Farmland is used by some of the world's richest people to diversify their holdings. Fertile agricultural lands are regarded as outperforming most investments while delivering lower volatility. As with any other investment, there are risks to consider. For instance, bad weather may cause major decreases in profits, the expense of running a farm can rapidly become intense, and running a farm can be difficult, to say the least.
How to Diversify a Farmland Portfolio
Diversification is essential in any investment plan. It lets you diversify your risk so that if one asset underperforms, it does not bring down your entire portfolio. Farmland is no exception. Every farm and crop is distinct, with its own set of advantages and disadvantages that alter periodically. Multiple farm investors can diversify their risk among multiple regions, tenants, and commodities.
To begin, you can diversify farming assets across areas to mitigate weather risks. Climate patterns can vary even within counties, with farmland on opposite ends of counties experiencing varying amounts of precipitation in any specific season. Farmers who comprehend those patterns know when to plant and when to provide their crops with much-needed water at different periods of the growing season.
Tornadoes, floods, droughts, and hurricanes are among the most significant threats farmers face; they can destroy crops and the revenues that come with them. The same flood is unlikely to hit two farms in opposing parts of the same state. This type of diversification will become more vital as climate change and severe weather patterns grow more common and extreme.
Farmland Real Estate Investment Diversification
Crop diversification can be added to farmland investments. Weather can be more or less advantageous to wheat, corn, soybeans, peppers, rice, and cotton in any particular year. Pests or invasive plants might appear unexpectedly and cause damage to one crop but not another. The more crops you cultivate in your fields, the less probable it is that they all experience a terrible year around the same time.
Crop prices are ultimately determined by demand. If demand for a single crop collapses, as it has dozens of times in recent years as a consequence of US-China trade policy, owning acreage that produces various commodities will help safeguard your portfolio.
If we were talking about retirement savings, we'd be talking about "owning the market" — seeking to buy mutual funds that include each stock in the S&P 500 or something similar. When it relates to farms, we're attempting to accomplish the same thing.
A varied farmland portfolio would comprise farms in several areas, implying variation in farming methods, weather, renters, and crops. A diverse portfolio would most likely comprise numerous distinct farms and farmers, as well as a range of crops if it concentrated on a particular location.
One of the benefits of buying a farm land is flexibility—the ability to cultivate a variety of crops on the property. Farmland in most locations will most likely adapt as climate change develops. Farmers might begin cultivating a new crop if it becomes an important element in fuel or animal feed.
How to Rent Out Physical Land
Another option for farmland as a passive investment is to buy farmland and then lease it to farmers who will operate it. Here are a few options for renting out physical land:
Converting and renting out land
You can purchase property that is not presently being utilized as farmland and transform it for agricultural use, such as urban farming or pastures. This is a more difficult procedure since licenses may be required to change it to agricultural use. There might also be work done to alter the physical land so that it may be utilized for farming. You'll also need to recruit renters and thoroughly vet them. This is the riskiest option, and you'll want to buy the land at a good price to secure a return on your investment.
Buy and lease
You can also buy existing farmland and rent it out to new tenant farmers. This will take a little more effort since you will need to qualify a suitable farmer to lease the property. You will want to learn about their agricultural experience and any other farming enterprises they may be involved in.
A sale-leaseback arrangement includes purchasing farmland from an existing farmer and then renting the property back to the farmer. Investors with a low-risk tolerance may like this arrangement because the tenant farmer is already working the property, has a steady income, and has already received your money for the land. In general, these types of contracts will be very expensive for the land buyer, but you may have recurring income flow relatively quickly.
What Factors Influence Farmland Returns?
Land prices grow, and the farm produces crops, which supply you with money. However, such revenue is not always steady. Two things influence farm income:
- Interest rates: The lower the interest rate, the greater the value.
- Price of commodities: The higher the price, the bigger the earnings.
Farmers earn more when commodity prices increase. The pricing point is determined by a phenomenon known as a super-cycle. A little on commodity super-cycles:
- Population increase drives them
- They can span between 20 and 70 years
- New advancements and technological improvements have an impact on them
- They are impacted on a worldwide basis (for example, China's need for metals and energy)
- Long-term commodity prices tend to increase and decrease in lockstep
It's difficult to know where we are in the cycle right now. While new breakthroughs, such as the electric automobile, are occurring, other factors (such as decreasing population growth) are preventing a commodities boom. It's difficult to predict what will happen. However, the value of farmland is linked to agricultural production as a commodity. We just do not know what is in store for agricultural supply and demand.
Do your research if you decide to use a crowdfunding platform and maintain realistic expectations. Farmland is a fantastic diversifier and can help to protect your portfolio from inflation. Instead of investing indirectly, you may consider acquiring your own land. Find a location that people would appreciate. When you're ready to sell, you don't have to worry about what harvest it produces or how much people consume.
Farmland investments are increasingly open to individuals as well as institutions. Purchasing farmland can be an excellent way to diversify your portfolio, but ensure you complete your research and due diligence. Invest in a manner that best suits your goals and risk tolerance.
Farmland is generally not a good investment for inexperienced investors. There are several moving pieces, so it is best suited to experienced investors. Working with an advisor who is informed and competent in this type of investment can be beneficial.