Highlight / September 10, 2020

Income Investments and Farmland

Something strange is happening in the financial world. Global stock markets have been overperforming relative to the general macroeconomic backdrop. Even as GDP, employment, yield from income investments like bonds, and other factors decline, stocks (especially blue-chip stocks) continue to rise.

This overperformance is in no small part thanks to the herculean efforts of central banks around the world, which are instituting QE policies at break-neck speeds. These institutions have simultaneously dropped their sovereign bond rates to record lows in order to stimulate spending.

This trend has some worrying implications. Many older investors are now facing what is known as reinvestment risk. In this scenario, investors convert maturing bonds into new bonds that yield far lower coupons. This steep decline in yield decimates retirement plans and threatens to send many potential retirees’ strategies into arrears.

The Search for Yield

The lowest coupon on a US bond in the year 1990 was 5.89%. Today’s 30-year yields of 1.39% represent a 76% decline, meaning retirees will need a principal over four times larger to achieve the same income stream if they reinvest in today’s bonds.

Treasury Bond yields are struggling to keep pace with inflation. 

For many, the effects of these developments are deeply troubling. While a 30-year US treasury bond currently yields 1.39%, inflation is now running at an estimated 1.71%. Risk-free investments no longer preserve wealth, let alone guarantee income. When risk-free returns don’t keep pace with inflation, what can individuals do to preserve the integrity of their wealth?

In today’s environment, alternative investments that offer promising yields are few and far between, especially if one has a low-risk appetite. Junk bonds offer high yields but are speculative and too high-risk to be considered for a stable retirement portfolio. Gold is as solid as a rock, but it provides no coupon for income. The recent moves in precious metals have certainly been impressive, but aren’t enough to replace income-yielding bonds in a stable portfolio. ETFs can be attractive for gaining exposure to broader market indexes, but are subject to growing scrutiny over their underlying liquidity risks due to overcrowding.

Farmland for Income Generation

However, for investors seeking income, there may be an answer. Land is shaping up to be one of the most significant hedges of a lifetime, presenting opportunities for principal protection and income. Additionally, land offers diversification as an asset class as well as through the various commodities that can be produced by the underlying asset.

Undercapitalized and relatively obscure, land offers the best of both worlds when it comes to low-risk investments with income opportunities. The stability of land, coupled with income derived from the productive capacity of the land itself, has led many to refer to this asset class as “gold with a coupon.”

While the valuation of farmland can fluctuate, it has remained relatively stable when compared to other asset classes. The “slow and steady” characteristic of farmland has led to outsized returns. The years 1994-2003 saw over 10% annualized returns, with land valuations outperforming US treasuries, the Dow Jones, and S&P 500 between 2005 and 2012.

Stable returns aren’t the only beneficial characteristic of land investments. Farmland is also uncorrelated to global equities, making it the perfect hedge in a diversified and stable retirement portfolio. Should (some would say ‘when’) global markets awaken to the reality that Main Street is struggling to recover from Covid-19, land could serve as a counter to this potential market correction.

The “gold” that is land also comes with an attractive “coupon” in the form of commodities. Agricultural products may fluctuate, but they have intrinsic value on the global commodity markets. Lumber futures recently hit all-time highs, demonstrating that diversifying with land allows investors to take advantage of fluctuations in commodity prices. Commodities are also uncorrelated to the underlying land that produces them, further highlight the depth of diversification presented by investing in productive farmland.

COP to USD, 1 YR. The crisis has caused the dollar to gain against the Colombian peso.

Farmland: Surprisingly Undercapitalized

With a lack of correlation, stable returns, and a coupon in the form of diverse commodities, one may be forgiven for assuming that land investments are well-capitalized. Contrarily, institutional investments make up a paltry 0.5% of total farmland value globally. There is inelastic demand for agricultural goods, and undercapitalization rates sometimes reach into the trillions of dollars for some geographies.

Nowhere is this lack of capital allocation more evident than in Latin America. Emerging markets in Latin America present a multitude of benefits when it comes to farmland investments, including preferred currency exchange, growing accessibility due to improving infrastructure, and comparatively high rates of economic growth.

There are currently over 50,000 hectares in Latin America that are actively seeking funding from outside sources. US-based investors are particularly well-positioned for this opportunity. The US dollar is on the other side of 88% of all foreign currency exchange transactions, making it the predominant global reserve currency. Demand for US dollars has increased as foreign currencies have tumbled in valuation relative to the greenback in the wake of Covid-19.

Infrastructure spending in Colombia. New projects will drastically increase logistical capabilities.

A Unique Opportunity in Farmland

In addition to preferential currency exchange rates, the rapidly improving infrastructure of emerging markets in Latin America is cutting down on transportation time and costs. These improvements increase access to pristine farmland. The dedication of the Colombian government to improve access to the country’s abundant agricultural potential is on display with the Via Pacifico project, which has seen over $230 million in investments since its inception. Via Pacifico will grant access to otherwise difficult to access Colombian farmland, 65% of which is currently lying fallow.

The rate of growth in Colombia is enough to make the 1990’s 30-year bond yields blush. With a compound annual growth rate of 7.6%, investing in Colombian land offers promising returns in an up and coming breadbasket nation. While both land and commodity prices may fluctuate independently of one another, the steady rate of growth in Latin America, and Colombia specifically, is impressive.

Land is an excellent asset class to consider for any portfolio, especially for those looking for income investments to replace bonds, which currently do not keep pace with the rate of inflation. Emerging markets present enticing yields that, when taken in tandem with the stability of land investments, offer the best of both worlds in terms of stability and returns that make this asset class the opportunity of a lifetime.

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