A recent AgLetter from the Federal Reserve Bank of Chicago pointed to a decrease in Iowa farmland values, continuing a pattern of lower agricultural land values since their peak in 2013.
Understanding the factors that influence the market value of farmland isn’t always obvious. Agricultural land appraisals are far more complex than residential real estate, and ripe for misunderstanding, confusion – and even contention. But they are an enduring fact of life for farm owners.
When it comes to the question of what farmland is worth, there are objective and subjective matters. Here are a few things to consider.
It’s a good idea to know what your farm is worth – even if you aren’t selling right now.
Having an accurate understanding of the value of your farm can provide a good foundation for important decisions beyond selling the land, such as determining fair cash rents or lease terms. Knowing the capitalization rate (or cap rate) is an important benchmark for determining return on investment. It is calculated as the ratio between cash rent and farmland value.
In a hypothetical example, land rented at $400/acre and valued at $8,000 acre has a cap rate of 5%. You can use this measure to compare against other investment options. You can read more about understanding the cap rate for farmland here.
Assessing farmland value is a very specialized skill.
Because of the multitude of factors that must be considered, it is important to seek out an expert in valuing agricultural land. Professional agricultural appraisers are trained to understand and synthesize market factors such as location, potential land uses, commodity prices, land productivity, land and soil quality, regulatory considerations and others. It is a complex and dynamic process. If not done properly, the basis for nearly all financial decisions becomes shaky.
Price and value may be different.
Price and fair market value can be very different numbers – and that can make the matter of appraisals all the more confusing. As mentioned above, the fair market value has many influential factors – but emotion isn’t one of them. Emotion and perceived worth can have a big impact on price. Land is in finite supply, and farmland turnover is relatively low. When the right opportunity comes along, particularly in the eyes of multiple potential buyers, emotion and bidding wars can drive prices out-of-sync with fair market value.
A land appraisal is an important factor if you need a loan.
When underwriting agricultural loans, lenders pay close attention to the land appraisal, particularly when it comes to the amount of credit they are willing extend. The purchase price may have been influenced by emotional or subjective factors, and may not be an accurate reflection of the land’s current value, at least as loan collateral. An accurate, objective assessment by a skilled appraiser is key from a lender’s perspective, but can also help to ensure your debt service is manageable. It’s important to know, however, that if you intend to borrow money against real estate, banking regulations require the appraisal to be ordered by the lender, not the borrower.
Of course, the land’s value as collateral isn’t the only evaluation tool for a loan consideration. Lenders also look at credit history, financial condition, character and repayment ability.
There will always be debate on the topic of what a farm is worth – but hopefully none around which community bank is dedicated to supporting Iowa farmers. Contact Bank Iowa to learn about the ways we help farmers live their best financial lives through our agribusiness financing and farm treasury management services.