Is A Bubble Brewing In Farmland? PowerShares DB Agriculture Fund, Market Vectors Agribusiness

farmlandJeff Uscher: It’s little wonder that yield-starved pension funds and other investors are investing in farmland.

That’s because farmland, a hard asset, produces high returns and, unlike other hard assets such as precious metals, provides investors annual income from crop sales.

The National Council of Real Estate Investment Fiduciaries (NCREIF) compiles data on the total returns (income and capital gains) on farmland purchased for investment purchases, primarily by pension funds looking for income and diversification.

In 2012, the annualized total return on investment farmland was 18.58%.

The NCREIF has data going back to 1992. Since then, the highest annualized total return was 33.90% in 2005 while the lowest annualized total return was 2.02% in 2001. Over the 20-year period from 1992 to 2012, the average annual total return was 11.83%.

And sharply higher prices for major agricultural commodities such as corn, wheat and soybeans have increased annual investment income for anyone investing in farmland.

Legendary hedge fund manager Jim Rogers has been buying farmland in Australia for a private fund.

“It’s the farmers, the producers, who are going to be in the captain’s seat when the prices go through the roof,” he told The Australian Financial Review back in 2011.

“The world has got a serious food problem,” Rogers told Time magazine. “The only real way to solve it is to draw more people back to agriculture.”

But is this rush toward investing in farmland now creating a huge bubble?

Is a Farmland Bubble Brewing?

Farmland prices have been rising across much of the Midwest.

The Federal Reserve Bank of Kansas City published a chart showing that prices of irrigated and non-irrigated farmland in the 10th District – which includes Colorado, Kansas, Nebraska, Oklahoma and parts of New Mexico and Missouri – were up by more than 30% in 2012.

Farmland prices are rising back East, too. In Ohio, cropland prices rose by 13.6% in 2012 and are expected to move even higher in 2013.

“With many dollars and buyers chasing farmland, it isn’t surprising to see land values increase substantially in 2012,” said Barry Ward, production business management leader for the Ohio State University Extension.

“Crop profitability along with low interest rates have been the primary drivers in the run-up in cropland values.”

Bare cropland in Ohio, Illinois, Nebraska and Indiana is averaging at least $5,000 per acre. Based on production and cost estimates for this year, an acre of corn will produce a profit of between $204 and $489 or between 4.0% and 9.7%, assuming an investor paid $5,000 for that acre of land.

Wheat is expected to earn a profit of between $122 (2.4%) and $288 (5.8%) per acre while soybeans are forecast to return a profit of between $102 (2.0%) and $295 (5.3%) per acre.

But the actual value of farmland will, like everything else to do with farming, depend on the weather.

Last year’s drought resulted in sharply higher crop prices and higher prices for farmland.

“The weather will dictate what happens to land values,” said Steve Bruere, president of Iowa real estate brokerage People’s Company. “We’ll have the world’s largest crop planted in 2013. If we have timely rains, commodity prices will go south and that will have a negative impact on values. If we have another short crop, then land values could continue their ride up.”

Also, if the Fed ends its quantitative easing policy, interest rates could start to rise and that would take some of the fluff out of the farmland market.

But even if farmland prices stabilize or fall, no one is predicting a major price decline and widespread farm foreclosures similar to what happened in the 1980s.

It is deep-pocketed financial investors who are buying much of the top-of-the-market farmland and not cash-strapped farmers. And about half of the new farmland transactions are being done for cash so lower crop prices will not create a wave of distressed farmland sellers.

Most observers think there is a bubble in farmland and expect that the bubble will not burst, but simply deflate slowly until land prices and crop returns are once again in line with economic reality.

Related: PowerShares DB Agriculture Fund (NYSEARCA:DBA), Market Vectors Agribusiness (NYSEARCA:MOO).

Money MorningWritten By Jeff Uscher For Money Morning

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