Best if printed in landscape.

Land

• Land encompasses all natural resources such as soil, minerals, and water.   In this course, the focus is on using land to produce agricultural products (including native grass).
• The economic return to land is rent.

Topics:

• Valuing a capital asset -- the value of an asset (e.g., land) is the "present value of its future earnings."
• Controlling land -- private control and public regulation.

This course does not address production issues such as soil fertility, erosion, pesticide application, range management, crop rotation, or tillage practices.  Those topics are addressed in plant sciences, soils, range management, and other production courses.

Text: Kay et al. Chapter 20 Land -- Control and Use (pp. 347-370).

Selected statistics (North Dakota):

• Total cropland and harvested cropland in 2002:  26,506,477 acres and 19,908,697 acres, respectively (http://www.nass.usda.gov/nd/intro73.pdf); some of the difference can be accounted for with
  • Conservation Resource Program (CRP) in Sept. 2006:  3,401,205 acres (http://www.fsa.usda.gov/Internet/FSA_File/sep2006.pdf; page 7)
  • Fallow in 2003:  1,800,000 acres (http://www.nass.usda.gov/nd/summfall73.pdf

• Compare the non-harvested cropland acreage in 2002 to the 6,300,000 acres fallowed in 1979. They are about the same.
  • These several statistics are enough to raise the question of "what is the impact of technology (i.e., less fallow) and social concerns on land use (created CRP)." 

Valuing Land

• A common question when discussing land is "how much should I pay for land; what is its value."
  • Link to NASS page with North Dakota land values
  • A second link to NASS page with North Dakota land values (page 5 of pdf file).
    • What relationship, if any, does there appear to be between land values and rental rate?

• The value of an acre of land is its potential profit over its useful life.  Restated, the value of land is the "present value of its future earnings."  This is also referred to as capitalization or capitalizing the land's future earnings.
  • Valuing land is similar to valuing other assets that will generate income in the future; that is, the value of the asset is the total of the present values of the future income.
  • PV = FV/(1 + i)^n
    • This formula illustrates the concept of discounting; for example, discounting future earnings to present value; review Kay et al, Chapter 17, pp. 278 - 283 for a refresher on discounting.
  • An asset that will last two years and generate $40 of income each year has a value of $74.38 (assuming a 5% annual discount rate). That is, the first payment that will be received one year from now has a present value of $38.10; the second payment will be received two years from now has a present value of $36.28.
  • A simple spreadsheet can perform the calculations.

   

  • Should a real discount rate or a nominal discount rate be used in completing the calculations? That depends on the assumptions being made about the future income.
    • If the analysis is being prepared on the assumption that the future income will be impacted by inflation and that impact is NOT represented in the projected future earnings, a real discount rate should be used. For example, the $40 annually is the projected future income before considering inflation. This assumption further assumes that the future income and discount rate will be equally impacted by inflation.
    • If the analysis is being prepared on the assumption that the impact of inflation is already incorporated into the projected future income, a nominal discount rate should be used.
    • Review Time Value of Money.

• Because land has a long useful life, the number of years of future income can be extended far into the future.
  • A short-hand way to capitalize earnings is V = R/d; where V is the value of the asset, R is the average annual net return, and d is a capitalization rate.  This method is referred to as income capitalization; see Table 20-1 on page 355 of text for an example.
    • This calculation (formula) is valid only for assets with infinite (or at least, very long) useful life, such as land.
  • This capitalization formula also assumes that the future earnings will not vary from period to period (e.g., year to year).

   

  • A better approach for valuing land may be to project future income for each year the property is expected to be owned. This includes projecting a value for the land at the time it will be sold or transferred.
    • This approach can be calculated with a spreadsheet.
    • This approach does not eliminate or simplify any of the assumptions about the future; it only makes them more apparent.

Several of these considerations require additional discussion.

• Future Earnings
  • An enterprise analysis can be used to calculate "return to land" by 1) determining revenue, costs and accounting profit, and 2) imposing an opportunity cost for all owned assets except the land.
    • Do you see the relationship between Table 20-1 and an enterprise analysis?
    • Does Table 20-1 include opportunity cost of labor, management, and risk?
  • What factors will influence future earnings?  Quantity of future production, price of the product, quantity of inputs, cost of inputs; imbedded in these projections are assumptions about inflation, technology, demand, and other similar considerations.
  • A challenge is incorporating into the analysis the variety of products and inputs involved in operating the land. 
  • Another challenge is projecting future earnings.
    • Link to NASS page with index of prices paid by farmers (page 15 of pdf file).  All prices and costs do not change at the same rate.
  • A third challenge is estimating the future resale value of land.
  • Again, a spreadsheet may be a way to consider this range of factors.

