Many factors affect the value of real estate, especially when it comes to farmland. It can be a little bit tricky to come up with a number. But farmers and investors need a method to assign value to farmland. Let's talk about the factors that go into it.
Two main factors determine the value of farmland: the sale price of comparable land and the capitalization rate. While each provides similar information, most investors want to look at both to make sure they are getting an accurate assessment of a property before they sign.
Market Knowledge is Required for Determining Price
The first step in assigning value to farmland is to get acquainted with the local market. A good indicator or starting point can be comparable sales. This isn't exactly an apples-to-apples comparison because every piece of farmland has unique qualities that add or detract value.
For example, a non-irrigated property sold for $2,500 per acre is in the same area as a similar property with an irrigation system valued at $500 per acre. Given these numbers, it is reasonable to say that the irrigated property might be worth $3,000 per acre.
This isn't necessarily a reliable method for determining a final sale price or actual value, but it is a good starting point. In real estate, the seller usually looks at several comps and takes an average price.
It is good to take a sampling of multiple properties because individual factors can have a significant impact on sale prices. For example, a farm in foreclosure will sell low, or a property with the right location for a specific buyer will sell high. The average number is five to ten properties, but it can be hard to find that many comps with farms.
How to Calculate Comparable Sales for Farmland
A simple land valuation looks at comps of comparable size in the same area but little else. A high-quality land valuation will take all of the features on a farm into consideration as they contribute to the property's value.
Features that might be considered include irrigation, soil quality, drainage, road access, proximity to storage facilities. Comparable sales will be similar in quality and characteristics to the property being evaluated.
Working with an experienced seller or broker can help fill in the gaps when there is a lack of available comps in the area. These individuals have the professional experience to assist in an adequate evaluation. They see many sales in their area and are often privy to the details on some of those sales.
Where to Find Information on Comps
Information on comps and county averages for land prices are public records and are available through the courthouse, government agencies, brokers, and bankers. Unfortunately, the process of gathering information is slow and often turns up antiquated data that can be misleading. For investors, it can pay significant returns to keep an eye on the market at all times. Or at least to network with brokers that have their eye on the market.
Limitations on Comp Data
Fluctuations in the real estate market make it difficult to use past data for future valuations. Comps are also shortsighted in determining the annual cash return an investor can expect on a property. In some cases, local buyers might impact sale prices. As an investor, paying too much for a property takes money directly out of profits. Another pitfall is buying low-cost properties with low rental prices.
Real estate agents, brokers, and appraisers all tend to come up with different valuations—the simple reason for the differences is how each party looks at the property. But they also tend to only look at the high-level details of the property. An appraiser is typically an impartial third party with no stake in the selling price of the property.
By comparison, a realtor or broker will be influenced to provide a higher valuation price based on their interest in the property sale. But that higher price isn't always without merit. Realtors tend to see details in properties that appeal to buyers. They often know what individual buyers might be willing to pay more for. And those details also factor into their valuations.
Plus, regulations in most areas aimed at preventing agents from influencing appraisal prices and lining their own pockets keep these two professions distinctly separate. The downside is that the appraiser is often unfamiliar with the property and this lack of knowledge may lead to a lower assessment.
Standard Methods for Calculating Farmland Valuation
Anyone, even those not familiar with the local real estate market, can get a good idea of the value of a property simply by calculating capitalization rates, learning about the local farming economy, and looking at data on comps. But there is one key factor to keep an eye out for. The influence of foreclosures and short sales on the agricultural real estate market may artificially lower valuations.
Comps are relatively risk-free in a stable market. Still, especially with agricultural land that is tied to the potential success or failure of a farm business, every valuation should consider the effect of foreclosure and short sale data. Rather than getting hung up on whether to include data on one short sale or foreclosure, investors are better served by looking at the percentage of these sales in the market.
If there is a high number of distressed sales, this could point to other problems in the local area, like a policy that hurts agriculture businesses. Further research will be needed to determine why so many farms are struggling in the area before proceeding with an investment.
Determining Capitalization Rates
In addition to using comps to get a baseline value for a property, investors and landowners also use the capitalization rate or "cap rate." The cap rate is the expected rent as a percentage of the purchase price. For example, land that rents for $100 per acre and has a purchase price of $3,500 per acre has a cap rate of 2.8%. Most investors already have a target cap rate in mind.
