Throughout history land has been the most basic repository of wealth and value through good times and bad. Many investors are now taking an interest in farmland because it offers particularly appealing portfolio diversification characteristics under current market conditions. Furthermore, supply and demand fundamentals could make farmland even more attractive over the next few decades than historical performance implies.
A large number of studies across a wide range of different markets and timescale’s have demonstrated that farmland has enormous potential as a portfolio diversification and optimisation tool. These studies have shown that, even taking into account the transaction costs associated with less liquid assets, farmland constituted a substantial portion of optimal portfolios across a wide range of scenarios.
For further detail and a summary of some of the more notable studies and other information on farmland as an asset class, see our Downloads Section. Below is a summary of some of the reasons investors are now looking at farmland as a serious alternative:
After a period of outstanding performance during the good times, many investors are now placing a greater emphasis on capital preservation during periods of severe market turmoil. An investment in farmland is backed by a rock solid asset in finite supply which is unlikely to depreciate in value. Historically, data shows that farmland has exhibited strong capital protection characteristics over prolonged periods of time. Unlike other depleting resource plays like mining or oil & gas, well managed farmland is a fully renewable resource which remains productive in perpetuity.
As an aggregate asset class, farmland has been shown to have a positive correlation with inflation. Historically, farmland values generally increase faster than inflation, making farmland an effective inflation hedge and capital preservation vehicle. This may be especially appealing to investors concerned about inflationary government policies (unprecedented increases to the money supply and monetisation of government debt).
Unlike other popular inflationary hedges such as precious metals, farmland also provides a regular income to the investor, making it a useful replacement for lost ‘risk free’ income on cash deposits and bonds due to low interest rates. Agricultural real assets offer reliable rates of income above 5% annually. Although not necessarily the highest return available in the real estate sector, this income is being earned on an asset that is unlikely to depreciate in value, with strong capital growth potential and a near 100% tenant occupancy rate (unlike commercial property, demand for quality farmland is always high, regardless of the economic environment).
By including farmland in a mixed asset portfolio investors are able to reduce the possibility of shortfalls in income during periods when other assets may produce little or no income. This is particularly true in a farmland leasing model. Whilst long-term upward trends in agricultural commodity prices are captured in the capital appreciation of the asset (which may be more volatile), fixed rentals have the effect of smoothing short-term cyclical volatility in commodity prices because input and output pricing risk is borne by the tenant farmer rather than the landowner.
Farmland investment captures both operating and capital returns through a combination of rental income and appreciation in the value of the asset. On a historical basis total returns from farmland have repeatedly outperformed mainstream assets including stocks, bonds and commercial real estate across a wide range of markets and timescale’s, despite relatively low levels of risk (measured in terms of the standard deviation of annual rates of return).
Studies have repeatedly demonstrated that farmland delivers higher risk adjusted returns than mainstream asset classes. In other words, farmland rewards investors with a higher level of excess return (‘risk premium’) per unit of risk.
Farmland returns have a low or negative correlation with traditional asset classes such as stocks and bonds and only a modest positive correlation with commercial and residential real estate. These characteristics make farmland an attractive diversification tool that can help reduce the impact of broader market volatility on a diversified portfolio.
Historically, farmland has repeatedly demonstrated its ‘flight to quality’ appeal, performing comparatively well during times of market uncertainty. The ‘recessionary hedging’ potential of farmland is particularly attractive to investors concerned about the strength and sustainability of the “global economic recovery”.
In an environment of bankruptcies, accounting irregularity, corporate fraud, complex and opaque investment structures and institutionalised greed expressed in the extortionate fees charged by underperforming investment managers, the simplicity of direct freehold ownership of ‘renewable resource real estate’ has a refreshing appeal for a growing number of investors.
Although farmland falls under the general classification of real estate, it has a number of unique characteristics. This has sheltered farmland from the extreme falls in asset values seen in commercial and residential property during the recent financial crisis.
In many of parts of the world, including a number of developed economies, there are a range of tax incentives associated specifically with farm real estate. This may include one or all of the standard taxes (income, capital and inheritance tax). This can further enhance net returns on farmland as compared to other asset classes.