Portfolio management has changed dramatically in the aftermath of the financial crisis, with investors understanding that it’s not enough to diversify assets, it’s also important to diversify underlying correlations. Farmland, which consistently has an above average risk/return profile, was underrepresented according to most metrics before the crisis. Its low correlation with equities and high correlation with inflation (making it a good hedge) would seem to make it an even more important asset class, but that underrepresentation has only continued, and a recent study from the TIAA-CREF Center for Farmland Research explains that it’s the idiosyncrasies of agriculture that make it difficult to invest in.
Farmland has low turnover rates
First, actually buying farmland directly is much easier said than done. “It is surprisingly difficult to precisely measure the rate of farmland turnover, but most evidence points to annual rates of transfer in the 1-2% range for arm’s-length production sector acreage,” says the report (arm’s length sales exclude sales within the family, such as from parents to their children).
This level of turnover means that the market is quite thin, so it takes longer to identify and procure farmland than most other assets, and valuation is more involved.
“Across regions, crop patterns, market price bases (often reflecting terminal market transportation cost differences), weather patterns and access to water, and many other differentiating features result in heterogeneity of properties and the resulting complexities in assessing individual asset values,” says the study.
Even when a suitable plot of land has been located and its value assessed in a vacuum, there are valuation differentials that may prevent you from paying a price that seems reasonable. An adjacent farm, for example, might be willing to pay more than the going rate for land because the costs of incorporating it into their existing operations is relatively low. On top of that difficulty, brokerage or auction commission costs often run 5%-6%, creating a yield drag that pushes all but long-term investors out of the market.
Highly correlated, indirect exposure is hard to find
Investors might want to increase their exposure to farmland without buying it directly, possibly through some sort of index or by taking equity positions with big Agro companies like Deere & Company (NYSE:DE) and Monsanto Company (NYSE:MON), but this has proven difficult to accomplish.
“There have not been any good replication strategies identified that exhibit meaningfully high correlation to returns from direct ownership of the asset, and thus remain somewhat an activity of investigation/refinement, or perhaps simply academic curiosity,” says the TIAA-CREF study.