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Kansas State

U N I V E R S I T Y

Department of Agricultural Economics

What we're going to do today...

· Introduction to Rental Arrangements

­ Types of leases ­ Principles of leases ­ Available information

Objective is to t Obj ti i t get us all on the same ll th page with regard to terminology and information that is publicly available.

Leasing & Excel Workshop

Kevin Dhuyvetter Troy Dumler Rich Llewelyn

· Ethics of leasing

Discuss issues/factors that lead to potential problems with lease arrangements (seem to be more common in current environment). Best way to learn is to actually get on the computer! Work with an example representative of the region, but learn how to tailor numbers to your situation.

· Working with KSU-Lease.xls

(hands on) Department Agricultural Economics Kansas State University www.agmanager.info

www.agmanager.info

Feel free to ask questions, disagree, and/or make comments at any time...

Kansas State

U N I V E R S I T Y

Department of Agricultural Economics

Renting cropland in Kansas ... g p

· Producers in Kansas rely heavily upon rented land in their th i operations ti

Introduction to Rental Arrangements

Producers using some rented land ...

100%

Percent of crop acres rented ...

100%

80%

80%

60%

60%

40%

40%

20%

NC

SC

SW

NE

NW

SE

20%

NC

SC

SW

NE

NW

SE

0% 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009

0% 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009

Source: KFMA database (farms with at least 100 acres of crop land)

Source: KFMA database (farms with at least 100 acres of crop land)

Almost everybody rents land... Al t b d t l d

www.agmanager.info

... and they rent the majority of their acres. d th t th j it f th i

4

Over the years, the majority of land leasing questions we receive pertain to:

· Impact of adopting new technologies · Cash renting (folks always want the "going rates") · "Non-traditional" leases

-- Net share rent -- Flexible cash rent -- Bushel rent -- Combination cash/cropshare

Test to make sure clickers are working ...

Which best describes your computer / internet access situation? 1. High speed internet 2. Dial up internet 3. Computer, but no internet 4. 4 I have a calculator, calculator does that count?

1

82%

· Terminating leases ... regardless of the topic pertaining to lease terms, method of addressing q estions does not change. questions change

9%

3%

3

6%

4

2

Which best describes you?

Types of leases on crop land · Crop-share

1. Producer 2. Landowner 3. Other

41%

47%

­ Landowner receives a share of annual revenues (grain sales and government payments) and typically shares certain production costs

· Cash rent

13%

­ Landowner receives a fixed annual cash payment in exchange for use of the land

· Numerous variations around these two

Producer Landowner Other

What type of leases do you use?

The lease arrangement for the majority of non-irrigated crop acres I rent or manage is... 1. Crop share 2. Cash rent 3. 3 Other 4. Does not apply

20% 13% 0%

1 2 3 4

What type of leases do you use?

The lease arrangement for the majority of irrigated crop acres I rent or manage is...

50%

67%

1. Crop share 2. Cash rent 3. Other 4. Does not apply

7% 0%

1 2 3

43%

4

Distribution of non-irrigated crop leases by type of lease... lease

Region Northwest West Central Southwest North Central Central South Central Northeast East Central Southeast State St t Cash 35.2% 35 2% 21.3 20.8 41.3 32.8 34.0 48.7 50.9 35.9 35.7 35 7 Share 54.6% 54 6% 58.5 76.1 54.8 53.8 63.0 42.4 39.6 58.2 55.7 55 7 Other 10.2% 10 2% 20.2 3.1 3.9 13.4 3.0 8.9 9.5 5.9 8.6 86

Crop share versus cash leases...

Relative to equitable crop share leases, fixed cash leases are...

71%

1. A good thing 2. A bad thing 3. Neither

(just different)

19% 10%

Source: Schlegel and Tsoodle -- 2010 KAS/KSU survey

11

Good

Bad

Neither

Trend towards more cash rent...

Trend in use of cropsharethat are crop share Percent of leases leases by regions in KS

10 0 W est 90 Ce nt ral Ea st

Timing of cash lease payments...

W est Ce nt ral Ea st

Trend in use of cash leases by regions in KS Percent of leases that are cash

10 0 90 80 70 Percent 60 50 40 30 20 10

On cash leases, payments are due... 1. Jan 1 (approximately)

52%

80 Percent

70

60

50

2. At planting

20 00 20 02 20 04 20 06 20 08 20 10 20 12

40 19 98

20 00

20 02

20 04

20 06

20 08

20 10

20 12

0 19 98

3. At harvest 4. Dec 31 (approximately) 5. 5 Multiple times 6. Other

7% 0% 21% 14% 7%

R egion i

R egion

Source: KSU and KS Ag Stat ­ Non-Irrigated Farm Lease Arrangement Surveys

Crop share continues to be the most prevalent, but the trend has been a shift from crop share arrangements towards more cash rent leases.

1) What factors have been behind this trend? 2) Will this trend continue, stabilize, or reverse?

1

2

3

4

5

6

KAS Crop Reporting Districts

Crop share versus cash leases...

Relative to crop share leases, the length of leases (number of years) for fixed cash rent tend to be...

