What happens when demand far outpaces supply?
By Jackie Clark
“We don’t have enough supply. We never have enough farms listed to meet the demand,” Jackie Pepper, a realtor with Just Farms Realty Inc., tells Better Farming. “You cannot buy 50 acres of workable farmland in southwestern Ontario for half a million dollars anymore; that does not exist.”
With those two sentences, Pepper gives an overview of the main forces at play in the farmland market right now. Limited supply and high demand have land values continuously increasing, particularly on prime farmland close to city centers.
To continue farming at a profit, producers already in the game must strategically decide where and when to invest, and how to handle rental agreements, both as landlords and tenants.
For new producers trying to enter the industry, access to land is an uphill battle.
Farmland is a story of scarcity and it’s impacting the very structure of the agricultural industry.
In 2021, farmland values increased 11.5 per cent between January and June, according to the Farm Credit Canada (FCC) farmland values report, released Sept. 28. From July 2020 to June 2021, that increase was 15.4 per cent.
“When it comes to farmland values overall, it’s always been and it continues to be about farm income and interest rates,” J.P. Gervais, vice president and chief agricultural economist at FCC, tells Better Farming.
Over the last year, “we’ve really seen corn and soybean prices take off,” he explains. Most of Ontario, except the dry northwest, had a positive growing season, leading to a positive outlook for income.
That positive outlook gives the “ability for operations to look at some of the options that are out there for them – one of which being expansion,” he adds.
“Since the start of the pandemic, interest rates remain historically at their lowest point. That opens lots of opportunities for businesses that have a strong balance sheet,” he says.
“Despite all the anxiety and the stress of the pandemic, the actual market outcomes for crop producers for Ontario have been positive overall. I think that triggers an increase in the demand for farmland,” he explains.
Combining that with limited supply and it’s “a recipe for high prices,” Gervais says.
His colleague, Stacey Wilks, a senior appraiser for FCC, agrees.
“In Ontario, strong demand exists from various sectors trying to compete for a very limited supply of farmland,” she says.
The increase isn’t uniform across all regions, however migration or expansion from higher-priced areas of the province to lower-priced areas is further impacting farmland prices, she explains.
“There’s a lot more diversified interest,” says Paige Handsor, also a realtor with Just Farms Realty Inc. “More people are seeing farming as an investment opportunity.”
Realtors that specialize in farmland “have definitely had more farmland inquiries from residential buyers,” she adds.
In rural areas, “people are buying farms for investment or to build a home on,” she says. “When we list a farm, our offers are split 50/50: 50 per cent from farmers, and 50 per cent from typical residential buyers.”
Previously, a house on farmland wasn’t viewed to add much value or wasn’t seen as the main investment on the property, explains Handsor. “Now, with what we’ve seen happening on the residential side, houses hold just as much value or more value than the farmland and contributing to those higher farm sales.”
Investors are also looking for additional features on the land.
“They’re looking for ways that they can subsidize their income from the farm. Solar, wind, second properties on the farm,” – they’re all assets, says Handsor.
When it comes to the actual land, “quality and price go hand-in-hand,” Wilks says.
“The soil quality matters. If you can grow vegetables or specialty crops that’s worth a lot more than the heavier soil types,” she says. Adding tile drainage to land also increases the value of the land and crop yields.
“Location is huge right now,” Handsor adds. “There’s such a strong demand for anything along the 401 corridor, from Napanee all the way down to Windsor.”
That demand comes from buyers who want access to the highway for commuting to off-farm responsibilities and activities, but also from developers.
“There’s a lot more interest from developers looking for long-term investments, and looking to buy right now. If you’re in the municipal planning or if you have services running to your farm, that’s a huge bonus,” Handsor explains. Municipal services are key for developers who are thinking of building residential or commercially on the land, but also for producers who might be interested in building new barns or processing facilities.
Impact on ag
Supply is tight, demand is strong, prices are soaring. What does that do to the ag industry?
In agriculture, “the competition between farms is almost entirely for inputs, and the key input is land,” says Al Mussell, research lead at Agri-Food Economic Systems.
To understand who’s able to grow their farm businesses, we must understand “what impacts the extent to which farms can compete for land,” he explains. A key factor, of course, is cost per acre.
For producers who already have a large-sized farm, “their effective margin per acre, as they’re able to operate at scale, is going to be far greater than the smaller producer,” he says. “So, they’re going to be in a better position to bid for land and that by itself will support farmland values.”
