Land values are booming in many parts of Australia, and whilst this is good for equity and your balance sheet it presents some challenges if you are looking to expand through purchasing more land.
One of the obvious challenges is return on capital (ROC%) which we are commonly calculating as low as 5-7% as ‘add on’ purchases to existing farm businesses. For many years we have deemed <10% for add on purchases as quite poor however in recent times >10% is hard to come by!
Example:
ROC% for a 1,000ha farm being considered by a potential buyer. The farm is a 100% crop proposition and no new plant is required to undertake the operations.
Farm profitability (based on average yields, prices & expenditure).
Income $620,000
Expenditure $435,000
Surplus $185,000 (before interest & tax).
ROC% sensitivity
$/arable acre Purchase price inc duty ROC%
$1,000 $2,593,500 7.1%
$1,200 $3,112,200 5.9%
$1,400 $3,630,900 5.1%
Note: Some basic math! Make 5%, borrow at 5-6%. There is nothing left, and it’s possibly even negatively geared!
Of course there are many factors at play when it comes to why land values are booming including just coming out of the lowest bank interest rate period ever, other investment options have their own challenges, farming is more and more being viewed as a reliable and safe investment (seasonal volatility aside of course), many farms have managed to lift production on the back of new systems and technologies, significant corporate investment and perhaps very importantly catching up to much of the remainder of the developed agricultural world when it comes to farm land values?!
Whilst this is all interesting, the reality if you are considering expansion through purchasing, is you have to contend with the reduced ROC% and the sheer amount of capital required to make a purchase.
As with all investments farming is a risk v reward game so with the reward (ROC%) reduced what is the risk (affordability) to you? This will all depend on what you have at your disposal (capital) and how well you currently operate what you farm (profit).
The Planfarm Consulting team met recently to discuss how to advise clients in such times and concluded that we should not be overly focused on the ROC% as it will not likely look great but instead focus on:
- Your balance sheet – what will a purchase do to % equity and what will your peak bank debt be as a % of land available as security (code for how much of a financial buffer will you have in case of a poor season or two first up?). Targets of equity >70% and peak debt as a % of land value <50% are reasonable but exactly what is right for you will depend on your situation and location.
Note: With interest rates having risen so sharply this year make sure this is built into your calculations.
- Profit history – do you have a proven ability to generate profits and pay off debt?
- Your desire – are you really sure you want the land at the price you are likely having to pay? In other words, how well does any purchase fit with your family and business vision and goals?
In summary with the reward, measured by ROC% at such low levels, surely anyone considering buying would not wish to take on too much risk! If you run into some poor seasons will you be able finance your way through to the better ones?
Finally, if you are a potential buyer make sure you are across both the profit and balance sheet metrics to fully understand the risks and opportunities of any purchase and, make sure you are up for the challenge as for most it will be just that!
