Buoyed by growing global demand for food, farmland values are rising, and REITs are getting in on the game.
The new kid on the block for real estate investment trusts (REITs) is farmland, whose potential rising values may offer risk-tolerant investors a chance to play land baron in cow country.
Indeed, proponents of a deeper look at farmland investing (inside and outside of REITs) make a compelling fundamental case. They’re focused on the need for a steady supply of productive farmland to help feed a growing global population. Of course, someone else could make the case that land price booms, especially in the ag world, can be followed by an unpredictable bust.
There may be a case for buying land outright under these broader fundamental drivers, too, but here we’re taking a look at where investments offer a slice of land “ownership.” Two farmland REITs have emerged since 2013 that, although thinly traded, offer longer-term land plays as worldwide demand for food swells. They’re the start of a market subset that could grow in coming years, and they join the ranks of timberland REITs that have longer roots in this alternative stock category. Timberland, too, will remain a closely watched real estate play to meet growing building demands in a tougher regulatory climate.
REITs are a special tax entity for investing mainly in real estate—shopping malls, apartment buildings, office complexes, timberland, and farmland. A REIT does not pay federal income taxes on distributed incomes, usually as dividends, to shareholders. This is because a REIT is allowed to claim a deduction on the dividend distribution. It’s required under tax law to distribute at least 90% of its ordinary income, meaning that a REIT can essentially eliminate income taxes at the firm level. For instance, a timberland REIT may pass its income from timber sales to shareholders as capital gains rather than ordinary income. They’re subject to the favorable tax rates of up to only 15%. By comparison, timber income is typically taxed at a corporate rate of as much as 35%.
"The whole value proposition for this asset class comes down to global food consumption,” says Brad Thomas, editor of the Forbes Real Estate Investor newsletter. “There is extremely strong global food demand, and they are not making any more land."
But we are making more people. Right now, the planet is home to roughly 7.2 billion humans, but that number is projected to surge to more than 9 billion by 2050, according to the United Nations (figure 1). To nourish that extra 2 billion, food production must grow by 60%, estimates the Food and Agricultural Organization of the U.N.
FIGURE 1: SHIFT UNDER WAY. Africa’s population is projected to increase the most and make up a greater share of the global population by 2050. Europe and Asia’s shares in the global population are expected to decrease, while the Americas will hold steady. India is projected to replace China as the most populous country. Source: Pew Research, United Nations.
Meanwhile, farmland has been delivering impressive returns for nearly 45 years. From 1970 to 2014, farmland financial performance in 26 states in the U.S. posted an average annual return of 11.57% compared with a 6.9% return in the Dow Jones Index over the same period, according to the TIAA-CREF Center for Farmland Research. The results are even better over a shorter time frame. Between 1995 and 2014, the Farmland Index posted a 12.66% average annual return, according to the National Council of Real Estate Investment Fiduciaries (NCREIF), which produces the index.
“In the last five to seven years … we have seen double-digit gains in farmland rates of return,” says Bruce Sherrick, professor of farmland economics at the University of Illinois.
“Farmland has moved up with world demand for food and renewable fuels,” he said.
REITs are traditionally the home of commercial office space, apartment buildings, retail space, and lodging. They’re attractive because they offer investors a potential income stream through dividend payouts and potential share appreciation. Some 192 REITs trade on the New York Stock Exchange, but only two—Gladstone Land Corp. (LAND) and Farmland Partners Inc. (FPI)—are farmland REITs.
Gladstone, which went public in 2013, and Farmland, in 2014, buy farms they rent to farmers. Investors purchasing a share effectively gain access to a share of the rental income from the farmland. In very simplistic terms, investing in farmland REITs is essentially investing in leased contracts.
Don’t worry about droughts or the impact of bumper crops. The price of farmland does not rise and fall at the whims of Mother Nature or the sometimes volatile price of grains. Nor does the income derived from REITs, experts say.
"Farmland prices do not respond much to single-period events, and move very slowly,” Sherrick says. When buying or valuing land, investors should look to expected revenues, not past performance, he says.
"More to the point,” he adds, “for institutional investors or for folks interested in buying a fund is that the cash rent charged tends to be very sticky and is not influenced much by one period’s grain prices.”
Or course, as we can see with other real estate adventures in the recent past, increases in real estate value can be followed by a decline, or even a crash.
Some investors have long favored the diversification REITs can create in portfolios, but farmland offers unique characteristics. Sometimes likened to "gold with a coupon," farmland values have historically shown a positive correlation to inflation while producing steady rental income.
"Farmland has a demonstrated positive correlation with inflation and negative correlation with financial securities,” Sherrick notes. “As a diversifier asset, it has exactly the characteristics you want. Many pension funds and long-term [investors] find this very attractive."
But farmland REITs are still finding their way, and while there are compelling arguments to sinking money into them, no fledgling investment is without risks. As with any developing investment vehicle, the early stages can suffer from a lack of liquidity, which in turn fuels volatility. They’re perhaps more akin to small-cap stocks: Gladstone’s market cap sits at $86.1 million and Farmland’s at $84.74 million. Average daily volume is skinny, ranging from 26,000 to 36,000 shares traded. Compare that to a larger, more established REIT like New York REIT Inc. (NYRT). Its market cap is $1.48 billion and it averages more than 588,500 shares traded daily.
"If one institution came in and bought a big block of stock in farmland, it would create a lot of volatility because there are not a whole lot of shares being traded," Thomas warns.
What’s more, there’s not a strong track record. “We’ve only had farming REITs for the last two years,” Thomas points out. “It is a risk because you don’t have a whole lot of history with their companies or their dividend-paying history.”
Still, these and other REITs may be worth a deeper look for investors who are comfortable including alternative investments as part of traditional stock portfolios and embrace the global population themes that will surely drive investing research for years to come.
Custom screeners at tdameritrade.com can help you sift through stock, REIT, mutual fund, and ETF choices using your own criteria.
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Brad Thomas / Forbes Real Estate Investor , TIAA-CREF Center for Farmland Research, National Council of Real Estate Investment Fiduciaries, and Bruce Sherrick / University of Illinois, are separate from and not affiliated with TD Ameritrade, which is not responsible for their services, policies, or commentary.
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