate of profitability, if at all in some cases.

Cash rent trends

Ward said cash rents are entering a period of relative flatness and that may last longer that many farmers want it to. Ward cautions, though, that there may be a segment of land that has not seen rent increases and they may still jump.
He said cash rents took awhile to increase even though grain prices were jumping higher, so it’s going to take awhile to go down.

“Pure economics indicates that rents have to moderate, just how quickly that happens is the question,” said Ward.

Communication

Ward’s advice is to be open and have good lines of communication with landowners. He said it is important that landowners understand corn and soybeans are in a period of lower prices and that could impact farming decisions.

“This is going to require delicate negotiations in the next couple of years,” said Ward.

He said farmers should explain that profit margins are not where they were a couple of years ago and that means some cuts could be necessary.

Competition

Ward said that intense competition and the size of farms in an area will also impact how landlords decide cash rents. If there is someone else standing in line waiting for the chance to rent that ground, the landowner may go with those who are willing to pay more even with these difficult financial times.

Trying to shed some positive light on the grain price futures, Ward said if corn increases to $4 or $5 next fall, then cash rents may not need to fall as quickly. However, another year of $3.50 for cash delivery means something will need to happen in regards to cash rents.

Yields vs. one price

Both Schnitkey and Ward suggest changing how much cash rents should cost for a field or designing a flexible lease with the landowner.

One suggestion Schnitkey presents is having cash rents depend on bushels yielded rather than a flat price. That way more productive land has a higher rent than land that does not yield as well. The lease could include cash rents increases as the field yields more and could also be dependent on whether corn or soybeans are planted.

Flexible leases

Ward presented these two examples of flexible leases in a previous column published in the Farm and Dairy. The following two examples display a couple of different flex lease methods that have been used by farmers in Ohio.

The parameters included in these examples are only one possible set of figures and are not meant to suggest that these should be included in all flex leases. Lease parameters will vary widely.
Flex Lease #1 — Cash Lease with a Bonus Approach.
Tenant and Landowner agree on:
• Base Rent (and max rent?)
• Base rent should be below market rent due to landowner upside.
• How to calculate and verify actual year-end revenue (yield and price verification);
• How extra revenue (actual revenue – base revenue) is shared? What %?
Flex Lease #2 — Percent of Gross Income Approach.
Tenant and Landowner agree on:
• Minimum rent (and max. rent?) Minimum rent should be below market rent due to landowner upside.
• How to calculate and verify actual year-end revenue (yield and price verification)
• Percent of gross income as rent by crop (range of percentages often used: corn – 25-33%, soybeans – 35-42%)

Ward said the bottom line for every farm is that renegotiations will depend on the farmer’s situation. He added that the issue of cash rents is complex and there is not one answer for every parcel or every geography.