Against the Grain
By Ellie Winninghoff
PCI Board Member Jason Bradford leads the farmland management program at Farmland LP.
While farmland is a hot alternative vehicle among institutional investors like Harvard University and TIAA-Cref, some wonder how alternative an investment it really is.
"[The price of] farmland is traditionally driven by commodity prices, which are set by publicly-traded financial markets," says Craig Wichner, managing partner at San Francisco-based Farmland LP, a private equity firm that converts farmland to organic.
The Department of Agriculture estimates that forty percent of the corn grown last year was used to produce ethanol, partly a result of a federal mandate to increase the amount of corn-based ethanol used in the nation's gas supply. But while this suggests that farmland values are partly correlated with politics, they are ultimately correlated with population growth, the growing demand for grains, meats, etc. Feedlots are the second largest consumer of corn.
According to Wichner, that means that corn-quality land in the Midwest is also correlated with the price of oil--not just in terms of the demand for corn but also with respect to the cost of inputs required to grow it.
"Midwest farmland is a bubble, and while the land is not debt-driven, the system is," he says. "The requirements for ethanol have driven up the cost of farmland and of food, and more land has been taken out of productive uses and converted to corn land.
"Food is correlated with oil, and if you are investing in farmland, you don't want that correlation," he continues. "A great alternative is sustainable Ag."
Since 2009, Farmland LP has provided investors with access to un-leveraged and professionally managed farmland in a REIT-like structure using sustainable agriculture best practices. The firm has acquired about 2000 acres--1100 acres about 50 miles east of the San Francisco Bay area in Brentwood, Calif., and 946 acres near Corvallis, Oregon. Its focus is farmland that is close to cities that have a strong demand for locally grown organic food.
Farmland LP plans to hold the land long-term, and to pay investors an estimated 8% net cash flow after the soil has been certified organic in a 4 to 5 year conversion period. The firm works with family offices and institutional investors, and the minimum investment has recently been raised from $50,000 to $500,000.
A stable source of value where the cash flow drives inflation
Land prices, of course, collapsed amidst the farm crisis of the mid-1980s. But since then, it has performed as an excellent hedge for inflation. According to the National Council for Real Estate Fiduciaries Farmland Index, the internal rate of return for U.S. farmland during the last two decades has been about 15%.
Wichner likes to compares an investment in farmland to owning long-term bonds.
"Ben Bernanke is working against me by printing money when I own a bond," he says. "[He] can print more money, but there's a diminishing supply of farmland. It's a great stable source of value, and the crops that grow on the land drive inflation."
Investors generally buy land at a 3.2% yield, he says--the price farmers pay to lease it. But as the value of the land has appreciated, the yield on the investment has also grown. "If you bought in l999 at $1400 per acre," he wrote in a presentation, "you would be getting nearly 7% cash flow [on the original investment] today, plus 7% appreciation."
Ticking time bomb
But despite the farming boom and growing concerns there may be a farmland bubble in the Midwest, there has been less attention paid to the escalating cost of inputs that have become de rigueur in conventional agriculture--fertilizer, herbicides, pesticides, GMOs and fuel. According to the USDA's Economic Research Service, yields increased 30% between l989 and 2009. And the cost of inputs tripled during the same 20-year period.
But the elephant in the room is the dwindling supply--and probable spike in the price--of oil. According to Richard Heinberg, senior fellow at the Post Carbon Institute (PCI), agriculture accounts for 16% of the U.S. annual energy budget--more than any other industry.
And that's not just energy to fuel farm machinery, power irrigation pumps, maintain animal operations, dry and store crops or to move produce from farm to processor to wholesaler to retailer to consumer.
"We use natural gas to make fertilizer," he has pointed out, "and oil ...as a feedstock for pesticides and herbicides."
The bottom line, he writes in a paper published by PCI that he co-authored with Kentucky State University fellow Michael Bomford, is that the "largest potential cost" resulting from the industrialization of agriculture may be "the extreme vulnerability of the entire system to global fossil fuel depletion."
According to Wichner, this means that conventional farmers will continue to be squeezed.
"Costs are increasing, and there's no reason to believe this trend will change," he says. "But the price [farmers] get is subject to public markets and risks. So the return for commodity-based farmland funds is driven by factors outside their control."
What's not to like about cutting the costs of a farm enterprise---and boosting its revenues? That, in effect, is Wichner's pitch for the "beyond organic" farmland management system he plans to scale.
According to Heinberg and Bomford, U.S. farms reduced their fossil fuel use by 30% between l979 and 2000--mostly by reducing their dependence on synthetic nitrogen and fertilizer inputs. Similarly, Wichner argues in a white paper that organic agricultural practices can reduce the energy required to produce a crop by 20% to 50% (depending on the crop and soil) --and thereby reduce the "exogenous risks" of high-energy prices on production and profits.
But not all organic is created equal. Organic vegetable farmers, for example, usually plant cover crops such as clover and legumes in rotations with the vegetables to restore soil fertility. Others use compost consisting of animal manure and other organic materials. But according to Wichner, many of these farmers still buy seeds or import compost from off-site.
"There's still a cost associated with that," he says. "It's not free."
Farmland LP is taking that to the next level by incorporating closed-loop systems on diversified (multi-crop) farms. The process begins by planting pasture for livestock, which will graze and restore the fertility of the land by depositing their dung.
"Animals are an essential and extraordinary part of maximizing soil fertility and the production of food from an acre of land," Wichner says. "Rotating land with livestock is a wonderful way to enhance sustainability and investment returns."
The model is based upon a rotation of specialist farmers around the property at management's behest. At the firm's Ferndale Farm Road Farm in the Willamette Valley near Corvallis, Oregon, for example, there is a sheep farmer, another for chicken and hogs, and a third for vegetables.
The farmers lease the land in a profit-sharing arrangement with the firm and its investors--something that reduces their risk and lease payments in the event of bad weather. But in general, Wichner estimates that the lease payments will be two to three times higher than they would be under a fixed rate.
"We don't grow just one giant mono-crop," Wichner says, explaining why the fund's volatility will be lower than that for conventional cropland. "We get a greater return than commodity cropland, and it has very low correlation to the cost of inputs used in conventional agriculture. But our system for growing is more complex. It's more management intensive, and it takes more intellectual and physical work."
And it depends on crops that can earn what Wichner estimates to be 50% to 200% premiums above conventional crops due to their status as organic local and sustainable. The formula also consists of circumventing processors, wholesalers and retailers--and selling direct.
A version of this article appeared at Financial Adviser Magazine
A former investment banker, Ellie Winninghoff is a writer and consultant specializing in impact investment. Her writing about impact investing is linked at DoGoodCapitalist.com, and she can be reached at ellie.winninghoff (at) gmail (dot) com.