56%

Length of cropland leases... g p

Region Northwest (10) West Central (20) Southwest (30) North Central (40) Central (50) South Central (60) Northeast (70) East Central E t C t l (80) Southeast (90) State Years rented 16.7 17.6 21.0 17.8 16.0 18.1 21.9 20.4 20 4 18.9 18.6

10 20

40 50

70 80

30

60

90

1. Longer

Producers tend to lease land from the same landowner for a long time. Long-term relationships can b good or bad... be d b d

2. Shorter 3. Basically the same

22% 22%

Source: Schlegel and Tsoodle -- 2010 KAS/KSU survey

Longer

Shorter

Same

Determining the terms of a crop lease ...

· How are cash lease rates or the terms of crop share leases established?

­ Short answer is "the market"

Identifying "the market" established rates through the use of surveys... th h th f

· Land Use Value Project of the K-State Ag Econ Dept j g p annually conducts one of four surveys

(irrigated, non-irrigated, pasture, input costs)

· While landowners and tenants (i.e., the market) (i e ultimately determine terms of crop share and cash leases, we use the equitable concept to arrive at a starting point for negotiations ­ and to better understand the market.

· Kansas Agricultural Statistics (KAS) annually surveys landowners and producers regarding land values and cash rents · With surveys there is often a trade-off between statistical validity and level of aggregation

Land owner Tenant

Sharing of expenses...

On non-irrigated crop share leases, we share the following:

48%

Example of market established crop shares...

Table 7. Southwest30 Nonirrigated CropShare Arrangements Table 7 Southwest30 Nonirrigated CropShare Arrangements

Crop Wheat (49 Leases) % of Total Leases in Lease Arrangement % of Total Leases in Lease Arrangement % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs Corn (3 Leases) Corn (3 Leases) % of Total Leases in Lease Arrangement % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs Sorghum (6 Leases) % of Total Leases in Lease Arrangement % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs Landlord's Percent of Crop Received (or of Costs Paid)* 33% Share 40% Share 50% Share Other % Share 48 1 98.0% 98 0% No 2.0% 2 0% No 100.0% Responses 100.0% Responses 51.0% 100.0% 51.0% 100.0% 2 1 66.7% 33.3% No No 100.0% 0.0% Responses Responses 50.0% 0.0% 100.0% 0.0% 5 1 83.3% No 16.7% No 100.0% Responses 100.0% Responses 60.0% 100.0% 20.0% 100.0%

1. Nothing 2. Fertilizer 3. Fert & chem 4. Fert & seed

19% 19%

5. Fert, chem & seed 6. Other 7. Does not apply

0% 10% 3% 0%

* The percentages calculated in this table represent the percent of landlords sharing the same percent of costs as they share of the crop. For example, 51.0% of landlords receiving 33% of the wheat crop paid 33% of herbicide expenses.

1

2

3

4

5

6

7

Source: Schlegel and Tsoodle -- 2011 KAS/KSU survey (available at www.agmanager.info)

Example of market established crop shares...

Table 6. West Central 20 Nonirrigated Crop Share Arrangements Table 6 West Central20 Nonirrigated CropShare Arrangements

Crop Wheat (21 Leases) % of Total Leases in Lease Arrangement % fT lL i L A % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs Corn (4 Leases) Corn (4 Leases) % of Total Leases in Lease Arrangement % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs % of Leases Sharing Insecticide Costs Sorghum (8 Leases) % of Total Leases in Lease Arrangement % of Leases Sharing Fertilizer Costs g % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs Landlord's Percent of Crop Received (or of Costs Paid)* 33% Share 21 100.0% 100 0% 95.2% 52.4% 52.4% 4 100.0% 100.0% 25.0% 25.0% 8 100.0% 87.5% 62.5% 50.0% 40% Share No N Responses 50% Share No N Responses Other % Share No N Responses

Crop share percentages by region...

Percent of Leases by Crop Share Percentage

Landlord Share 20.0% 25.0% 33.3% 33 3% NW 10 NW-10 0.0% 0.0% 96.2% 96 2% 0.0% 0.0% 0.0% 1.9% 1.9% 100% WC-20 WC 20 0.0% 3.5% 96.5% 96 5% 0.0% 0.0% 0.0% 0.0% 0.0% 100%

+80%

Crop Reporting District SW-30 SW 30 0.0% 1.4% 94 5% 94.5% 1.4% 2.7% 0.0% 0.0% 0.0% 100%

50-80%

NC-40 NC 40 1.4% 0.0% 62.7% 62 7% 28.9% 6.3% 0.0% 0.0% 0.7% 100%

20-50%

C 50 C-50 0.0% 0.7% 83.4% 83 4% 13.1% 0.7% 0.7% 0.7% 0.7% 100%

5-20%

SC 60 SC-60 0.0% 0.0% 90 8% 90.8% 6.4% 2.1% 0.0% 0.0% 0.7% 100%

< 5%

NE 70 NE-70 0.0% 5.3% 22.3% 22 3% 27.7% 44.7% 0.0% 0.0% 0.0% 100%

EC 80 EC-80 0.0% 1.0% 70.7% 70 7% 9.1% 17.2% 1.0% 0.0% 1.0% 100%

SE 90 SE-90 0.0% 0.0% 94.4% 94 4% 0.0% 4.2% 0.0% 0.0% 1.4% 100%

No Responses

No Responses

No Responses

40.0% 50.0% 66.7%

No Responses

No Responses

No Responses

75.0% Other Total

* The percentages calculated in this table represent the percent of landlords sharing the same percent of costs as they share of the crop. For example, 52.4% of landlords receiving 33% of the wheat crop paid 33% of herbicide expenses.

