Midwestern agriculture is on the cusp of unprecedented profitablility, or the brink of disaster. You pick.
We still have 7 million ‘good’ acres of CRP that ‘could’ be released for cellulosic, or grain, production.
Perhaps that would buy the Presidents farm bill signature.

Don’t Bet the Farm

Farmland prices have soared, and bulls say underlying trends will keep the boom going. Sound familiar?

By JIM MCTAGUE

YOU’VE LIVED THROUGH THE TECH-STOCK BUBBLE. The dot-com bubble. The residential-real-estate bubble. Now, get ready for the cropland bubble. - At year-end 2007, farms — the latest count shows that the U.S. has 2,089,790 — are what Miami condos and San Diego McMansions were at year-end 2004: properties so hot that they’re likely to have a meltdown in their future. As city slickers in many parts of the nation see the market prices of their homesteads deflate faster than a New Year’s party balloon, farmers are watching the values of their land swell by annual double-digit percentages. Nationwide, farmland prices skyrocketed 50% over the past three years, to an average of close to $2,200 an acre through August, according to the U.S. Department of Agriculture. While that’s the latest month for which federal data are available, there’s no doubt that prices are still sprinting ahead. - Ground zero for the phenomenon could very well be Iowa, which, like a newly active volcano, sits at the center of a massive dome of rising farm and pastureland prices stretching across America’s heart

and beyond, from Ohio to the Dakotas. Bidders for Iowa farmland have become almost as eager as the politicians scurrying around the Hawkeye State desperately stumping for next month’s presidential caucuses.

Mike Duffy, an economics professor at Iowa State University, calculates that the average year-end farm price in the state will be a record $3,908 an acre — $508 higher than the USDA’s August estimate (see map). Prices will have jumped an average 22% this year, he estimates.

THE PHENOMENON ISN’T confined to the Midwest. In some Eastern states, where residential development has squeezed farmland supply, prices have doubled over the past five years. (The costliest U.S. farms are in Rhode Island, averaging $12,500 an acre.) And in the West, states like Montana and Wyoming have seen prices of both farm- and pastureland soar.

Virginia Benz, a broker at Prairie Rose Real Estate in Steele, N.D., says that good, productive farmland is up 30% this year in her state, to the highest level she’s seen in her 30 years in the business. Even “the poorest, most unproductive land is selling for $600 an acre,” she marvels. Some purchasers are from Minnesota, where rural land is even pricier.

All bubbles have catalysts, real or perceived. The tech-stock boom was driven by the belief that technology was changing both our lives and investment realities. And the residential-realty boom was driven by faith that interest rates would stay very low and that the baby boomers’ wealth would keep the new, second- and vacation-home markets robust for decades.

The catalysts in the farmland bubble are federal subsidies to ethanol producers and the belief that ethanol demand will keep rising and that China’s and India’s new wealth will keep boosting global commodity prices.

Indeed, U.S. farmers are switching to corn from other crops, curbing supplies of food grains. Nationwide, from 2002 to 2007, the number of acres on which corn was planted rose 24%, to 86.1 million. And the energy bill recently signed by President Bush and strongly backed by both parties mandates that oil refiners eventually boost ethanol use as a gasoline additive to 36 billion gallons a year from the current seven billion gallons.

Aided by a drought that reduced food exports from Australia, net U.S. farm income will hit a record $87.5 billion this year. Americans spent $642.5 billion on food in 2006, up 4.5%. And warnings have begun appearing in print — see the Dec. 8 issue of The Economist — on TV and online about the end of “cheap food.”

Farm rents also are climbing, up more than 16% since 2003. Even so, an investor who buys land will have no problem finding tenants to work it for him, says agricultural-property auctioneer Rex D. Schrader of Fort Wayne, Ind., because, with commodity prices high, they believe they will still be able to make fat profits.

Rising rents appeal to Wall Streeters who want a piece of the hot action but don’t know a corn stalk from a pole bean. Schrader, who auctions off 50,000 acres a year in 38 states, says that 10% of his customers are investment groups of five or six people who want in on the current boom.

Farming has become so lucrative that households with more than $1 million in investable assets rose by 17% in both Dakotas from 2005 to 2006, versus 9% in New York and 10.5% in California, reports the Phoenix Affluent Marketing Service in Rhinebeck, N.Y. Nebraska’s ranks of millionaire households’ rose 16% in that span.

MANY FLUSH FARMERS are reinvesting their gains in additional acreage. This means that the market isn’t nearly as leveraged as was residential real estate, says Iowa State’s Duffy, and so is less prone to becoming a bubble. Furthermore, farmers can lock in profits on futures exchanges at current prices going out two or three years. Indeed, 2008 futures for corn, soybeans and wheat reached new highs in late-fall and early-winter trading.

Investors are so sold on this story line that they still are buying farmland in water-starved areas of Georgia. “People still strongly believe that land is a good investment,” says Ben Hudson of Hudson and Marshall Auctioneers in Atlanta. “The drought had no adverse impact on prices.”

Bruce Babcock, another Iowa State economist, e-mailed Barron’s that the passage of the ethanol provisions in the just-signed energy bill assured him that there is no bubble building. He went out and bought some corn acreage himself.

But the case for farmland isn’t airtight.

In fact, some smart money that invested in Iowa farmland in 2000 is bailing out, happy to have made a profit. According to Duffy, 56% of Iowa farmland was owned by farmers from 2000 to 2005. The other 44% was owned by investors. The split today is 60% farmers and 40% investors.