The positive feedback cycle continues to support large farms getting larger and smaller farms exiting the industry.
“Since the 1961 census, the number of farms in Canada has declined from just over 480,000 to less than 200,000,” explains Mussell in a recent policy note. “Over the same period, the farmland area declined from about 173 million acres to 159 million acres.
The implication is that the average acres per farm increased from 359 acres to 820 acres.”
Smaller operations are leaving agriculture and it’s difficult for new producers to enter.
“There’s no doubt that higher prices create a barrier to entry,” Gervais says. “Some people will say ‘land has always been expensive,’ but if you put land prices in relation to the income you can derive off the land ... if you look at that ratio of prices to income, that’s really high.”
The disparity between land prices and income you can make from the land is almost at the highest it’s ever been, he explains.
“Economists sometimes refer to land as a residual input,” says Mussell. After paying for all other inputs, including labour “whatever is left over that represents the budget that you have to bid for land.”
For a large farm that has modern machinery and is available to farm efficiently on a large scale, “what they have left over after they pay for their seed, fertilizer and spray, is going to generally be a higher margin compared to someone who has a lesser machinery set and doesn’t have access to that same level of technology and performance,” he explains.
Dr. Brady Deaton at the University of Guelph collects data annually on producers’ perceptions of land prices, rent prices and land value dynamics. He’s a professor and McCain Family chair in the department of food, agriculture and resource economics.
In 2020, of 1,540 producers, rural landowners and tenants surveyed, 57.9 per cent believed farmland prices in their region will increase, and only 1.6 per cent believed they will decrease, according to Deaton’s data.
Deaton also asked respondents who they believed was purchasing most farmland and the answer varies widely by region. In Perth County, respondents believed 95 per cent of farmland changing hands was purchased by producers.
That number was 100 per cent in the United Counties of Stormont, Dundas and Glengarry, and 90 per cent in Wellington County, Oxford County, Huron, Lambton and Chatham-Kent.
Meanwhile, respondents believed zero per cent of the farmland purchased in the Regional Municipality of York was made by producers. In Peel, respondents believed only five per cent of land sold is purchased by producers, according to Deaton’s survey data.
Those numbers suggest that land in regions close to Toronto is more likely to be purchased by investors or developers, as opposed to producers.
That trend has been going on for a few years.
In 2016, survey respondents reported that only two per cent of purchases in York were made by producers mean-while, 80 per cent were non-farmers buying land for investment.
To buy or rent?
Renting farmland has been a successful part of farm business models for a long time.
Some producers may see investors buying land as a negative, however “they still need farmers to work the land,” says Handsor. Investor landlords can create “new opportunities for different operations who are short on capital, or if you’re looking to expand your operation without taking on a huge financial risk.”
Renting farmland “allows farmers to diversify their portfolio, just as it allows landowners to diversify their wealth portfolio,” says Deaton. “The rental market enables people to scale up their production without having to have full ownership of that land.”
Similarly, “for people that want to own farmland as part of their wealth portfolio but don’t necessarily want to farm it, it’s advantageous to that group of investors,” he explains.
Many landowners who rent out farmland are individuals who are part of farm families who own or inherit land, but don’t want to farm it, he adds. Others are rural landowners who aren’t connected to agriculture themselves.
How can producers decide when it makes sense to rent instead of buy?
Some land is so expensive that a purchaser would not be able to cash flow the purchase of that land from the income you make on that same land parcel, Gervais explains. “So, you’re going to have to spread the purchase over your entire operation. At the same time, you don’t want to put your whole operation at risk if interest rates go up, or if commodity prices decline.”
So, producers should weigh their purchasing ability against opportunities to rent, he says.
“Historically it’s been a pretty good business model to build some equity in your operation to purchase the land,” he adds. “But at the same time, you’ve got some operations that will rent what they need to be able to spread their equipment over so many acres. They don’t need to own it all to farm at a profit.”
With the scarcity of land these days, potential buyers see land come up for sale that likely won’t be for sale again for another several decades, Gervais explains.
“From a strategic standpoint, you have to look at the profitability; look at the risk management aspect of it,” he says. “You don’t want to put your entire operation at a much higher risk of not being able to meet debt obligations and so forth, by purchasing land you cannot afford.”
However, “some strategic considerations exist that are more of a long-term nature,” he adds. “What will your farm look like in five years? What kind of operation are you going to run?