Color coding scale

Source: Schlegel and Tsoodle -- 2010 KAS/KSU survey (available at www.agmanager.info) Source: Schlegel and Tsoodle -- 2011 KAS/KSU survey (available at www.agmanager.info)

Ownership of pivot...

On irrigated land the center pivot system is typically owned by the...

50%

Example of market established irrigated crop shares...

Table 8. Southwest30 Irrigated CropShare Arrangements

Landlord's Percent of Crop Received (or of Costs Paid)* Crop Wheat (42 Leases) % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs % of Leases Sharing Energy Costs Corn (172 Leases) % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs % of Leases Sharing Energy Costs Soybeans (16 Leases) % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs % of Leases Sharing Energy Costs Alfalfa (28 Leases) % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs f h i bi id % of Leases Sharing Insecticide Costs % of Leases Sharing Energy Costs 25% 4.8% 100.0% 100.0% 100.0%

No Response

1. Landowner 2. Tenant 3. Does not apply

14% 36%

11.0% 100.0% 100.0% 100.0% 100.0%

No Responses

17.9% 100.0% 100.0% 100.0% 100.0%

33% 76.2% 100.0% 100.0% 100.0% 100.0% 69.2% 100.0% 100.0% 100.0% 97.5% 87.4% 100.0% 100.0% 100.0% 100.0% 71.4% 100.0% 100.0% 100.0% 100.0%

40% 7.1% 100.0% 100.0% 100.0% 100.0% 4.7% 100.0% 100.0% 100.0% 100.0% 6.3% 100.0% 100.0% 100.0%

No Response

50% 2.4% 100.0% 100.0% 100.0% 100.0% 5.2% 88.9% 88.9% 88.9% 100.0%

No Responses

Other 9.5% 100.0% 100.0% 100.0% 100.0% 9.9% 100.0% 100.0% 100.0%

100.0%

6.3% 100.0% 100.0% 100.0%

No Response

No Responses

7.1% 100.0% 100.0% 100.0%

No Response

3.6% 100.0% 100.0% 100.0% 100.0%

*The percentages calculated in this table represent the percent of landlords sharing the same percent of costs as they share p p g pp p of the crop. For example, 100% of landlords receiving 33% of the wheat crop paid 33% of fertilizer expenses.

Landowner

Tenant

NA

Source: Schlegel and Tsoodle -- 2008 KAS/KSU survey (available at www.agmanager.info)

Example of market established irrigated crop shares...

Table 7. West Central20 Irrigated CropShare Arrangements

Landlord's Percent of Crop Received (or of Costs Paid)* Crop Wheat (8 Leases) % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs % of Leases Sharing Energy Costs Corn (31 Leases) % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs % of Leases Sharing Energy Costs Sorghum (3 Leases) % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % of Leases Sharing Insecticide Costs % of Leases Sharing Energy Costs Soybeans (2 Leases) % of Leases Sharing Fertilizer Costs % of Leases Sharing Herbicide Costs % f h i bi id % of Leases Sharing Insecticide Costs % of Leases Sharing Energy Costs 25% 12.5% 100.0%

No Response No Response No Response

Principles embodied in an equitable lease ... p q

50%

No Responses

33% 87.5% 100.0% 100.0% 100.0%

No Response

40%

No Responses

Other

No Responses

· Profit maximization (MR=MC) ( ) · Economic profits (expected profit = 0*)

9.7% 100.0% 100.0% 100.0% 100.0%

No Responses

No Responses

87.1% 100.0% 100.0% 100.0% 85.7% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% % 100.0% 100.0%

No Responses

3.2% 100.0% 100.0% No Response 100.0%

No Responses

No Responses

· Opportunity costs

No Responses

No Responses

· Ri k across l Risk lease types t · Equal rates of return on annual investment q

(if economic profit = 0, then rate of return = 0)

* On average, in the long run

No Responses

No Responses

No Responses

*The percentages calculated in this table represent the percent of landlords sharing the same percent of costs as they share of the crop. For example, 100% of landlords receiving 33% of the wheat crop paid 33% of fertilizer expenses.

Source: Schlegel and Tsoodle -- 2008 KAS/KSU survey (available at www.agmanager.info)

A good crop share lease should follow five fi e basic principles ...

1. Yield increasing inputs should be shared g 2. Share arrangements should be re-evaluated as technology changes 3. Total returns divided in same proportion as resources contributed 4. Compensation for unused long-term long term investments at termination 5. Good l dl d/t 5 G d landlord/tenant communications t i ti

Principle #1: Yield increasing inp ts sho ld be shared inputs should

Examples of yield increasing inputs · Fertilizer

y Px Py

· Irrigation water · Herbicides ??? · Seed ???

