I have an interest in investing in farmland through an REIT structure. I have been looking into this for a few months and I have found a few things to look out for when investing in farmland…
All REITs are use tax efficient debt structure to develop their business. There are however a few farmland REITs which use enormous amounts of debt to fund their ventures.
Clearly, you need debt to operate this type of business, however things can get a bit much if the debt gets out of hand. Obviously farmland is a stable asset and it has outperformed the stock market in the last forty years by a comfortable amount. This does not mean it’s a sure bet.
If I was investing in a farmland REIT, I would ensure:
-debt is under control (reasonable Loan-To-Value ratios
-cash-flow positive - positive cash flow shows that the management is making sensible investments and
Farmland is play on rising food prices and water scarcity. The long-term fundamentals make sense. Nevertheless, if investors alll jump the market could easily overheat as it did in 2008.
If farm values decline suddenly a heavily leveraged farm will be unlikely to survive - make sure your investments has relatively low-levels of debt.
Find investment opportunities where the manger has experience in farmland investor and agriculture. If I see a manager who has no experience managing a portfolio of farmland properties, I would question whether his authority.
There are even Farmland REITs in the US where the CEO manages a portfolio of other companies - not just farmland. This indicates that management is only interested following the farmland trend and they are not suitably qualified.
Skin In The Game
I borrowed this term from writer and investor Nassim Taleb. You need to find farmland managers where their interests are closely aligned to yours and they stand to loose by poor decision-making and manager.
Skin in the game would mean a manager:
-with 100% of his net worth in the investment
-focused entirely on farmland investing and has not diversified into other businesses
-with no diversification - all his eggs in one basket.
A lack of skin in the game would mean:
-high fees for managing the investment. Fund managers should charge a fee on their profits, however one should ask whether it is necessary for them to earn anything for simply managing the portfolio.
Be cautious when you encounter these type of managers…
Valuing the farmland you invest in is absolutely crucial. While farmland has acted as a good hedge against uncertainty and volatility in the past, it has also plummeted in value a number of times.
The enterprising investor should try to ensure they value the land they are investing in, or at least ensure the land is undervalued.
Valuing land is a difficult task and normally it requires a professional.
You could also follow the advice Buffett gives in his 1986 Berkshire shareholder letter:
In 1986, I purchased a 400-acre farm, located 50 miles north of Omaha, from the FDIC. It cost me $280,000, considerably less than what a failed bank had lent against the farm a few years earlier. I knew nothing about operating a farm. But I have a son who loves farming, and I learned from him both how many bushels of corn and soybeans the farm would produce and what the operating expenses would be. From these estimates, I calculated the normalized return from the farm to then be about 10%. I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out.
If you are interested in investing in farmland, there are plenty of articles around the community about it. If you don’t see any topics which relate to your interests, create your own topic!