It’s no secret that a well-diversified portfolio is a key to long term financial success, and we’ve often discussed how agricultural investments can help achieve that diversification.
But not all ag investments are the same. And as the large-scale financialization of agriculture is playing out, investors – especially institutional investors – are showing an increasing preference for permanent crops like mango and lime over row crops like corn and soy.
The pandemic saw a widespread retreat into more secure asset classes such as gold, commercial real estate, and, of course, farmland. Spurred on by a renewed interest in ESG allocations, institutional players are flocking to the farmland space. But why are they choosing permanent crops specifically?
Permanent vs. Annual Crops
Although both permanent and annual crops benefit from the underlying fundamentals of farmland as an asset class, they can be very different investments.
Annual crops, often called row crops, are comparatively straightforward – each year these crops are planted and harvested, sometimes with multiple planting and harvesting seasons per year. Annual crops include corn, wheat, and soybean.
Alternatively, permanent crops are much more nuanced in their time horizon and harvesting cycles – for example, it can take anywhere between five and thirteen years for an avocado tree to start producing fruit.
Permanent crops are characterized by longer time horizons and higher yields.
This longer time horizon is daunting for some – but it leads to returns that are beginning to significantly outperform those of row crops, and investors are starting to notice.
“For income, permanent crops rule,” according to a report by Institutional Investor, which notes that, “these crops’ annualized income has climbed from 13.06 percent to 18.28 percent in the past decade. Income from annual cropland has hovered at about 4 percent.”
The oft-cited NCREIF Index
This has led institutional investors to pursue permanent crop assets on a larger scale. TIAA-CREF, a financial services provider with a focus on research and medicine, recently allocated almost $5 billion of its over $500 billion dollars to the farmland space, diversifying into permanent crops such as walnuts, pistachios, and cranberries.
The move represents a very unique perspective on farmland assets in which the value of the property lies more in the trees than in the land. Justin Ourso, manager of the fund’s agriculture portfolio, mentions that the trees themselves can constitute, “anywhere from 50 percent to 80 percent of the value of the farm.”
When we think of farmland, the first thing that comes to mind is just that – farm land. But with permanent crops, the value of the underlying asset is as much in the trees as anywhere else. This creates a unique model for appreciation that often leads to much higher valuational increases, as well as a stronger yield profile.
Trends in Agribusiness Benefit Permanent Crops
With most of the global population increase occurring in the developing world, a tidal wave of people will enter the middle class in the coming decades. The world will host an additional 700 million humans by 2030, with over 1.7 billion individuals joining the middle class by this same time.
Demand for permanent crops will increase in proportion to the population. Markets are already experiencing the early stages of this phenomenon, with crops such as nuts, seeds, and tree fruits increasing over 6% year over year. Since permanent crops tend to be high-value goods that perform better in markets with higher median incomes, this trend will favor the permanent crop space especially.
But population growth isn’t the only reason that institutional investors are flocking to permanent crops. Declining yields from traditional income-generating investments are also motivating the shift.
Compared to the outsized returns of permanent cropland, interest rates on risk-free investments and corporate paper alike have given way to record low yields that barely keep pace with inflation. This has led to a search for yield that is driving institutional investors towards farmland.
As the race for sizable yields continues to pressure investors around the world, alternatives have seen record inflows. These confluences have led to the number of agricultural investment funds increasing by a whopping 625% in only 12 years, numbering 145 in 2017 with over $32 billion in assets under management (AUM).
However, even though we’re seeing an increased interest in permanent crops and farmland in general, the sector as a whole is still significantly undercapitalized.
Less than 1% of the total value of farmland globally has institutional backing, and data scientists estimate that 75% of the world’s agricultural land consists of family farms. There’s still plenty of room for the financial sector in the farmland space – which means this trend is likely to continue.
When it comes to institutional investment in farmland – and especially as it concerns the permanent crop space – allocations have been excessively confined to developed markets, especially in the United States. And in the US, land suitable for the type of permanent crops that investors are beginning to favor – tree nuts, citrus fruits, and berries – is not widely available.
In fact, the best permanent cropland in the US is mostly confined to California and Florida, where the agriculture sector is already firmly established. Higher costs of labor and inputs will put downward pressure on yields from these investments, even in sectors where returns are traditionally high.
Not to mention that valuational increases may be limited by the absence of potential scale-ups on the part of the regional ag sector in general. In short, the industry in these regions is about as good as it’s going to get, at least for the immediate future.
North America and Europe’s scientific approach to farming means that the average price per acre in the United States is well above $4000, with premium land in the Midwest sometimes costing over $7000 per acre.
It’s not like institutional investors are unaware of this trend. In fact, recent deals from international funds like the Carlyle Group have poured hundreds of millions of dollars into the ag sector at various stages of the supply chain, and Nuveen, one of the world’s largest asset managers, has acquired farmland in over 17 countries including Chile and Peru.
The growing interest in permanent cropland in emerging markets will have serious implications for institutional investors. But they aren’t the only ones who stand to benefit. New investment vehicles are opening up access to the permanent cropland space in emerging markets.
Latin America’s Huge Potential for Agribusiness Development
Along with hosting the bulk of the world’s population growth and middle-class entrants, the developing world has by far the most lucrative opportunities for permanent crops.
Nowhere is the opportunity more prevalent than in Latin America, which hosts over 11% of the world’s arable land. The northern portion of South America is situated on the equator, meaning fruit and nut trees can grow year-round, cutting down on the required time to achieve an abundant harvest.
The increasing stability of the region has yielded some startling discoveries. Colombia is using only 35% of its rich farmland, with the remaining 65% laying fallow.
With the most expensive farmland rivaling that of the United States, the vast majority of South American cropland is much less expensive – Paraguayan farmland can cost as little as $150 per acre.
Investing in Permanent Crops
When institutional players make investments in permanent cropland, they do so with a key understanding of the underlying product, its market, its growing process and harvest cycles, the region in question, its climate, its logistical and market access, its soil quality, and a wide range of other factors that are essential in assessing the value of an agriculture investment.
Institutional investors are looking to permanent crops for many of the same benefits that have cause private investors to seek out the space. With long time horizons, higher yields, and the potential for significant appreciation, the permanent crop space is certain to see a dramatic rise in interest from institutional and private investors alike.