Calculating the cap rate isn't a foolproof method. Without having some market knowledge on average rent prices, it is easy to overpay for land. The average rent for ag land can be found in government records at courthouses and through brokers.
Government surveys often report data on average rent prices. But the numbers are limited to the responses of voluntary participants and may not provide a complete picture. The best resources include farmers who rent land and those who finance those farmers.
Land Income is a farmland developer in California committed to using technology to build profitable agriculture endeavors.
Using Both Methods for Farmland Valuation
Given the limitations of each method, it can be helpful to combine both methods to provide an accurate picture of farmland valuation. Comps provide a listing of typical sale prices and may be able to provide rental prices too. Cap rates help investors determine what prices will be profitable to choose between good investments and money pits.
Most commonly, the numbers will be similar using these two methods. When they come up with significant differences, it is an indication that more research is needed to do an accurate valuation. Ultimately, working out the math requires background knowledge in the agricultural real estate market and farming operations.
The key to making a profitable long-term investment is to rent the land to good farmers. These farmers can make money and take care of the property so that it does not lose value.
Benefits of Using Both Methods
Farm pricing varies significantly between different regions due to factors affecting local economies, policy, and geographical conditions. For example, an Avocado farm in central California is prime real estate. Still, the same farm in another region like the midwest or even the drought-riddled valley would be worth much less.
There are also significant differences between cropland and pastureland, so it depends on how the agricultural property is utilized. The national average for cropland is around $4,100 per acre, while pastureland is about $1,400 per acre. Using both methods aims to address situational factors and provide a more equitable assessment of the property.
Impact of Agriculture Business on Valuations
While real estate and investor types circle around the importance of data on sale prices and rent prices to assign value to a property, both traditional methods overlook the key factor that ultimately feeds into the value of a given property. That is the potential to produce income through its intended purpose — agriculture.
Before investing in farmland, a cursory understanding of how farm businesses work and their profitability is good background information. Why does this matter? If a farmer struggles to run a profitable business, they won't cover their expenses like paying rent. The only way that farmland investors make money is by finding good, profitable tenants to work the land.
Market Research
Investors should consider the market saturation in a given area for the type of farm to be purchased in a broad scope. While most cropland can be converted to various crops, animal farms are commonly built for a single purpose. That means a hog farm in an overly saturated market is probably up for sale due to a flood of competition in the market that is hurting business.
Crop or Animal Prices
Gather some basic information on the going rate for different crops when buying cropland or the price of meat and other animal products when buying pastureland. It is essential to know both input and output costs to determine a reasonable profit margin for the intended business. This data will help investors make good purchasing decisions, and landowners make good lease decisions. Plus, it all trickles into calculating an accurate cap rate.
Regulations
Another important detail that has a significant impact on agriculture operations is local regulations. The Environmental Protection Agency (EPA) and the Food and Drug Administration (FDA) are two of the most common entities involved in regulating farm activities, but they aren't the only ones. The regulations that these administrations enforce affect the way that farmers do business. Highly restrictive regulations make it more difficult and more costly to operate a farm and therefore factor into the valuation of farm property.
Livestock production farms are regulated in how and what they can feed their animals, how they dispose of animal waste, and how they can treat and prevent illness in herds. Crop farmers are regulated in what types of crops they can plant, including specific varieties that may be genetically modified and pesticides they can use in their fields.
The Bottom Line on Farmland Valuation
Coming up with a value for agricultural land is much more difficult than other types of commercial real estate. For one, there are far fewer comps available. And when there is another farm that has recently sold, there are several factors that might affect an individual sale that does not apply to all properties.
The locality of agriculture markets and the family farm concept, which has been a backbone feature of American agriculture, are the strongest influences driving lower valuations. Plus, add to those factors that farms are at a higher risk of foreclosure and short sale due to operational costs, and it can be challenging to find a single good comp. Luckily several factors can be used to determine value.
For investors looking to get involved in buying agriculture real estate, beginning with a good understanding of agriculture economics is a good place to start. Investors should follow that up by networking with the right brokers and agents and get in the habit of watching the farmland real estate market closely.
Land Income is making the most of California's agriculture resources. We buy farms that increase in value by selecting good water access and cultivating the right crops. Get started investing in farmland agriculture today!