Sharing yield increasing inputs in the same % as income p provides the economic signal g to both parties to apply the optimal amount of the input.

y*

x*

x

Principle #2: Technology ma Technolog may affect share arrangements

Examples of technological change · Reduced-/no-till · New crops/rotations (e.g., double crop) · Center pivot irrigation p g · Hybrid seed · Bi t h l Bio-technology · Precision agriculture (GPS, autoswath)

Impact of new technologies ... p g

· Why do people adopt new technologies? · What happens as "new" technologies become common practice? · How does this impact relative contributions?

Adoption of new technologies ... p g

... tends to cause problems because traditional arrangements or rules-of-thumb are often not appropriate. ... should not be a problem if we follow basic principles of a good lease. ... if problems persist as to what is equitable, can lead to alternative leasing arrangements (e.g., cash lease).

Principle #3: Returns di id d in same proportion as R t divided i ti resources contributed.

This requires annual contributions of both parties to be identified (budgeting type approach). Base input values on expectations consistent with the time-frame of the lease (if expectations end up being

significantly off, be willing to make adjustments).

Land contribution ...

The land contribution has typically been based on an "average market value" for the land along with an historical average return to land. ith hi t i l t t l d

As cash leases become more common, the land contribution can be set equal to the cash rent. However we still H till often struggle with what the "right" number is. b i

RenttoValue Ratio, Nonirrigated Cropland

7% State avg = 4.8% NC avg = 5.1% 6% SC avg = 4.3%

Machinery contributions ... y

Machinery contribution should be based on average costs. Two methods for estimating g g the machinery contribution:

1. 1 Machinery investment approach - annual contribution is based on depreciation, interest, repairs, fuel and oil, and labor. p , , 2. Custom rates approach - annual contribution is based on reported custom rates and the typical operations.

Rent/Value, % %

5%

4%

3%

2% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: Kansas Agricultural Statistics and KState

Crop production input contributions ... pp p

The value of contributions for input expenses such as seed, herbicides, insecticides, seed herbicides insecticides fertilizer, etc. are generally valued at current market prices and represent "typical" p p yp production practices. How do we deal with input prices if they deviate significantly from historical averages (e.g., fertilizer, fuel)?

Principle #3: Returns di id d in same proportion as R t divided i ti resources contributed.

Shared Sh d contributions ($$$)

Total costs Equitably E it bl shared inputs are shared 1/3 ­ 2/3 Total nonshared costs

Annual contributions (i.e., costs) A l t ib ti (i t ) identified through budgets

Landowner's contributions ($$$)

Tenant's contributions ($$$) Landowner's contributions ($$$) Shared contributions ($$$)

Tenant's contributions ($$$)

Determine relative contributions of nonshared costs

(e.g., T = 67% and LO = 33%)

Principle #4: Compensation f unused long-term C ti for dl t investments at lease termination.

It is generally recommended that landowners make long-term investments such as terraces, irrigation well, lime, alfalfa seed, etc. If the tenant pays for long-term investments, or shares their cost, he should be compensated for his share of any value that remains when the lease is terminated

Lime, soil fertility (P), alfalfa stands, even no-till soil building (organic matter)

Principle #5: Good G d communications between the i ti b t th landlord and the tenant.

Because so many of the terms of a lease are based on negotiation between the landowner and the tenant, good communications are ,g critical. A lease is a legal contract in Kansas thus it is Kansas, suggested that terms of the lease agreed upon by both parties be put in writing. This becomes more important as the complexity of leases increases ­ or as the volatility of crop and input prices increases. increases

Written versus oral leases... Is your typical lease written?

1. Yes 2. No 3. 3 Does not apply

34% 63%

Legal Issues with Leasing Land in Kansas

Publication C-668 available at www.AgManager.info

www.agmanager.info/farmmgt/land/lease/default.asp#Leasing Papers

3%

1 2 3

"Non-traditional" leases ...

· Cash rent · Net share rent · Bushel rent · Flexible cash rent · Combination cash and crop share rent Because th B there is currently much interest i tl hi t t in these types of leases, there must be good reasons to use them ...

Cash rents ...

Numerous good reasons to go to cash rent, but lando ners b t landowners and producers need to prod cers recognize several things when doing so ...

· Land tends to change hands more often · Relative risks change g

Landowner/producer risk-return tradeoff

x

Risk premium...

How should cash rent for non-irrigated land compare with expected returns from equitable crop share...

[P d Producer]

Cash rent

1.

Crop share

5-10% higher

23% 23%

Re eturn, $/a ac

??? Crop share Cash rent

2. 2 3.

Roughly equal

19%

5-10% less 10-15% less 10 15% l

13% 13%

[Landowner]

4. 4 5. 6. 7. sx

15-20% less 20-30% less

6%

30-40% less

3%

Risk, $/ac

8.

>40% less

0%

1 2 3 4 5 6 7 8

Comparison of landowner income by lease type...

Landowner Income by Lease Type & Land Quality, 200910

300 261 250 227

+15%

Why might producers pay a higher rent with a cash lease than crop share?

