The Clustering of Regional Farmland CAP Rates
By Matt Harrod
The CAP or Capitalization rate for investment farmland is simply the cash rent or total income divided by the asset value (be careful, this can be in gross numbers or net of taxes and expenses). It is a simple measure of returns to investment that allows comparison not only between regions and farmland types, but also with other assets such as stocks or commercial property. It can also be a measure of perceived risk, with investors demanding a higher CAP rate for those assets perceived to be more risky.
Today we are looking US annualized quarterly row crop (annual) farmland value CAP returns from NCREIF, a group of institutional investors who pool their data in order to benchmark against one another (if you aren’t familiar with NCREIF, see the description below the chart). What we see in the chart below is a re-ordering and clustering of regional returns from the year 2000 up through Q3 2022.
Since the early 2000’s on the left we have moved from a market where there was a broad range of regional CAP rates ranging from about 4.3% to 6.1%, to today where we appear to have two distinct and relatively tight clusters. The higher return group, ranging from 3.8% to 4.1% includes the Mountain States (ID, NV, UT, AZ), the Pacific Northwest (OR, WA), the Pacific West (CA), and the Southeastern US (NC, SC, GA, AL, FL). The lower return group ranging from 3.2% - 3.3% is comprised of the Corn Belt (IA, MN, IL, IN, OH) and the Delta States (AR, MS, LA). A few items of note for the individual regions; First, by far the largest change over this time is the Delta States, having dropped from 6+% in the early 2000’s to a 3.0 – 3.3% in recent years, placing it consistently on par with the Corn Belt, which is often perceived as the low-risk “T-Bill” of the farmland market.
Second, the range of returns across all regions have narrowed from that 4.3% - 6.1% to a tighter and lower 3.2% - 4.1%, and the volatility of those returns (the quarterly ups and downs) have been reduced as well since about 2018. We need to keep in mind that this data is a measure of the NCREIF membership and not of the market as a whole as measured annually by USDA, but there are still a number of possible drivers and takeaways, including:
· NCREIF investments in annual cropland market from the year 2000 to Q3 2022 has increased over 1,500%, from $560 million to over $9 Billion. It would appear that as this market has become larger and more knowledgeable and sophisticated, opportunities for arbitrage in time and geography have been greatly reduced. In other words, the market has become more efficient.
· The sheer increase in the number of buyers and capital have likely decreased the number of properties selling at a price undervalued relative to their income and/or the number of overvalued properties has increased, driving out volatility and value-buy opportunities.
· CAP rates for annual cropland from the Rocky Mountains and westward are higher than those in the Corn Belt and Delta regions, likely reflecting higher perceived risk in those western regions.
· Farmland is a complex and sophisticate market. If you are going to equal or, better yet, beat these performance numbers, you had better be working with experts.
Next up: The triad of farmland valuation and returns; CAP rates, interest rates, and farmland value per acre. You can’t change one without affecting at least one of the others.
From the NCREIF (National Council of Real Estate Investment Fiduciaries) website:
"Established over 35 years ago, NCREIF serves the institutional real estate investment community as its Data Central, representing the largest, most robust and diverse database of country-specific real estate assets in the world.”
“The NCREIF Farmland Index is a quarterly time series composite return measure of investment performance of a large pool of individual farmland properties acquired in the private market for investment purposes only. All properties in the Farmland Index have been acquired, at least in part, on behalf of tax-exempt institutional investors - the great majority being pension funds.”