Understanding the drivers of farmland values

Today FCC ag economics released a report  on Canadian farmland. The objective is twofold: Understanding the drivers of farmland values and providing an outlook of the possible patterns for 2015.

Farmland values are driven by three main components: interest rates, farm crop receipts, and a momentum effect. Low interest rates support a strong demand for farmland. Crop receipts influence the income earning potential of farmland, and higher income pushes farmland values higher.  The momentum effect is all about patterns, and historically changes in Canadian farmland values happen at a slow pace.  

Making projections about future patterns in farmland values requires assumptions about interest rates and crop receipts. Low interest rates are assumed to persist through 2015 and into 2016. Projections from AAFC suggest moderate declines of crop receipts in most provinces in 2015.

For province-specific projections, we combined these assumptions with some more local relationships such as the impact of oil prices on land values in Alberta.  While farmland values increased in 2014, our projections for 2015 reveal a similar pattern, albeit at a more moderate rate.  This is what we refer to as a soft landing - a scenario in which farmland values will gradually stop increasing and stabilize at levels consistent with the positive long-term outlook for agricultural markets.

How do land values measure up in history?

Are the patterns in farmland values consistent with the income earning potential of the land? This is a difficult question – but some insights can be gained by looking at the ratio of farmland prices relative to crop receipts. This is a tool widely used in financial markets, although net income is generally the preferable measure in these cases. In the current case, crop receipts track the patterns in farmland values better than net income.

Our analysis shows that farmland values have recently been increasing, along with the ratio of price to crop receipts. Yet, the ratio is consistent with its long-term average in many provinces. In other provinces such as Quebec and Ontario, the ratio of farmland price to crop receipts is higher than the historical average in these provinces.

Outlook for 2015 remains positive

While farmland values are projected to remain strong, the overall pace of appreciation is expected to slow down as a result of softer crop receipts.  Of course, the second half of 2015 will be the determining factor. Weather conditions, the value of the Canadian dollar and a host of other economic factors will impact crop receipts and ultimately farmland values.

Farmland can represent as much as 65 per cent of farm assets – often times more. Farmland is a significant component of a producer’s operation and balance sheet.  Producers must look closely at their operations and balance sheet and ensure they can manage through a number of scenarios when it comes to revenues, expenses, debt and asset values.  

Madeline Turland, Ag Economist Intern