· Lower costs (easier to manage)

Traditional crop share T diti l h 212 194

+9%

Cash rent 173

+9%

· Increased production flexibility · Ability to manage risk with crop insurance

125 138

+11%

In ncome, $/ac c

200 150 100

159

· Easier method of expansion · Timing of when rates were negotiated

50 0 Excellent Good Average Fair

· Other???

Land Quality

Source: Schnitkey, G. University of Illinois

45 46

Market rate for average cash rent... Methods of establishing cash rent values ... g

· Market going rate (if available)

Average cash rent per tillable acre for non-irrigated crop land in 2011 in my area was...

1. < $30

32%

· · ·

Crop share equivalent (adjusted for risk) p q ( j ) Landowner's cost Amount tenant can afford to pay

The last three require yield, price, and g government payment projections (as well as p y p j ( cost information used for crop share).

2. 3. 4. 4 5. 6. 6 7. 8.

$30 $35 $30-$35 $35-$40

21%

$40-$50 $40 $50 $50-$60 $60-$70 $60 $70

7% 7% 4% 14% 14%

$70-$80 > $80

1 2 3 4 5 6

0%

7 8

Market rate for average cash rent...

Average cash rent per wet acre for irrigated crop land in 2011 in my area was...

1. 2. 2 3. 4. 5. 6. 7. 8. < $60 $60-$75 $60 $75 $75-$90 $90-$110 $110-$140

13% 39%

KAS surveyed market rates ...

30%

$140-$170 $170-$200 > $200

0%

1 2 3 4 5

9% 4% 4% 0%

6 7 8

KAS report (switched to county-level in 2009 for

rent, dropped CRD-level land values in 2011)

KSU report ­ basically a repackaging of KAS data

(show more history and estimate "missing values")

Kansas Nonirrigated Cash Rents, 2011*

Nonirrigated Cash Rent ­ 2011 change from 2010, $/ac

* Cash rent values as reported by USDA NASS and Kansas Agricultural Statistics (KAS).

KAS did not report values for BR, DP, GT, KE, RA, TH and WY counties ­ values for these counties were filled in with multicounty averages. counties were filled in with multi county averages

Of 95 counties with data in both 2010 and 2011, 35 (36.8%) decreased, 54 (56.8%) increased, and 6 did not change.

State average = $44.00 compared to $43.50 in 2010 (+1.1%)

Average change = $0.43 (ranged from $5.50 to +$7.00)

Kansas Pasture Cash Rents, 2011*

Pasture Cash Rent ­ 2011 change from 2010, $/ac

* Cash rent values as reported by USDA NASS and Kansas Agricultural Statistics (KAS).

KAS did not report values for ED, GT, HS, KW, LV, ST, SV and WY counties ­ values for these counties were filled in with multicounty averages. counties were filled in with multi county averages

Of 95 counties with data in both 2010 and 2011, 27 (28.4%) decreased, 51 (53.7%) increased, and 17 did not change.

State average = $16.00 compared to $15.50 in 2010 (+2.4%)

Average change = $0.59 (ranged from $4.00 to +$7.00)

Kansas Nonirrigated Cash Rents, 2011*

2011 average irrigated cash rent*

$126.0 $126 0 $120.0 $120 0 $116.0 $116 0

$102.0

$85.5

$94.0

$95.0

* Cash rent values as reported by USDA NASS and Kansas Agricultural Statistics (KAS).

$108.0

$105.0

Averages can be misleading because... 1) Not all land is equal 2) Not all relationships are equal

* 2011 Cash rent values as reported by USDA NASS and Kansas Agricultural Statistics (KAS). Values at the county level were only reported for 28 of 105 counties.

Crop land cash rents for 2012... Methods of establishing cash rent values ... g

· Crop share equivalent (adjusted for risk)

- Converts equitable crop share rent to an expected dollar amount per acre My estimate as to what cash rents for crop land in 2012 will be, relative to 2011, is...

1. Down > 10% Down 5-10% Down 2-5% Steady Up 2 5% 2-5% Up 5-10%

3% 6% 3% 0% 1 2 3 4 5 6 7 19% 26% 42%

· L d Landowner's cost ' t

- Based on the premise of landowner's continuing to receive comparable returns to what has been received in the past

2. 3. 4. 5. 6. 7. 7

· A Amount t t tenant can afford to pay t ff d t

- Residual approach ­ after tenant pays all expenses, whatever income is left represents cash rent

Up > 10%

Kansas State

U N I V E R S I T Y

Department of Agricultural Economics

Flexible Cash Rents ­ WHAT?

· Flexible cash rents simply refer to land rental arrangements where the amount of cash rent paid (received) can vary based upon some predetermined formula (i.e., formalizes bonus rents) · Methods of "flexing" rental rates, i.e., formulas are based on:

­ Yield (actual for producer, county average, etc.) ­ Price (harvest, season average, actual) ­ Revenue (yield x price, crop insurance, residue) ­ Costs (e.g., fertilizer price) ­ Other...

www.agmanager.info

Flexible Cash Rents

Flexible Cash Rents ­ WHY?

