How to Determine Fair Farmland Rental Rates
Three approaches to help you answer the question: what is the right rental rate for farmland?
Agricultural renters and landowners alike seem to struggle with the same question: what is the right rental rate for agricultural property? I commonly hear this question from beginning farmers seeking land. Yet, just as frequently, it comes from landowners searching for a farm tenant. Although owners and renters may find themselves on opposite sides of the bargaining table, in general both parties are looking for a fair rental rate that does three things:
- Reflects local agricultural and market conditions.
- Compensates the owner for costs associated with property ownership.
- Allows the tenant to operate a viable farm business and maintain the property in good condition.
If both parties come to the table with these three goals in mind, then they have a good shot at working out a lease agreement and a rental rate that meet everybody’s needs. Assuming, of course, that the tenant has a viable business plan.
If you find yourself in this position, you have multiple options for how to come up with a rental value. This article sets out three distinct strategies for determining farmland rental rates. While the best method will depend on your own unique set of circumstances, using a combination of these strategies can help you arrive at a solution that works for both parties.
The Going Rate in Your Area
One strategy to determine a fair rental price is to look at current rental values for similar properties nearby. This strategy works best when there are comparable rental agreements in your locale. It may be hard to find a good “comp” for a whole farm rental that includes land, facilities and equipment. However, in most agricultural communities it is easy to determine a typical market rate for renting farmland.
Cash rental rates reflect the value of what the land can produce, as well as the demand for agricultural land in your area. Land that is more productive and easier to work will be more expensive to rent than land that is less productive and harder to work. Soil type, slope, aspect, accessibility and prior management all influence land quality and rental price. Competition between farms can drive prices up when the demand for farmland in your area exceeds the supply.
The best way to gather information about rental rates is to talk with other farmers and landowners in your neighborhood. Find out what their rates are, and ask about any additional stipulations in their lease agreements that might affect the price. Prices can vary widely, even within a single locale, so it is best to gather information about comparable properties.
You can also use data from the USDA National Agricultural Statistics Service (NASS) to develop a sense of typical rental rates in your area. NASS reports average rental rates for cropland and pastureland at the county level. However, they do not report the range of rental values. Average rental rates provide little guidance on how to price land that is significantly more or less productive than average.
Owner’s Carrying Cost
Most owners and renters will agree that a fair rental price should compensate the owner for any expenses associated with owning the property. Owners are typically responsible for paying taxes and insurance on property held in their name, and they often pass on other routine costs to their tenants, such as electricity, repairs, and maintenance.
Owners also incur an opportunity cost of keeping their capital invested in a property. While this is not a cash expense, it is a real economic cost. As an owner, if you were to sell your property and invest the earnings in a financial account, you would expect to see a rate of return on your investment. Your opportunity cost of owning farmland is the loss of potential gains from other possible uses of the capital you have invested in the farm.
If you are an agricultural property owner, consider what rate of return you would be willing to accept from a rental agreement. Appreciation of agricultural land values may also contribute to your return on investment. For example, assume your property value appreciates by 2% per year and you earn a 3% rate of return from your tenant. That represents a 5% annual rate of return overall. Some owners may be willing to accept a lower rate of return from their rental agreement if the tenant’s activities help to maintain or increase the property value over time.
Understanding the owner’s carrying cost is especially helpful for determining rental rates when an agricultural property includes buildings and equipment. Here is a fictional example of how two parties might apply this method:
A livestock farmer (tenant) is negotiating a rental agreement for a farm property that includes land, fencing, animal housing, and storage structures. The property has a market value of $400,000. The property owner pays $10,000 annually in property taxes and insurance. The tenant agrees to pay for electricity and other utilities, and take responsibility for the cost of routine repairs and maintenance. The owner is willing to accept a 2% rate of return, which represents the opportunity cost of keeping their capital invested in the property. A 2% rate of return on the $400,000 assessed property value is $8,000. Both parties agree to a cash rental rate of $18,000 per year, or $1,500 per month.
Tenant’s Business Plan & Budget
A third strategy for determining a rental rate is to figure out what the tenant can afford. If you are the tenant, you should sketch out a business plan and develop a budget that includes the cost of renting land and facilities. This recommendation applies regardless of which strategy you use to settle on a rental price. Having a budget will help you to avoid signing a rental agreement for a property that you cannot afford.
If you are not sure what rental value to use in your budget, start by plugging in a value based on going rental rates, or based on your estimate of the owner’s carrying cost. Once you have a plan and a budget, look at your numbers and ask some critical questions:
- What percentage of my earnings will go toward rent? Is this normal for my industry?
- Will I have enough cash flowing into the business to cover my monthly/annual rental payments?
- Will my business fully utilize the property in the first year? If not, will it grow to fully utilize the property at some point in the future?
- Will my business be profitable in the first year? If not, when will it become profitable?
Answering these questions can help you negotiate rental values and terms that make sense for your business. If you face a significant cost to transition into the new property, perhaps the property owner would agree to a discounted rental rate in the first year. If you anticipate significant growth in your business, you might propose a rental rate that increases over time as your earnings and your utilization of the property grow. Demonstrating that you have a viable business plan can build trust with the property owner and increase their confidence in your management abilities.
These three strategies give you a starting point for negotiating a fair rental value. Yet there are many other terms to consider in a lease agreement, some of which may influence the price:
- How long will the lease last?
- Who will be responsible for major repairs?
- Can the tenant make improvements to the property? If so, who will pay for the improvements, and who will own the improvements when the lease ends?
It takes time to consider all of the questions that go into developing a sound lease agreement. Having a written agreement is important to protect the interests of both parties. Yet the best rental agreements always seem to emerge when property owners and tenants develop a relationship based on mutual respect and a shared set of values. Taking time to identify and articulate your own goals is a good starting point to help you find a good rental arrangement.