Does this purchase fit into my succession or transition planning? Will it bring economies of size and lower my average costs of production?”
Understanding a farm’s long-term vision can help producers decide if purchasing land makes sense.
Currently, “interest rates are still low, paired with high crop yields and high crop prices; it can make floating a farm mortgage easier,” says Handsor. Some producers looking to expand are also looking to offload smaller parcels, some of which are in the five- to 50-acre range.
“More people are looking to offload those smaller parcels and in turn, put a larger down payment on more acres on a larger chunk of land,” she explains. It may provide an opportunity for folks looking to invest in smaller parcels, however, “there’s more people competing. More people can get approved for a mortgage on 50 acres or under.”
If purchasing land isn’t feasible or strategic, producers can engage in many different types of rental agreements with rural landowners.
Each year, Deaton asks producers what the average going rate is to purchase and to rent an acre of land in their region and records the median responses. In 2020, median rent values range from $50 to $300 per acre, whereas the cost of purchasing tended to range from $4,400 to $20,000. The relationship between rent and purchasing values is not always directly proportional and rental values ranged from 0.57 per cent to 2.5 per cent of the cost of purchasing.
Each year since 2016, the region with the lowest percentage has been either Peel or York, demonstrating that as land values skyrocket close to Toronto, rent changes less dramatically.
When comparing rent to purchasing, “land rental rates are a lot stickier,” Gervais says. “It takes multiple years of lower prices, poor production and whatnot to put pressure on land rental rates to come down and historically I’d say in that case they haven’t come down much.”
“Rent tends to be a little flatter in its response to things,” he says. “It hasn’t increased over time at the same high rate as land prices.”
Land rental agreements tend to persist through years of low income.
“We’ve had situations where rental rates were really high compared to what you could really generate in terms of income. Do you let go of that land as soon as you have one negative year?” Gervais posits. “No, not necessarily, because if you don’t renew those contracts (there’s) a chance that you’re not going to be able to lease or rent it again.”
What’s remarkable, given how modern and productive agriculture is in Ontario, is that many rental agreements are made via a simple handshake, Deaton says.
“Despite the persistence of a large rental market for long periods of time, in Ontario – one of the premier agriculture systems of the world – one of the major inputs is governed by informal arrangements that aren’t characterized by formal legal contracts,” he explains. And “despite the informality, when we did a survey of farmers, they had long-term expectations,” for those rental agreements.
He’s not sure why this is. “It must be advantageous to both farmers and landlords,” Deaton says.
The demand for farmland continues to grow.
“Farming definitely has a stronger social presence than it ever has,” says Handsor. Social media and local marketing “brought a lot of attention to what’s happening in rural Ontario.”
More people are interested in agriculture, which “creates interest, especially on smaller acreages and small farms with homes on them,” she says.
Meanwhile, supply remains limited, keeping prices high, which facilitates large farms getting larger.
Historically, large-scale operations, such as the Bonanza farms of the late 19th century, often gave way to smaller, more intensively productive operations, Mussell explains.
“Basically, the individually managed small farm was just so much more efficient than the large-scale farm,” he says. “Bonanza farms emerged very quickly and they disappeared just as quickly.”
A similar phenomenon was seen in state farms in former communist bloc countries.
“That background would say that large farms can adopt this larger-scale technology but eventually the pendulum will swing back toward the smaller farm,” says Mussell. However, “I’m thinking less and less that that’s going to happen.”
With improved technology, producers can manage large land bases just as productively as small parcels, he explains. That trend continues “supporting farmland values.”
Agricultural stakeholders should pay attention to the long-term impact of continuously accelerating land prices on the structure of the industry.
In the short-term, “the crystal ball is very murky, but I believe the industry will continue growing,” Gervais says. “The ownership model remains pretty strong overall.”
In the past, “there is a trend suggesting more of an increase in farmland values happens in the first six months compared to the change over an entire year,” Wilks says. Since income is looking strong in 2021, it will be interesting to see if that trend holds true for the second half of 2021.
Land values make purchasing extremely difficult for folks who don’t have access to capital, but the experts have some tips.
“Speak to a realtor so you can have a realistic expectation of farmland values,” Pepper says. A realtor can help you understand the current market, and options that fit your budget.
Also, “for anyone looking to fulfill those smaller acreage and home dreams, don’t be so locked down to location,” Handsor says. “There’s a lot of beautiful places in Ontario that go overlooked, and if you’re willing to move that’s where your opportunity is going to be.” BF