· Method of allowing rents to vary from year-to-year without having to renegotiate rents annually

(avoid (a oid mental ang ish associated with rental rate negotiation) anguish ith

Flexible Cash Rents ­ WHY?

· Trend in Kansas has been moving away from crop share leases to more cash leases · Volatility of last few years has significantly increased the risk of fixed cash rents

­ Most popular question received in the summer of y y 2008 was "How can I terminate my lease with my current tenant?" (in 2009 several questions about tenants walking away)

· Way of sharing/managing risks associated with volatile markets ( ith t hassles of crop share lease) l til k t (without h l f h l ) · FSA has changed rules allowing flexible leases · Somewhat "force" a higher level of communication relative to fixed cash rent (poor/lack of communication is

often an issue with problem lease arrangements)

62

Grain markets have been a bit volatile recently...

Daily JUL Wheat Futures Price (Sep 1- Jun 30 each year)

14.00 8.00 7.00

Is 2012 going to be another 2009?

Daily Futures Prices for 2012 Futures Contracts

15 14 13 12 Wheat Corn Soybeans

9/1/11 = $8.78 / / $ 11/30/11 = $6.79 Change = $1.99 9/1/11 = $6.47 11/30/11 = $5.52 Change = $0.95 9/1/11 = $13.83 11/30/11 = $11.47 Change = $2.36

Daily DEC Corn Futures Price (Jan 1 - Oct 31 each year)

12.00

10.00 Price, $/bu

$12.78/bu ­ 3-12-08 $5.85/bu ­ 3-12-09

Price, $/bu

6.00 5.00 4.00 3.00

$7.88/bu ­ 6-26-08 $4.04/bu ­ 6-26-09

8.00

6.00

4.00 4 00

2.00 1.00

2.00

Pr rice, $/bu

11 10 9 8

19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09

Extremely volatile crop prices make negotiating fixed cash rents very difficult and risky y y

Price, $/bu

17.00 15.00 13.00 11.00 9.00 7.00 5.00 5 00 3.00

19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09

19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09

Daily NOV Soybean Futures Price (Jan 1 - Oct 31 each year)

$16.31/bu ­ 7-3-08 $10.06/bu ­ 7-2-09

7 6 5 7/1/2011 8/1/2011 9/1/2011

(good chance someone is not going

Crop share has a built in buffer to this risk.

to be happy).

10/1/2011

11/1/2011

Day (7/1/11 through 11/30/11)

63 64

Flexible Cash Rents ­ WHY?

· Less need to negotiate lease every year...

­ It appears that some people feel that once a cash pp p p rent is negotiated this rate is appropriate into eternity...

Cash rent historical perspective

KS non-irrigated crop land rent; 1967 2011 non irrigated 1967-2011

1967-2011: avg growth = 3.00%; geo growth = 2.81% 1992-2011: avg growth = 1.58%; geo growth = 1.71%

$50 $45 geo growth $40 ren ($/acre) nt $35 $30 $25 $20 $15 $10 $5 1967

Rent has fallen e t as a e 25.0% of years

35% 30% 25% 20% rent $ growth rate 15% 10% 5% 0% -5% annual growth rat (%) te

­ Tenants are concerned that if they increase their cash rent, they will never be able to lower it (is this true?)

-10% 1975 1983 1991 1999 2007 1971 1979 1987 1995 2003 2011

65

1967-2010 average land value growth = 5.37%

Flexible Cash Rents ­ WHY NOT?

· Complex! · Theory and intuition guide conceptual design, but little help with specific details · Not needed if cash rents are renegotiated frequently

(every year?)

Flexible cash rents ­ HOW?

· There is not a single right way to do this!

(but there are plenty of wrong ways)

· A couple things to keep in mind

­ Risk-return trade-off suggests that higher risk is Risk return trade off associated with higher expected returns and vice versa ­ Absolutely critical that all parties involved understand the flexible arrangement and how it can play out under different scenarios (i e have a (i.e.,

written lease and include example calculations)

· Hard to think of everything, which means we might need to be "tweaking" arrangement regularly · If designed wrong, might increase risk wrong · Appealing for certain situations, but not appropriate in all cases (depends on why you are considering cash rent)

­ Important to remain "flexible" with flexible cash flexible rents (somewhat of a learning process)

Flexible Cash Rents ­ HOW?

Steps to determining a flexible cash lease 1. Establish a base cash rent

(often tied to local market and/or costs of production) · Id tif what risk adjustment should be (if any) Identify h t i k dj t t h ld b )

Flexible Cash Rents ­ HOW?

Questions to ask 1. Does cash rent flex up and down or only up?

(this should impact base price as it relates to market rate)

2. Determine what base rent will be "flexed" on flexed

· Price deviation from base (fixed bushel rent) · Yield deviation from base · Price and yield (revenue) deviation from base · Gross revenue deviation from base · Cost deviation from base

If cash rent only flexes up (i.e., base rent is a floor), should base rent be adjusted to reflect risk situation? Examining the options market might help guide thinking on this issue...

At-the-money call options premiums as % of futures* ---------- Scenario ---------A B 9.4% 9.0% 7.4% 7.0% 7.3% 7.0%

Flexible Cash Rents ­ HOW?

