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The Link between Farm Policy and Farmland Values

One of the principal objectives of farm policy is to provide a financial safety net for America’s farmers. Since the depression era of the early 1930s, the Federal government has provided an ever-changing suite of policy tools designed to bolster farm incomes, limit financial volatility, and ensure the livelihood of America’s farm sector. The programs would, in turn, maintain America’s capacity to produce agricultural goods for food, energy, and other uses.

Current forecasts indicate that in 2014, the Federal government is set to provide more than $6.1 billion dollars in financial support to America’s farmers. The financial safety net provides a number of pecuniary benefits to agricultural producers. Farm policy payments provide an effective floor for the expected revenues, provide a more stable source of income for servicing farm debt, and allow farmers to take on financial risks that would otherwise not be feasible.

However, the financial safety net also introduces a number of unintended consequences. One unintended consequence that is often overlooked is the effect of farm policy payments on agricultural asset values.

The Capitalization of Farm Policy

Economic theory suggests that farm policy may alter farmland values through the “capitalization” of program benefits. Economic theory teaches us that the value of any productive asset is determined by two factors. The first factor is the expected returns from owning the asset, and the second factor is the opportunity cost of capital (or discount rate). This is often called the net present value formula.

Price of farmland = (Expected returns)/(Opportunity Cost of Capital)

The primary source of the expected returns for farmland is production of agricultural goods and services. However, other sources of expected returns include a wide range of goods and services including the potential income from converting farmland to residential or commercial use, recreational uses of farmland, energy production, and mineral extraction.

The financial safety net provided by farm policy represents one additional income stream available to farmers or farmland owners. Thus, by raising the expected level of cash flow associated with a parcel of land, some farm programs are expected to increase underlying farmland values. In other words, the value of these farm program payments is “bid” into the price of land. Potential landowners may be willing to pay a higher amount to gain access to the income stream associated with government program payments. For example, when farmland is offered for sale, landowners and real estate professionals often advertise the base acreage or CRP contracts associated with the parcel.

Other programs, such as insurance or revenue guarantee programs, decrease the volatility of the expected stream cash flows. This is where the second factor, the opportunity cost of capital, comes into play. The opportunity cost of capital reflects the discounting of uncertain future returns. If a person believes that a future stream of payments is unlikely to occur, they will heavily discount the likelihood that payments will be received. This is why riskier loans often charge a higher interest rate. When it is believed that future payment is unlikely, the lender must receive additional support to guarantee the contract. The opposite result is often true for agricultural policies. Income and revenue guarantee programs make the probability of future income more likely, and as a result, landowners place a greater value on the underlying value of the goods used to produce farm income, with land serving as the primary input in agricultural production. The guaranteed rate of return behaves more like the guarantee from a risk-free asset.

Agricultural economists have studied the link between farmland values and agricultural policy through various incarnations of the Farm Bill, as well as similar farm policies around the globe. In most instances, analysis indicated that farm program payments are associated with higher farmland values. However, the published estimates of the degree of capitalization span a wide range. A recent review of the literature suggests that as much as 12 to 40 percent of the value of farmland may be explained by farm policy payments.

The Consequences of Farm Policy Capitalization

The literature on capitalization teaches us that although farm programs are principally designed to impact farm incomes, their effects likely spill over to the farm balance sheet. Farm real estate is the major asset on the farm sector balance sheet, accounting for more than 82 percent of the sector’s wealth. As a result, farm real estate values are considered a critical barometer for farm sector financial well-being. Farmland values throughout much of the United States have experienced a rapid appreciation in recent years as a result of high farm incomes, favorable exchange rates, and low interest rates. The total value of U.S. farm real estate currently exceeds $2.4 trillion.

Many farmers benefit from an increase in farmland values. Farmland serves as the principal source of collateral for farm loans, and higher farmland values enable many farmers to finance the purchase of additional inputs or to finance current operating expenses. At nearly $187 billion, farm real estate accounts for 59 percent of the sectors’ debt. In addition, farm real estate serves as a retirement instrument for many farm households, so higher farmland prices would likely provide a more comfortable retirement.

On the other hand, benefits of farm programs may accrue to landowners instead of farmers. If a landlord is able to adjust rental rates to capture the expected farm program payments, some or all of these benefits may be transmitted to the landowner instead of providing a financial safety net for America’s farmers. In addition, the policy capitalization may lead to higher farmland values which would hamper the ability of beginning farmers to purchase land. Likewise, higher farmland values make the intergenerational transfer of farmland a delicate issue for many American families. With current farmland values in many areas of the country at an all-time high, these issues are expected to become even more important for farmers and policy makers in the near future.

Following the net present value formula, many economists predict a flattening or decline in farmland values in coming years. Farm income, particularly in the crop sector, is forecast to decline, and short-term interest rates are predicted to increase. If both factors come to fruition for a sustained period, the net present value formula would suggest a decline in farmland values. Although farm program payments have been a relatively small share of farm income in recent years, farm programs may again play a critical role as a financial safety net. In this environment, we may see a renewed scrutiny of farm policy capitalization under the new farm programs authorized by the most recent farm bill (Agricultural Act of 2014).

This post was co-authored by Jennifer Ifft, Cornell University, Charles H. Dyson School of Applied Economics and Management.


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