One Size Doesn't Fit All Lease Agreements

www.agrinews-pubs.com
Tom Doran
2010-05-11

BLOOMINGTON, Ill. – There was little change in farmland lease types over the last two years, according to a survey by the Illinois Society of Professional Farm Managers and Rural Appraisers.

Traditional cash rent accounted for 35 percent of the leases used, and variable cash rental agreements represented 11 percent of the leases for this year.

Various crop share leases are used by 45 percent of respondents, led by 24 percent using traditional crop share.

Crop share with supplemental rents accounted for 11 percent of leases, while crop share with some modifications other than supplemental rents had a 10 percent share. The remaining 9 percent of leases were custom farming arrangements.

Richard Grever of Hertz Farm Management in DeKalb was a panelist at the recent ISPFMRA lands value conference and gave his insight into the various lease agreements.

“It’s been a very exciting time with leases, especially for cash rent, and all of us who watch commodities markets know why there is all this excitement,” he said.

The upward trend in the commodity market that began in 2007 and increasing yields grabbed landowners’ attention.

“There was a tremendous amount of gross income out there, and landowners were no different than the seed companies, the herbicide companies, the fertilizer companies. Everybody saw this tremendous pie out there, and everybody wanted their share,” Grever said.

“It was a great opportunity for landowners just to step back and say, ‘what can I do to maybe share in some of this upside potential, maybe share in some of the risk and increase my income besides just raising the cash rents or using strictly cash rent.’

“What a lot of people didn’t realize though is when they saw this tremendous gross income out there and had been cash renting their farm for a long time, they probably didn’t have a real good feel for what the input costs had done.”

Input costs had been on an upward trend since 2003, and larger hikes were noted in 2008 and 2009.

“Fortunately, for 2010, it started going the other way, but I think most landowners and operators would tell you that 2009 was the most expensive crop they ever produced in their life with the big increase in fertilizer expenses,” Grever said.

“The positive for 2010 is input expenses are coming down. That is predominately because of fertilizer. This is probably helping to offset the lower commodity prices that we have right now.”

The lower input costs have helped stabilize cash rents for 2010.

“For a lot of landowners, certainly the trend has been away from 50-50 crop share lease,” Grever said. “I don’t think that trend is going to change, but, again, with this increase in farm income it gave a tremendous opportunity for landowners just to step back and look so see what else they can use to maybe increase their income. We did see some shifting in custom and modified crop share.”

The number of modified crop share arrangements increased by about 3 percent from last year to this year, and custom leases went up 1 percent from last year.

“We did see cash rents increase because of the increase in grain prices, and even with these skyrocketing cash rent rates, most farm operators did fairly well,” Grever said.

“If they had decent yields and did a good job marketing their grain, there was a tremendous amount of income out there for everybody to participate in.”

The traditional crop share lease “is sort of a thing of the past,” he said, primarily through long-term relationships between an owner and operator or in a family situation.

“But there has been a little bit of a shift. Some landowners just want to stay with a share lease, but there’s ways to modify that a little bit to make it a little more competitive with some of the other type of arrangements,” he said.

“What I’ve seen is maybe a shifting of how the input expenses are divided. There are some cases where the operator will pay for a larger share if not all of the crop herbicides.”

With the arrival of new seed technology and associated cost increases, there have been situations where the operator pays for a larger share of the seed to cover those technology costs.

“There’s also the situation where the landowner wants to stay with the share lease, but then when you show what the difference would be for the return between a share a maybe a custom or modified share, there’s a tremendous difference,” Grever said.

“Then you look at how you’re going to bridge that gap a little bit, but in some situations where the operator is paying some additional cash above that share lease and how much would just depend on the quality of the farm and how much that difference is, then it is negotiated how much you want to make up the difference.”

Grever has used modified share leases – a hybrid between custom and crop share agreements – in the last few years to take advantage of higher grain prices.

“It allows the operator to still participate in the crop production so he has some incentive to maximize yield, but it also has the landowner taking some more risk by paying more of the crop inputs they get a larger share of the crop and if everything works right they can greatly increase their income potential,” he said.

For most farmland with higher productivity, a modified share lease typically has the landowner receive between 75 percent and 80 percent.

The operator would get 20 percent to 25 percent or providing labor and equipment. The landowner pays for a majority of the crop input expenses.

“It also allows the owner to have more control over the operation just because they’re paying for the crop inputs,” Grever said.

“Then there’s the custom agreement which for a high quality farm year in and year out most of us would experience that that is going to provide the highest return where the landowner takes all of the risk. With the high grain prices and good yields that would more than offset the higher input costs.

But most farm operators would not want to operate all of their ground under custom, but it certainly works well for maybe some larger operators how are up against payment limitations, as well as younger farmers who just don’t have the capital to compete with the bigger farmers and pay these extremely high cash rents.

“These work real well,” Grever noted. “Obviously, it requires management as far as maximizing production and doing a good job marketing your grain, but that’s certainly been a great way to compete with some of the cash rental arrangements.”

Other lease agreements vary depending on regions. For example, there are some 40-60 net share leases in central Illinois.

“This has been a good way for the landowner to participate because they’re getting a share of the crop,” Grever said. “In this example, the operator pays for 100 percent of the crop inputs and gets 60 percent of the crop and owner would get 40 percent. So, obviously, as the yields vary their income can vary also.

“These are not as prevalent. When you get to the southern Midwest you would see more of these types of leases. This has been quite as favorably for the operator the last couple of years because of the higher input costs. When they’re paying for all of the input costs it hasn’t been quite as favorable for these types of leases.”

The traditional cash rent leases have lower risks. Unfortunately landowners, in most cases have minimal control of what is happening on their farm, according to Grever.

There also is concern that cash rents may not be collected, particularly at extremely high levels. Grever has seen flex leases become more prevalent the last couple of years as cash rents skyrocketed.

“Most of the flex leases have some type of base rent, so the landowner is guaranteed a certain payment,” he said. “Then there is some kind of formula that would be based on yield or price or both that would potentially give the landowner a bonus payment if things work right — if yields are high and grain prices are high also.

“When these first became more prevalent, there were some concerns by the Farm Service Agency, but I think they’ve worked through that and now it’s not a problem. These are considered cash rent leases.

“The farm operators like them because they obviously have a big concern if they start paying really high cash rents with the higher inputs we’ve had the last couple of years, there’s a big uncertainty as far as what are the profits. So they’d like to share some of that if things work right for them.

“Landowners like them because most landowners certainly want to maximize their return, but I think most landowners would say they’d like to be fair about it, too.”

Farm managers often are asked what are fair cash rents and fair returns to the operator. There is no right or wrong answer, Grever noted.

“What somebody is willing to accept for a return is different than the next person,” he said. “So there is no really right or wrong answer, and that’s where these flex leases come in real well because you’re sharing some of the risk and you’re going to share some of the upside potential also.

“If a landowner is willing to consider these other type of leases besides cash rent, then you have to show them, based on certain scenarios, what is the return potential.”


Return to Article List