Questions to ask 1. If cash rent only flexes up (i.e., base rent is a floor), should base rent be adjusted to reflect risk situation? -- YES 2. But, how does this relate to price triggers

(i.e., when bonus payments start kicking in?)

Crop (contract) Wheat (Jul 2012) Corn (Dec 2012) Soybean (Nov 2012)

A. Current volatility (30.0, 28.7, 23.5) and 240 days to expiration (8 months) B. Historical volatility (22.3, 23.5, 22.3) and 240 days to expiration

* Based on futures market closing prices on 10/21/2011 and Black-Scholes options model Black Scholes

Flexible Cash Rents ­ HOW?

Questions to ask 3. What yields and prices are used to determine actual gross revenue?

a. Yields and prices used for determining adjustments to base rent need to be consistent with those used in determining base rent and should be spelled out in lease. g p b. Suggestions ­ use actual crop yields as turned in for insurance records and a multi-week or monthly average y g cash price for a relevant market (if post-harvest prices are used, prices should be net of storage costs). I would not use actual prices received for crop. What about insurance prices?

Flexible Cash Rents ­ HOW?

Questions to ask 4. What crops should all be included in calculations?

a. Goal is to pay bonuses when income is high and thus it is important that bonuses are tied reasonably close to what is actually done. However, the benefits of additional complexity need to outweigh the associated costs. b. Suggestion ­ include crops that account for the majority of the production and income and those which data will be readily available. Nothing wrong with applying percentage changes from 80-90% of acres to 100% of acres rented. Remember KISS principle... p p

Flexible Cash Rents ­ HOW?

Questions to ask 5. Are crop insurance and government payments (e.g., ACRE, SURE) included / accounted for?

a. Typically crop insurance indemnity payments are received when income is low and thus they would not be expected to trigger bonuses. However, if working p gg , g with gross income for farm they could be included (need to account for premium cost). b. Suggestion ­ do not factor in crop insurance or government payments to bonuses (i.e., these are handled strictly by tenant), but share information in case things need to be changed in the future.

Flexible Cash Rents ­ HOW?

Questions to ask 6. What about flexing cash rent based on costs of crop inputs?

a. Probably only makes sense for major inputs that have considerable price risk (e.g., fertilizer, irrigation fuel). Establish a $/acre for each crop ( $ p (and total for farm) ) based on quantity and price and then flex on price deviation from base (do not use actual price paid). b. Suggestion ­ if this is a major concern, consider going back to crop share lease. Focus on yield and price first to keep things slightly less complex.

Flexible Cash Rents ­ HOW?

Questions to ask 7. What will final rent be under alternative potential outcomes?

a. Ask yourself lots of "what if" questions to make sure you know how things "turn out" under various p price/yield scenarios. y b. Suggestion ­ take time to create example outcomes as this will help with identifying the terms that need to be p y g included in written lease (include examples showing relevant calculations in written lease).

Flexible Cash Rents ­ SUMMARY

· Flexible cash leases are simply a way of sharing risks of unpredictable markets (and yields?) without the hassles of crop ownership · Why not simply give landowner ad hoc "bonuses" bonuses when times are good? · Th There are many types of flex leases ­ no one t f fl l method is right or best in all cases · Communication, communication, communication!

(remember it likely is a learning process for both parties)

Kansas State

U N I V E R S I T Y

Department of Agricultural Economics

View of other party to the lease...

How do you view the other party in a lease?

77%

Ethics of Leasing

(thoughts from Kevin and Terry)

1. Competitor p 2. Partner 3. Neither 3 N ith C nor P 4. Does not apply

13% 7% 3%

2 3 4

www.agmanager.info

1

View of other party to the lease...

Who has more "power" in negotiating the terms of a lease?

77%

Fixed cash leases...

Of land that I rent (manage) on a fixed cash rent, on average, the rental rate is renegotiated...

44%

1. Landowner 2. Tenant 3. Neither

(roughly equal)

1. Every year 2. Every other year 3. Every 3-5 years 35

20% 3%

0% Landowner Tenant Neither

1 2 3 4 5

26% 19% 11%

4. 6 years or more 5. Does not apply

Responsibility for rental rates...

Whose responsibility is it to see to it that a landowner's cash rental rate is equitable considering current conditions? 1. 1 Landowner 2. Tenant

72%

"Other" government program payments...

Producers should receive 100% of payments from programs such as CSP that are due to their management. 44% 1. Strongly agree 2. Agree 3. Neutral

19% 30%

28%

4. Disagree 5. Strongly disagree

7% 0%

1

2

1

2

3

4

5

View of other party to the lease...

Who "typically" needs the income from the land the most?

59%

Mineral / wind rights leasing...

If land is leased for mineral/wind rights, who should receive the income? 1. Landowner 2. Tenant

28%

86%

1. Landowner 2. Tenant 3. Does not matter

14%

3. Shared

14% % 0%

Landowner Tenant Irrelevant

1 2 3

Mineral / wind rights leasing...

