Land prices are sensitive to capitalized values, and with 10 year rates rising and the FED more likely to raise the Federal Funds rate, land prices could come under increasing pressure with raising rates and declining income.



 

The relationship between the capitalized values and actual farmland values is important to appreciate. When farmland prices are above the capitalized value, the fundamental return and rate drivers of farmland prices suggest that either farmland prices are too high or that there are expectations for future increases in returns or lower rates. An extended period with prices well above implied capitalized values occurred in the 1980s, prior to the fall in farmland prices during the agricultural financial crisis. Between 1984 through 2006, farmland prices and capitalized values tracked each other closely. Since 2006 however, the capitalized values have been above actual farmland prices. An interpretation is that capitalized values are not suggesting that farmland prices are overvalued, or that the income experienced in that period was not viewed as totally permanent. In the past year, simple application of the formula resulted in the capitalized value increasing from $9,213 in 2014 to $10,754 in 2015. This occurred because the ten-year rate decreased from 2.54% in 2014 to 2.12% - a greater percentage decline than the percentage decline in income. Importantly, at low interest rate levels, capitalized values are very sensitive to rate changes.

While capitalized values increased between 2014 and 2015, actual farmland price decreased from $7,700 to $7,650 (see Figure 3). In addition to NASS reported values, other reports also suggest that land prices are declining (click here for values in the Seventh Federal Reserve District and here in Indiana. The Illinois Society of Professional Farm Managers and Rural Appraisers reported price decreases between 2 and 7% during the first half of 2015 (click here for more detail). These farmland price decreases are likely occurring because of fundamental conservatism about the agricultural economy, and anticipation of rate increases.

Commentary

Small increases in interest rates could also have a dramatic impact on capitalized value. Take the 2015 cash rent of $228 per acre and 2015 farmland price of $7,650 per acre. An increase in the ten-year CMT rate to 2.98% would cause the capitalized value to equal the 2015 farmland price. The 2.98% rate is only 86 basis points higher than the current rate. The last time the actual ten-year CMT rate exceeded 2.98% was in 2010, only five years in the past.