Buy or lease?
When we think of farms and ranches the first thought that comes to most peoples mind is the physical, private property. That is no longer the case. Farms and ranches are often the agricultural business that is built upon either owned or leased land. It may come as a surprise to many of you that I don’t own a single acre. The picture above is the headquarters for our operation that is leased from my father and a cousin. We lease additional land in Medina County from a few distant relatives and are currently working on a larger lease agreement with a friend and colleague.
It is smart business to separate the land from the business, regardless if you own it or not. To put it simply the land ownership is the real estate business and farm ownership is the farming business. They are very distinct, separate businesses that should be kept as such regardless if you own or lease.
The reality is that purchasing rural property is no longer an option for farmers and ranchers because of land values. Land values have been increasing rapidly for the past few decades. The land is often no longer valued for it’s agricultural use, but for it’s recreational use. This more often than not prices agricultural business out of the market. For our farm business model purchasing land just simply isn’t an option.
Leasing land is an alternative business model that can increase profitability, manage risk, support business succession and overall increase access to capital. Leasing land gives new farmers a chance to kick-start their careers. For older farmers who are looking to retire and do not have a succession plan to their children leasing to other farmers can often be a great option. It allows them to retire with income from their land and still maintain ownership of the property. When they make this land available to aspiring farmers wanting to get started it benefits both parties.
I often find that the demand for leased land far exceeds the supply, but perhaps the tide is turning. U.S. Census data shows that over the next decade more than 50% of America’s privately owned land will transfer ownership. The number is staggering and unprecedented. Never before in a nations history has that much land transferred in such a short time frame. My theory is that there will be a myriad of opportunities for young, aspiring farmers to lease land. Unless farming profitability increases substantially purchasing will still not be a good option. Leasing allows quick access to land, allowing you to scale up the business without having to raise the capital to purchase land.
There are some important considerations to think about when signing onto a lease. I will do my best to highlight what I think is the most important, but always remember that if you have legal questions it’s best to seek the advice of a real estate lawyer that specializes in farm & ranch real estate before committing to a lease agreement. The price of the lease is probably the biggest concern for most farmers and will probably be the most difficult part of a lease. The most fair method of calculating the lease payment requires taking into account the returns for the enterprise such as grazing cattle. For example most of our lease agreements are set at a rate per animal unit. Because we keep good financial records I know how much it costs me to produce and the return to expect for various animal units. This allows me to easily discern how much I can pay for a lease. An equitable lease fee should reflect the relative profitability of operating the land and account for the farmers contribution to the capital improvements of the land and infrastructure. For example with a grazing lease the farmer may determine that to increase profitability more fencing and water points need to be installed. This is a capital contribution from the farmer to improve the land and should be adequately accounted for in the lease fee. Additionally good management practices and the farmers demonstration of high productivity can increase the value of the land.
One major drawback of leasing is you often bear all of the risk. Bad economic downturns or severe weather events that effect your crop or livestock can be financially devastating. The landowner often has a guaranteed return through lease payments and the farmer may not reap a return on the business. This can be mitigated by the landowner and farmer having more of a “participatory” agreement where the risk is shared. If a “participatory” agreement isn’t for you then another consideration is increasing the length of time for the lease. This can help even out the good and bad years.
The most important aspect of a lease is having an adequate agreement. Both parties should have a legally binding contract rather than the all-too-common hand shake agreements. This will prevent either party from prematurely abandoning their side of the lease agreement. It will be clearly written what is expected of the landowner and the farmer. Should an issue occur then both parties have a legal document that they can refer to for guidance on resolution.
Leasing land is a vital part of our business at Parker Creek Ranch. It has allowed us to access land and maintain growth with our farm business. I am not saying that leasing is for everyone, but at the very least you should certainly consider it.