Who should receive income for compensation for damages associated with oil / gas exploration? g g p 1. Landowner 2. Tenant 3. Shared

14% 45% 41%

Rental Ethics . . . Our Perceptions

· Tenants have the information (power) · Cash rents tend to rise over time · Manna-from-heaven payments often should be shared · Foot-in-door high rents often inappropriate · Landowners need money just like tenants · Landowners are sometimes unethical too · Family situations often are the worst · Ethical behavior more profitable in long run

1

2

3

88

Tenants have the power!

· L d Landowners often: ft

­ ­ ­ ­ Are generations and geographically removed Are unaware of current farming practices/technology Are old and easily taken advantage of View the arrangement with a tenant as a long-term commitment handed down from their parents ­ Think that farming is a low-income business and so want to "do their part" in aiding it ­ Believe there are few potential tenants and so are beholden to the existing tenant ­ ­ ­ ­

Tenants have the power!

· L d Landowners often: ft

Are generations and geographically removed Are unaware of current farming practices/technology Are old and easily taken advantage of View Many of these with a tenantthearesult of the the arrangement points are as long-term commitment handed down from their parents are fact that a number of landowners ­ Think that farming is a low-income business and so want landowners aiding it to "do their part" in "by inheritance" as opposed to investing in land intentionally. are ­ Believe there are few potential tenants and soThus, beholden to the existing tenant d as "money I never returns are often viewed t ft i "

· Tenants take advantage of the situation

­ Unintentionally (may be poor managers) ­ Intentionally ("she never asked me to raise rent")

had before" as opposed to "what · Tenants take advantage of the situation I expect from my investment.managers) ­ Unintentionally investment." (may be poor

­ Intentionally ("she never asked me to raise rent")

· Only occasionally do we see a landowner shafting a tenant

· Only occasionally do we see a landowner shafting a tenant

Cash rents rise over time

· Although cash rents do fall about 30% of the years, on average they rise 2-3% annually g y y

­ Unusual to see a 3-year contract rate that shouldn't be higher than the previous contract

Manna-from-heaven payments

· Unexpected payments, typically from the g government, should be shared according to parties' , g p costs

­ Examples: CRP, CSP, EQIP

· Landowners & tenants who see stable crop-share terms for years think that translates to stable cash rent

­ We see cash rental rates that haven't changed for years and decades · Landlord: "We didn't know." · Tenant: "She never asked for a higher rent."

· If tenant does nothing to earn payment it should go to the land i.e., the landowner land, i e · Such payments should be discussed between landowner & tenant (especially the relative associated costs) )

91 92

Foot-in-door high rental payments

· High rent payments on new contracts often are followed by stagnant rates for many years, which could be:

­ A) Tenant overbids to get land, then realizes he's not p profitable so rationalizes stagnant rents g ­ B) Tenant uses this as a strategy to acquire land and pay lower-than-market rents over time · This is the least ethical outcome of the two

Landowners need money too

· Tenants often make the argument that "she doesn't need the money" y

­ This is completely irrelevant!

· Ad itt dl landowners sometimes foster this Admittedly, l d ti f t thi perception

. . . which tends to change when investment-minded heirs g acquire land being rented

· Some tenants who do this actually beg for lower y g rents in near future, realizing that landlords are reluctant to change tenants

­ This is really unethical! reall nethical!

93 94

Landowner ethics

· Landowners may use their land for non-ag purposes and yet expect the same rent

­ Utility poles oil leases poles, ­ Lease hunting

Family situations often are the worst

· "Sweat-equity" parent-child relationships lead to unrealistic expectations across generations · Family members have trouble believing their own parents, children, parents children or siblings would cheat them

­ Backlash then goes overboard

· Landowners think if they paid too much for land it should bring a higher rent

­ This is completely irrelevant!

· Landowners might demand certain farming practices yet expect market rent

­ e.g., no f tili fertilizer; conventional tillage ti l till

· Family members often are "always around" and so the pain always resurfaces

­ Hard to "forget and move on" forget on

· Landowners make demands on current tenants to "fix" problems of past tenants fix

95 96

Ethics is good long run economics

· Poor ethics results in high tenant turnover:

­ Increases cost of relationship establishment and monitoring ­ Reduces profit to the land (tenant makes short run decisions)

Miscellaneous

· Landowners rarely will evict tenants!

­ Often will sell land rather than evict tenants ­ Will put up with atrocious behavior of tenants (especially relatives)

· We as educators / consultants have some blame · Bad business leads to unethical behavior

­ Poor management causes "I deserve more" ­ B d behavior is rationalized Bad b h i i ti li d ­ Promote perceptions of "poor returns to farming," "sweat equity," etc. ­ B li Believe, like many, th t farming is "special" lik that f i i " i l"

· Good ethics should emerge because it is the "right right thing to do," not for the purpose of long-run profitmaximization

· Educators / consultants should

­ Tell landowners it's okay to evict tenants ­ Help clients understand that FARMING IS A BUSINESS!

97

98

Kansas State

U N I V E R S I T Y

Department of Agricultural Economics

www.agmanager.info

If interested in receiving weekly AgManager.info Update or any of our other Ag Econ newsletters via email, please contact Kevin Dhuyvetter or Rich Llewelyn. (Kevin: [email protected] 7855323527 or Rich: [email protected] ­ 785.532.1504).

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