Does the farmland market make sense?
The Canadian farmland market has been strong for the last decade. But a question on people’s minds is “does it makes sense?” To answer this, let’s examine the relationship between farmland values and farm income.
To track the value of farmland relative to crop receipts, we use the Farmland Price-to-Earnings Ratio (PE ratio). It measures the price of farmland as a multiple of crop receipts. Used to assess other financial assets, the PE ratio is one measure of the affordability of farmland compared to its long-term average.
Let’s use the PE Ratio to examine farmland values and crop receipts in Canada and the U.S.
Agriculture and Agri-Food Canada (AAFC) is forecasting Canadian crop receipts for 2017 at another record level, $34.5 billion, a 1.4% increase over 2016. This would be an amazing achievement, especially considering weather challenges in parts of the Prairies and Central Canada. Crop receipts have been setting record four of the last five years.
Despite strong crop receipts, the PE ratio exceeded its twenty-five-year average at the end of 2016. Will we see this ratio increase further away from its average in 2017? We’ll have to wait for the release of the 2017 FCC farmland values numbers next week for the answer. An average value increasing faster than 2% will make the ratio trend up.
Crop receipts in the U.S. peaked in 2012 at US$231.6 billion and are estimated to be US$189.7 billion for 2017, a decline of 18%. While U.S. crop receipts declined during that period, the average U.S. farmland value levelled out with growth rates of 11.4% (2013), 7.8% (2014), 1.4% (2015), -0.7% (2016) and 1% (2017). As a result, the U.S. PE Ratio has also trended higher than its long-term average.
Despite different trends in U.S. and Canadian farm economies, farmland looks to be valued at a higher multiple in both countries than in the past. This can be explained a few different ways - it doesn’t mean the market makes no sense.
The low interest rate environment makes farmland attractive to prospective sellers that prefer to hold on to land as an asset and makes it affordable to buyers.
Another explanation is that buyers could also attach a stronger valuation to farmland because the outlook for agriculture suggests stronger future growth.
Leigh Anderson is a Senior Economist at FCC with experience in agricultural markets and risk. He specializes in monitoring and analyzing FCC’s portfolio, industry health and providing industry risk analysis. In addition to his speaking engagements on agriculture and economics, Leigh is a regular contributor to the FCC Economics blog.
Leigh came to FCC in 2015, joining the Economics team. Prior to FCC, he worked in the policy branch of the Saskatchewan Ministry of Agriculture. He holds a master’s degree in agricultural economics from the University of Saskatchewan.