While many investment vehicles are

providing poor returns, investors and farmers alike value the stability farmland offers.

The uncertainty and low returns of the stock market, money markets, bonds and other investments are inducing investors to look at diversifying their portfolios with something less risky. That’s why investors, as well as farmers interested in expanding their operation, are snatching up Illinois farmland almost as quickly as it comes on the market, according to agricultural real estate experts.

"Farmland traditionally has been a stable investment," says Ray Brownfield, recently retired president of Capital Agricultural Property Services Inc. (CAPS), based in Lisle. "Other than during the 1980s, farmland has proven itself during the past 75 years and has appreciated from two percent to five percent a year across Illinois."

Brownfield cautions that farmland is a long-term investment. "Most investors understand that they can’t buy land and expect to turn it over quickly for a big gain," he points out. His insight is based on almost 20 years with CAPS, which provides management, real estate brokerage, consulting and appraisal services for farm operations in major growing regions of the United States.

Pete Petges, vice president for 1st Farm Credit Services’ northern Illinois region, adds that the historical trend bodes well for all buyers, whether they are investors who will rent their land or farmers who are expanding their operation. "Investors who want to diversify their portfolios appreciate the control they have with land," he observers. "It is a finite and tangible resource; they can see it and walk on it. They can change the conditions and improve it. They can’t do that with stocks and bonds."

The market also is attractive for farmers who want to buy property near their current operation to expand their base or bring in additional family members. "Whether they plan to hold onto the land indefinitely or sell down the road, they realize that farmland is a good place to put their money," Petges says.

One of the primary reasons that northern, central and western Illinois farmland is a good investment is the continued stability in land values of the past dozen or so years, according to Mark Akers, ARA, director of appraisal services for 1st Farm Credit Services. Based on the annual benchmark farm analysis by 1st FCS appraisers, average farmland values in the association’s 42-county service area increased about two percent from July 2001 to July 2002. The DeKalb County benchmark (Class A farmland), for instance, is selling for nearly $5,000 an acre. (See chart above.)

"Land values in Illinois have climbed steadily following the declines of the early 1980s," Akers explains. A combined inflation and recession caused that crash. "The high interest and unemployment rates slowed demand for development in the collar counties around Chicago," Akers says. "Competition for land on the market was reduced, and prices fell."

In 1989 the overall economy started to improve. "With more favorable interest rates and the end of the recession, development in the collar counties increased, creating demand for farmland from tax-free exchanges," Akers notes. "This competition for land has added demand and continues to fuel increases in land values in Illinois."

Adding to that competition, Brownfield points out, is the the fact that the current economy is not offering a great incentive to sell farmland and reinvest those funds in other investment vehicles. In addition, sellers may have to pay taxes on the proceeds of a sale whether they bought or inherited the land, and capital gains also can be an issue. "Thus, there is a shortage of listings in the marketplace," Brownfield says.

With pent-up demand and fewer farms coming on the market, Petges reports that competitively priced farm real estate is selling quickly.

The farmland that comes on the market today usually is estates from families who have passed the land to the next generations. According to the spring 2002 Farmland Values and Lease Trends Survey from the Illinois Society of Professional Farm Managers and Rural Appraisers, estate settlement accounted for the largest number of farmland sales in Illinois in 2001 (43 percent). Next came 1031 tax-deferred exchanges, which totaled 22 percent of the land sales. The desire to switch to non-farm investments accounted for only 14 percent of sales in the state. (See chart 2.)

A 1031 tax-deferred exchange allows a seller to roll over the proceeds from the sale of an investment property into the purchase of one or more like-kind properties. Capital gains taxes are deferred and equity is retained. "High activity in the 1031 market is compounding the demand situation," Brownfield says. "Large tracts of 300 to 700 acres are most attractive because this amount of land can readily satisfy the 1031 exchange dollars to be reinvested." Tracts that size coming to market are not plentiful, making it more difficult to exchange into one property.

The sale of farmland for suburban and semi-rural housing and commercial development also is driving the interest in investing in farmland. "There is no place where the trend of conversion from agriculture to residential and commercial use is more evident than in the Chicago collar counties," Akers says. "This development pressure has been strong for the past decade and is expected to continue (See chart 3.) as long as interest rates remain low."

As has been the case for the last several years, recreational-use land with some woods and perhaps water remains in strong demand as city dwellers seek a country refuge. "In western Illinois, for instance, the price of recreational land is almost equal to that of tillable farm ground," Brownfield observes.