Steve Leuthold no longer owns farmland he picked up for a song in the last bust. Leuthold, chief investment officer of Leuthold-Weeden Investment Capital in Minneapolis, sees ominous parallels between today’s boom and those of the 1970s and 1980s, which saw farm prices soar. In Barron’s Aug. 9, 1982, issue, he wrote a cover story entitled “Grim Reapers,” which called the farmland market’s top. His prediction of a 50% correction was overly optimistic; he ended up buying two Iowa farms at $600 an acre, 75% below their peak prices.

THAT BOOM WAS TRIGGERED in 1972 when President Nixon signed a wheat deal with the former Soviet Union and also improved relations with China. The subsequent rise in U.S. farm exports lasted until the Soviets invaded Afghanistan in 1979 and President Carter canceled the wheat deal in protest. This couldn’t have occurred at a worse time, coming as it did in an era of fuel shortages and gas lines, inflation and soaring interest rates. Nonetheless, farm prices continued to rise, aided by easy financing. Few saw disaster arriving…until it arrived.

This time around, Leuthold sees a more moderate pullback — 15% to 20% in three to five years — because buyers are employing less leverage and interest rates are lower. His main concern is that the ethanol boom rests on shaky economic underpinnings. Without government subsidies, ethanol makes no sense, he maintains. And the subsidies could disappear because of a backlash against costs of producing the fuel — higher supermarket prices and huge demand on water supplies. The measure was opposed by groups representing the world’s undernourished and by competing agricultural interests like the National Cattlemen’s Beef Association. Big Oil dislikes the program, too, and Big Oil has deep pockets to lobby Congress.

The rush for ethanol is easily the biggest factor behind rising farm prices. And a glut of ethanol could develop quickly as more and more farmers try to get rich quick by switching production to corn. In fact, the glut may be here. More than 130 ethanol plants now operate in the U.S., up from around 80 three years ago, while the number of gas stations selling ethanol is as underwhelming as the number of drivers demanding it. Recently, construction on three proposed U.S. plants was halted amid a growing oversupply of the fuel. Hart Energy Publishing reports that U.S. ethanol inventories climbed 12% from August through September, while average prices had slid from $1.91 a gallon to $1.67.

ETHANOL ENTHUSIASTS DISMISS such setbacks as temporary blips that will disappear with the help of the new mandate for greater use of ethanol. But the fuel does face major challenges. For one thing, while cheaper than gasoline, it contains less energy than that fuel, producing lower mile-per-gallon readings and forcing motorists to refuel more frequently.

In addition, the oil industry sees problems getting that corn crop to the distilleries and the resulting product from the distilleries to refineries. Because ethanol is more corrosive than gasoline, it can’t be shipped through gasoline pipelines.

What else could spoil the ethanol story? Ken Green, a scholar at the American Enterprise Institute, says a significant decline in oil prices would burst the bubble. Scientific breakthroughs could hurt, too. Duffy says the $64,000 question is whether efforts to produce ethanol from seaweed will succeed.

Ethanol, of course, isn’t the only force pushing up farm prices. A global commodities boom has been under way for several years now, lifting prices for a broad variety of foods. But contrary to the assurances of farmland promoters, demand for food isn’t endlessly elastic. Food expenditures in the U.S. dropped three times since World War II — in 1974, 1981 and 1992, years when consumers were pinched. At some point, possibly soon, rising prices for some crops will trigger declines in per-capita consumption.

Meanwhile, other countries are providing more and more competition for American farms. The U.S. share of the global corn market, now about 60% or 70%, is headed to 55% or 60%, says the USDA. And high prices encourage farmers to keep ramping up production, ultimately leading to a glut of whatever crop is hottest — and lower prices.

Marc Faber, a Barron’s Roundtable member who manages investments from Hong Kong, bought farmland in New Zealand some years back in anticipation of growing global food demand. But he considers U.S. farmland wildly overpriced and, as a result, sees arbitrage opportunities in farmland-rich Russia, Paraguay and Uruguay.

The Russian embassy in Washington says that farmland around Moscow sells for about $1,000 an acre, while in the hinterlands the price is about $400. Peer Voss, a farmland broker in Uruguay and Paraguay, says prices are still relatively low in those countries despite rapid appreciation in the past two years. He says land in Uruguay has risen 250% and now ranges from $800 an acre in the least desirable areas to $1,700 in the best.

The most imminent threat is the housing meltdown. Leuthold says that, historically, a convulsion in one part of the realty market eventually has affected all others.

In the agricultural sector, ranchland and recreational farmland already have been quietly hit, having peaked in 2006, according to brokers. Jack Horton of Vale, Ore., who has been selling rangeland for 36 years, says prices are down 10% on average, and as much as 20% to 30% in some areas of his state. Recreational plots, bought by sportsmen, have also tanked, he adds. The drought in the West also is hampering demand for working ranches, as is the high cost of cattle feed, resulting from — what else? — the ethanol boom.

BROKERS TOOK HEART WHEN Louis Bacon of Moore Capital Management spent $175 million recently on the 250-square-mile Forbes Ranch in Southern Colorado for a holiday retreat. “It’s the American dream to own part of the West,” Doug Hall of Hall & Hall a multi-state brokerage company located in Billings, Mont., says. “There are an awful lot of people who made a lot of money who want to enjoy it while they have it.” But smaller places — under 5,000 acres — away from the mountains are harder sells, he acknowledges.

John Stratman, a broker for the Mason & Morse Ranch Co. in Glenwood Springs, Colo., concurs that the lower end of the market has slowed. “I don’t think the buyers have gone away. They’re on the sidelines because of all the negative publicity about the residential and subprime markets; and they’re sitting there waiting to see which way the economy goes.”

If the economy does teeter into a recession, that would make continuation of the farmland boom all the harder. At this stage, any investor should be wary of betting the farm on a farm. A Miami condo might be a better deal. After all, you can buy a nice one now for just 60% or so of what you would have had to shell out three years ago.