Cropland leasing trends
Midwest cropland lease rates declining with slight shift to flexible leases.
According to the Michigan State University Department of Agricultural, Food and Resource Economics reports on 2013 and 2014 Michigan land values and leasing rates, Michigan cropland rental rates from 2012 to 2013 increased an average of 10 percent to $154 per acre for tiled cropland. From 2013 to 2014, however, these rates declined 8 percent to $142 per acre. The 2015 Illinois Farmland Values and Lease Trends report showed similar results for Illinois—2014 showed a decline in the range of 10 to 15 percent to $250 to $300/acre for good to excellent cropland, respectively. The Illinois report also predicted that declines in the sales prices of corn and soybeans would mean a further cash rental reduction in 2016 and slightly more strictly cash leases converting to flexible cash leases.
There are many reasons why a farm operator and a landowner might consider a flexible cash lease, including financial goals, fixed costs, net worth, operating capital and tolerance for risk. A cash lease payment obligation is considered a fixed cost, as are loan payments, property taxes, insurance and other costs that might be due each year regardless of income. Rising cash lease rates put stress on the operating capital of some cash cropland lessees. As Gary Schnitkey pointed out in Parameters for a 2016 Cash Rent with Bonus, cash lease rates need to be reduced for 2016 in Illinois to avoid farm lessee losses.
One of the things that have made strictly cash leasing popular is its simplicity. Each party knows what is to be paid and the timing of the payment. Some landowners receive 50 percent of the rent at lease signing, particularly if the lease is signed after Jan. 1. To further reduce risk, the remaining 50 percent can be discounted by the cost of borrowing so 100 percent of the lease payment is received at lease signing. Others are willing to wait until just before crops are planted, such as March 1. The flexibility of a flexible cash lease introduces decision making and complexity into the lease terms for both parties. The fewer the terms that flex, the simpler the lease negotiation. In the Midwest, the flexible leases that are predominantly being used flex on the basis of crop yield or revenue.
To create a flexible lease, landowner and lessee need to agree on:
- A base cash rent. This is new guaranteed cash rent paid each year no matter the crop. It is usually less than what was paid as a strictly cash lease. The reduction in base rent can be offset by greater sharing in the income created by the yield, the sales price of the commodity being grown or a combination of both.
- Crop revenue or yield trigger. The landowner will not share in any additional yield or revenue until it exceeds the trigger point. For example, if the farm has an average yield of 175 bushels of corn per acre, that can be considered the base yield. The trigger may also be a higher yield than the average if it is agreed that the landowner will not receive any flex rent until the yield exceeds what the farm has historically done. It is whatever the parties agree to. Revenue (sales price times yield) may trigger the flex payment. For corn, a predicted, agreed upon sales price of $4 per bushel for the 175-bushel assumed yield would create a revenue trigger of $700 per acre. The landowner would not receive a flex payment until revenue exceeded this amount. The same could be done for other crops being grown.
- The landowner’s share of the yield or revenue above the base. For example, the more the landowner agrees to reduce guaranteed cash rent, the greater the percentage of yield or revenue that can be paid as flex rent. It is whatever the parties to the lease agree is fair for each. For example, if the landowner agreed to a 25 percent reduction in cash rent, his share of the flex payment may be 50 percent to compensate for the additional risk taken to forego a guaranteed higher cash rent.
- Documentation. How is yield or revenue documented to the satisfaction of the landowner? The lessee must be willing to share what he may have formerly considered confidential information. If the flex is based on yield, will all weight tickets be provided? For revenue, will weight tickets and sales receipts be provided to document both the yield and price? This is a very critical area of the negotiations and must be carefully written. If not done correctly, a disagreement at payment time can threaten the long-term working relationship between the landowner and the lessee.
This article was originally published in the Michigan Farmer Magazine.