Also making investment in farmland favorable is the strong demand by farm operators to rent quality ground at competitive rental rates. "Competition remains very strong among farmers seeking additional land, and cash rent seems to be the type that is drawing most of the interest from prospective renters," Brownfield says. "Even where production was below normal, the rental and land value markets remain stable to strong."

Akers adds that cash rents have been stable throughout 1st FCS’ territory for the last two to three years, despite low commodity prices. Several factors contributing to that stability include:

1. Government payments are supporting farm income and strengthening the farm economy. "There are conservation provisions in the new farm program that are heavily funded, and, as the new year progresses, owners and operators will become more aware of those opportunities which can provide additional income to the farming operation," Brownfield reports. "This, over time, may also capitalize into higher rents and land values."

2. Larger farming operations are able to lease additional land without incurring additional fixed cost. "There are some pockets showing increases, but mostly due to localized specialty crop contracts," Akers adds.

When buyers locate land in which they are interested, they need to consider several factors before making a purchase, depending on whether they will farm the land themselves or plan to rent it to a farm operator.

Petges says potential buyers need to find out what the land values have been in the area for the past few years, as well as average cash rents and returns.

Buyers also need to find out what soil types are on the land and what the land’s productivity has been for the past several years. Brownfield recommends checking the Illinois Soil Bulletins, published by the University of Illinois’ College of Agricultural, Consumer and Environmental Sciences. He says a professional farm manager or realtor can assist with the process of learning about the land. 1st Farm Credit Services financial professionals also are a good resource.

Environmental issues are another concern. "Find out if there is anything potentially hazardous on the land such as buried fuel tanks or refuse piles," Petges suggests. "Also learn what is near the land. Are there nearby areas that have been cited for chemical spills? Have they been cleaned up? These issues could impact the value of the land."

Zoning is an important issue as well, particularly in residential and development areas. "Some Illinois counties have strict zoning regulations," Petges says. "If you want to change something on the land, such as building another home on the property, can you do so?"

Brownfield advises that farmland purchasers and investors have an exit strategy even if they think they will hold onto the land forever. "Always consider how difficult it would be to sell the land in a reasonable amount of time," he says. "If it was attractive to you as a buyer, would it be attractive to someone else?"

When analyzing whether to put money in farmland or other investments, it is important to understand how the rates of return are related across different asset classes such as stocks, bonds and commercial real estate. "Farmland’s returns are not highly correlated with those of many other financial investments," says Bruce Sherrick, associate professor of agricultural and applied finance for the University of Illinois’ Department of Agricultural and Consumer Economics. "However, farmland’s returns are positively correlated with common inflation indicators." (See chart below.)

A recent study shows that since 1990, Indiana farmland has generated greater returns than stocks within the Standard & Poor’s 500 index, a broad-based index of common stocks considered a benchmark for U.S. equity performance. Chris Hurt, Purdue University agricultural economist, says the results would parallel an investment in Illinois farmland. "Farmland has done quite well in Indiana relative to other investments, especially the stock market," he reports.

Hurt compared a $1,000 investment in S&P stocks in 1990 with an identical amount invested the same year in Indiana farmland. Returns covered the nearly 13-year period ending July 31, 2002. Stock earnings were based on annual returns and dividends; farmland earnings were based on annual returns plus land value appreciation, minus certain expenses. Income tax consequences were not subtracted from either set of numbers.

Hurt found that while average returns by annual percentage growth were slightly higher in the stock market, Indiana farmland came out ahead in total returns. He says the numerical improbability occurred because the S&P 500 experienced greater annual highs and lows during the period analyzed, while farmland values and returns inched up steadily each year.

"The pre-tax value of $1,000 invested in 1990 in farmland was about $3,800 in July 2002, while in S&P 500 stocks it was about $3,300," Hurt reports.

Hurt contends farmland might become an even more attractive investment in the years ahead, particularly if the stock market continues to sputter.

Petges agrees that farmland can be a valuable asset to an investment portfolio, although it has a different value proposition than do stocks or bonds. "Investors and farmers alike need to keep in mind that farmland is a long-term investment that shouldn’t be turned over in six months," he explains.

Chart's 2 and 3 Source: Illinois Society of Professional Farm Managers & Rural Appraisers' Farmland Values and Lease Trends Survey

Debbie Coakley is a freelance writer based in Warrenville. She frequently writes on agricultural topics for Agri Marketing magazine and other publications.