Alternative Investment: Farmland (3 of 8)
Productive agricultural land is a tangible asset that can be directly owned and offers the prospect of both regular income and capital preservation.
'Farmland' is Risk Level 3 of 8 in Alternative Investments.
Demand for land and soft commodities is being driven by strong macro-economic trends. The most notable macro trend is the increase in global population which hit 7 billion at the end of 2011 and is predicted to reach 9 billion by 2050 according to data from the United Nations Population Division. This is estimated to average an increase of about 75 million people a year.
In addition, as Asian countries such as India and China grow richer their populations are eating more meat, which in turn requires more grain to feed livestock. It takes 7 pounds weight of grain to produce a single pound of beef.
Stability And Diversification
Farmland is a classic defensive investment and can be both a store of wealth and provide regular income in recessionary environments - whatever happens in the wider economy, people need to eat. Farmland has a low correlation to many other asset classes and has outperformed traditional asset classes over the long-term. In 2008, when many stock markets were down by over 40%, farmland values increased by over 15% in the US according to the NCREIF Farmland Index. Other locations witnessed similar rises.
Despite the strong fundamentals supporting farmland investment, it is still an under-owned asset. In many cases the barriers to entry and costs of transaction are prohibitively high and many institutional investors have been constrained from investing in the sector by their benchmarks, strategies and investment memorandums.
Widely reported food price spikes in 2008, 2010 and the summer of 2012 are testament to the growing mismatch between supply-and-demand for agricultural produce. The activities of state-backed investment funds, such as the Chinese government-run Heilongjiang Beidahuang Nongken Group, which recently purchased over 800,000 hectares of land in Argentina, demonstrate how seriously the issue of food security is being taken.
The majority of investments in this sector were launched in 2010 and 2011. They emerged on the back of the 2008 financial crisis: a global event which increased investors’ appetite for more diverse assets not correlated to the stock market. In addition, the widely reported global food price spikes of 2008 increased awareness of the need for investment in agriculture.
The products offer an even split of defined and open-ended exits. A defined exit project is dependent on a certain level of funds raised resulting in good land production; an open-ended exit strategy requires commitment to a more speculative play.
All the products offer annual returns from year one, derived from a regular harvest income, but only one product has the confidence to offer a fixed annual return.
Ownership structures vary from beneficial ownership to investors purchasing a lease or sub-lease, to a UCIS. What happens in the event of a provider default may be open to scrutiny.
Geographically, most of the projects are located in emerging and frontier markets where land is cheaper, harvest yields are potentially higher - but risks can be greater. Notable exceptions are projects based in the UK and Australia, where returns on offer may be lower – but this is reflected in the lower level of risk.
As well as the investors’ tenure over land, other areas that need to be prioritised in the investment equation are the experience of the operating company farming the land: the initial land valuation and its quality, as well as the proposed use of funds provided by investors. Many products remain opaque on this point and every effort should be made to ascertain how much of the money raised is used directly on the project and how much is used to pay the product provider or fund distribution.
Ongoing charges include the costs of the appointed farm operator and may not always be made clear, despite being taken from investors’ returns –a variable cost that can add an unquantifiable risk to the investment. A lack of transparency therefore can make assessing some of the investment opportunities difficult.
Good projects in this sector feel like responsible investments. Whilst they may not trumpet CSR credentials or have a green halo, putting money to work to help produce food for a hungry planet is a productive use of capital and should benefit us all.
Farmland continues to be an attractive area of investment. The fundamental case for investing in farmland has only grown stronger throughout 2012 and the prospect of largely uncorrelated, genuinely diverse returns appeal to investors.
Directly held farmland products can offer access to the sector with relatively low minimum investment levels and strong returns on offer. However, few have mature track records of any significance and so the apportionment of investment funds and progress on the projects and harvest yields, for now at least, remain opaque.
- Future demand for food
- Direct purchase of land
- Annual returns from year 1
- Emerging markets with cheap land
- Counter-party risk - farm operator/manager
For investors and agents, directly owned farmland makes sense within a portfolio – it is a defensive investment that does not rely upon strong economic growth and provides returns that are not correlated to traditional investments. But any investment needs to be carefully researched to ensure the model makes sense and the risks are understood.
Investors need to be confident that they are paying a fair price for their land, that the land is (or will shortly be) productive and that there is a market for the crops and a distribution chain in place to ensure they get to market. Investors need to be certain that they are not inadvertently investing in a land-banking scheme dressed up as an agricultural investment.
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