Let’s take a quick look at some economic data involving a western Montana ag operation. If we look at a yield of 80 bushel Hard Red spring wheat at $7/bushel, we have a gross return of $560/acre. Then factor into the equation the direct cash cost of real estate with fertilizer, herbicides and fungicides, seed, crop insurance and taxes. The rough cash cost estimate becomes $260/acre. This leaves a return of $300/acre to cover equipment costs, fuel, labor, return to the land and return on the farmer’s management. This seems like a hefty return, but it is inconsistent.
I called Triple W Tractor for prices on new equipment found on a typical western Montana farm. This includes a 250hp tractor, 28-foot disc, 28-foot cultivator, 25-foot set of double disc drills and 60-foot pull type sprayer. All this vital equipment costs approximately $450,000 when purchased new. A new combine would be $400,000-$500,000. This does not include an extra tractor to run a grain auger or trucks for hauling grain. The bare-bone minimum equipment required would total $600,000-$700,000. Hence, financing for a six-year term would set the farmer’s payments in excess of $100,000 per year.
Does $600,000-$700,000 appear extreme? If you look at a hay producer set-up using an all-wheel-drive tractor with a loader, a disc mower, round baler and hay rake, this equipment adds up to a $200,000 investment, which does not include tillage or hauling equipment. This is why the salesman I asked indicated that his sales in dollar volume are above two to one for used equipment over new. So how does the farmer make this work? They spread the risk as much as they can. Successful farmers in our state typically have a blend of leases and owned ground. Crop insurance is critically important so that income levels can be maintained despite poor yields due to harsh weather conditions, insect infestations, etc.
There are several approaches farmers use to survive. Farmers will successfully forward contract grain sales and forward purchases on inputs. Some farmers haul grain to various markets to gain profit. Others have leveraged their home operations to pick up additional land. Given the rate of return on cropland or the capitalization rate, farmers have to be careful stewards of what they purchase in order to not be over leveraged. By this I mean if a farmer’s operation has a market value of $5 million and he is generating a 2-4 percent return, then he may be able to make an investment in a $1 million property to add on to the existing operation. The efficiency of size plus the contribution of the larger property “support” the purchase price of the smaller property. Rural real estate values are above ag values because of demand from both agricultural producers wanting to expand and non-agricultural buyers wanting to buy. This is why an ag property does not “pencil.”
Whether an individual chooses eastern or western Montana depends on the goals of the purchaser, but investing in an agricultural property can be wise. A typical agricultural investment is strong on land and small in depreciable assets such as buildings. We have observed capitalization rates in various land markets running anywhere from 2-4 percent. This means that the owner of the land receives 2-4 percent return on the value of that property. Also, there is appreciation in the asset value. We have observed markets in eastern Montana that are generating a 6-8 percent rate of growth per year over the last five years. Some markets in western Montana are showing up to a 10 percent annual rate of growth. What makes this an attractive investment is the owner has a property that they and their family can enjoy, pride of ownership, getting a 2-4 percent return, investing money into a property to make it better, and having recreational activities such as hunting, fishing, camping, etc. If they own it for a few years and values increase, then when they sell the property they will have a healthy rate of gain. It will be taxed at a lower rate than ordinary income due to being taxed at the lower capital gain rate.
As mentioned earlier, there are two types of buyers of agricultural properties: “add-on” agricultural buyers and buyers with non-agricultural funds. You may hear about government assisted young farmer programs. These assist with minimal amounts of production loans and have not had an influence in the land portion of the production process. Actual farmer numbers are dwindling while farm acreages are increasing. This is a result in part due to the aforementioned challenges.
Is there opportunity in rural Montana? You bet! The “value added” concept and retained ownership of cattle are both methods that are proving profitable for ag producers. While potential returns in agriculture may not meet the required rate of return, many investors seek the immediate non-monetary returns and appreciate the long-term benefits. As one investor recently shared with me, “even though the rate of return may be lower than a commercial investment, there is a huge intrinsic return in owning a Montana ranch.”
Dave Heine is a licensed real estate broker, a certified general appraiser and an accredited rural appraiser. He works at Premiere Real Estate Professionals, Inc.
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