The COVID-19 crisis has dramatically increased market volatility, and is pushing investors to diversify their assets. As the desire for alternative assets continues to rise, farmland is showing itself as a powerful tool for those seeking assets that are not correlated to publicly traded markets. Global farmland is emerging as a new safe haven for investors, providing diversification, inflation protection, and return potential.
In a crisis, investors typically pursue well-known alternative investments like commercial real estate, gold, silver, and oil. But COVID is deeply impacting many of these markets – gold prices, for example, recently skyrocketed on currency debasement fears, and oil took a major dive earlier this year due to geopolitical disagreements.
This is where agriculture emerges as a promising tool for diversification. Not only because alternative investments related to agriculture are not correlated to traditional vehicles like stocks or bonds, but also because they’ve brought consistent returns over the last decades.
The agricultural sector showed resilience even during the 2008 crisis, while most of the world was going through a severe and prolonged recession. And within the agriculture space there was an asset that outperformed many others – farmland. Research shows that farmland not only consistently produced positive returns, but it also outperformed the U.S. treasuries, the Dow Jones, and the S&P 500, before and after the 2008 crisis.
Annual volatility of U.S. farmland vs Bonds and stocks (Source: The Financial Times)
Rethinking Agriculture as an Investment
The farmland market in the U.S. is worth a stunning $2.5 trillion. To put it in perspective, multifamily housing (one of the biggest segments of commercial real estate) is worth $2.9 trillion. They both share a vast market and are also driven by population growth.
Farmland and multifamily real estate will always have demand. A growing population will need more housing options, and more people also means the need for a larger food supply. In the future, farmland will need to produce 70% more food just to keep up with population growth.
Moreover, farmland is scarce and finite, which influences appreciation. In Canada, farmland for sale was valued in $464 per acre in 1988, and reached $3000 in 2018. Meanwhile in the U.S. farmland has gone from $885 to a stunning $4000 per acre in 2018. According to the National Council of Real Estate Investment Fiduciaries’ Farmland Index, the annual return for farmland averaged 11.5% over the last 25 years.
Annual returns vs Volatility (1970-2018) (Source: Nuveen)
But opportunities in farmland are by no means limited to the developed world. In fact, the most attractive farmland opportunities often lie in emerging markets, not only in terms of appreciation, but in terms of cash yields as well.
While farmland in the US has shown consistency over the years, appreciation has slowed recently. Average farmland prices in the US increased just .02% from 2018 to 2019. Not only that, but cash yields for farmland in developed markets tend to be lower due to seasonal growing conditions and higher operational costs.
In addition, farmland opportunities in developed markets, particularly the US, are limited in terms of cash yields by a focus on low-margin staple crops like wheat, corn, and soy.
Going beyond developed markets, there is potential for stronger diversification when thinking globally. Investing in emerging markets can bring exposure to a variety of markets, crops, and economies.
In emerging markets, the growth potential of agriculture is often higher than in the developed world. Due to the improvement of infrastructure and supply chains, farmland in many developing regions can appreciate radiply, as better access to markets and logistics can increase value.
Although, potential returns are not limited to long term appreciation and geographical diversification. Depending on the contract modality, there’s the possibility to adjust risk to receive higher profits. In other words, investors can get exposure to an agricultural commodity to increase their returns.
For instance, in a custom farming contract, the investor can choose an operator to be in charge of farming while taking all the risk and rewards. Or even with a share lease – also known as variable rent – the investor and tenant can farm together to then share the revenues from sales.
Getting familiarized with farmland
Farmland is very similar to the housing market. According to Financial Times, location and asset quality impact risk perception in both markets, meaning that significant improvements will translate into higher returns.
In real estate, painting a few walls involves a low risk/return, but completely restoring a residential property means getting a much higher rent. For farmland it can go from expanding the arable land to bringing in new machinery to installing irrigation systems to boost production.
Farmland investment in emerging markets is also being bolstered by the adoption of an innovative new business model – Farming as a Service. The FaaS model allows precision farming techniques to be implemented at scale, can convert fixed costs into variable costs for farmowners, and can be an excellent way of mitigating production risk.
The outcome of geographically diversifying can be extremely appealing. The unmet yield potential and arable land availability of emerging economies – like Latin America and the Caribbean – can turn into a massive opportunity. Take for example Colombia, where 40% of the country is arable land and the GDP from agriculture is significantly increasing.
|On top of long-term appreciation, investors can realize returns through revenues from rent or sales. Any additional exposure to the commodity itself can boost the revenues from a farmland investment. This combination of appreciation and cash flows has led many to refer to farmland as ‘gold with a coupon’.|
In times of uncertainty, farmland can be a great diversifier that offers long term returns. COVID is making us rethink diversification, and many investors are looking for alternative assets – and, in many cases, alternatives to the alternatives. In this context, farmland arises as a safe haven, being non-correlated with traditional investment vehicles and offering long-term appreciation and potential returns.