Producers often ask the question, “Can I buy a piece of land and pay for it running cattle or farming?” This is a simple question that often is met with a simple “no.” The reason the answer is no is much more complicated.
The easiest and least expensive way to expand a farming operation is through leased/rented ground. These leases are either on a share-crop arrangement or cash rent. For simplicity, we will assume the added ground will be cash rent.
Valuing cash rent is never easy either. Multiple things come into play, such as farm productivity, location and producer rivalries, that all influence the price a parcel can fetch on the open market. To assist producers with valuing cash rent, OSU publishes the Oklahoma Cropland Rental Rate Survey CR-230. This publication states that the average farmland rental rate in Oklahoma for 2018-19 was $32.90/acre.
This creates another question that is very interesting and unpopular among producers, “Is that enough?” Can landlords afford to rent land for that much money? Another way of looking at it is this: Would a farmer be indifferent between buying land to farm or renting it out for $32.90/acre?
How much is land worth? OSU also publishes land value data. A short 10 years ago, the average Oklahoma cropland sales price average was $1,212/acre, and pasture sold for $1,437/acre. Compare that with today where cropland averages $1,838/acre and pasture sells for $2,081/acre. These numbers might come as a shock where pasture is more valuable than cropland. However, our state is very diverse, with a majority of the cropland in western arid regions of the state and more pasture in the wetter eastern regions.
Here is an example. Assume a farmer wants to expand his operation by 100 cropland acres. He can lease cropland for $32.90/acre or buy land for $1,838/acre. Which should he choose? Using a simple amortization calculator and ignoring closing costs and commissions we can get close to determining the cost of the land.
A 30-year mortgage at 5.5% interest with no down payment on $183,800 will result in an annual payment of $12,753.31. The total interest paid on the loan is $198,799.
The farm will have to generate at least $127.53/acre to cover the payment. That does not include the fact that the money used for the principal payment is not tax deductible and will have income tax due on it. To expand the farm by purchasing is $127.53/acre compared to $32.90/acre by leasing.
So why would a landlord lease ground for $32.90/acre? As we can see, simple interest (or the opportunity cost of capital) on the farm is $10,109/year at a 5.5% annual rate of return. That would be a conservative return on investment if the money was invested elsewhere. By that calculation, the land rent would have to be $101.09/acre to cover the opportunity cost of capital for owning the land.
There are a few obvious answers to why there is a discrepancy here. It is rare that land is not purchased solely for its farming profit. Land also is bought with money received by outside income sources like off farm jobs and energy income. Also, inherited land, if it is sold could result in substantial capital gains taxes, making the sale prohibitive to some.
Therefore, if you purchase land to farm and expect the farming enterprise to pay for it, interest rates will have to be low, the purchase price must be very attractive and standard farming enterprises should be expanded in order to be successful.