 

• Present Value

• Value of an asset is calculated by capitalizing its expected future earnings or income for its useful life:  V = R/d.
  • Capitalizing involves discounting future earnings to present value.
• What factors influence d (the discount rate)?  Inflation?  Cost of capital?
• What assumptions are being made in Table 20-1; more specifically, what assumptions are being made when using a capitalization formula (such as V = R/d)?  Are those assumptions always valid?
  • The assumption of no variation in earnings has already been identified

 

• Profitability v. Feasibility -- Do not overlook the difference between profitability and cash flow; compare Tables 20-1 and 20-2 in Kay et al.

• That is, be certain to recognize the difference between 1) earnings or profit and 2) cash flow.
• Is the value of an asset based on its projected profit or projected cash flow?

Land Ownership

• Benefits and disadvantages of owning land
  • Owning land offers the security of knowing it is available; it is a means of accumulating equity; the owner has the decision making authority; and it can be a source of pride
    • There are limits on how land can be used -- physical limits; legal limits (e.g., zoning ordinances, environmental regulations)
  • Owning land generally requires more cash than leasing land; land often provides a relatively low rate of return; land usually is subject to property taxes that must be paid by the owner.
  • What role does government regulation of land use have on the operation of farm land?
    • land use regulation (zoning, waste management plan)
    • voluntary federal government land use programs (conservation compliance, CRP, EQIP)

Leasing Land

• Lease
  • Common types of lease arrangements -- cash rent, share-crop or share-livestock, variable cash lease
  • Characteristics of alternative lease arrangements -- level of risk!
  • Negotiating a lease agreement -- landowner's considerations; tenant's considerations
• Benefits and disadvantages of leasing land
  • Leasing often requires less cash than ownership; is an opportunity for the business operator to collaborate with the landowner; offers flexibility to add or remove acreage from business
  • Leasing land is less certain than ownership; leased land is not a means to accumulate equity
• What determines the rental rate for land?  What role does enterprise analysis have in reaching a lease agreement?  What role does communication have in reaching a lease agreement?  What role do goals have in reaching a lease agreement?  What role does opportunity cost have in reaching a lease agreement?  What role does risk management have in reaching a lease agreement?

Alternative Uses for Land (or any real property, such as a building)

• The answer to this question is different for every tract of land, whether you own it or lease it.  What we need to accomplish with this discussion is to assure you are able to analyze the information you gather about the land's opportunities.  Thus we also need to consider what information you need to gather for your analysis and what information you do not need to gather.  We also need to consider "where do I find that information I need for this analysis. "

Government Regulation of Land

• Voluntary government programs -- conservation reserve program (CRP), conservation compliance, highly erodible land (sodbuster), wetland (swampbuster)
• Mandatory government regulations -- zoning, Endangered Species

Summmary of Key Points

• Enterprise analysis and opportunity cost of owned assets except land provide the foundation of determining both a rental rate and the value of land.
• Capitalizing projected future return to land is the basis for valuing land; capitalizing involves 1) using an enterprise analysis and opportunity cost to project future earnings, and 2) discounting the future earnings to present value.
• Again, the difference between profitability and feasibility (cash flow) need to be recognized in analyzing whether additional land advances the business owners' overall goals.
• Opportunity to expand owner equity and opportunity to manage risk also should be considered in deciding whether to add land to the business operation.
• Managers need to recognize and carefully consider the long-term assumptions incorporated into an analysis of whether to acquire additional acreage. Technology, government policy and market opportunities are some of the assumptions.

The next topic addresses labor.

Last Updated August 17, 2010

Email: David.Saxowsky@ndsu.edu

This material is intended for educational purposes only. It is not a substitute for competent professional advice. Seek appropriate advice for answers to your specific questions.

E-Mail:sswandal@ndsuext.nodak.edu
Published by Agricusiness and Applied Economics
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North Dakota State University, Fargo, ND 58105-5636
Phone: (701) 231-7441