The agricultural economic transition is creating an interesting emerging trend. Farmland is now starting to turn over at an increasing pace. Older producers at seminars are asking, “Should I sell now at the peak?” Others are seeking individuals to purchase their farms to carry on their legacy because they have no family members who want to carry on the legacy. Still others have children and grandchildren who have inherited the farm and now want to cash in their inheritance while land and asset values are still strong. Let’s conduct a “sniff test” exercise that I went through recently with an individual who wanted to purchase farmland near his operation.
The first question I ask is, “Will the farm purchase be consistent with your business, family, and personal goals?” Too often investment decisions are made without determining their alignment with goals of other family members and partners.
The producer must determine whether he or she has been profitable in the existing business or has sustainable outside income to cash flow the purchase. No, this is not the income shown on tax returns where showing losses is often the goal, but accrual adjusted income statements accounting for changes in inventory, payables, etc. Making an acquisition with a poor record of profits and income is often a recipe for disaster.
Next, examine financial leverage. Will the new acquisition or investment result in a debt to asset ratio above 50%? High financial leverage is often a business killer in the down part of a cycle, particularly on highly specialized grain operations.
Of course, examine the working capital position after the purchase. Is your working capital to revenue ratio above 33%? A financial shock absorber in terms of liquidity is necessary to meet expenses and debt service should the economic downturn result in a negative margin.
Another suggestion is to set aside one year of debt service payments in cash in the bank. Individuals often lose on real estate investments in situations when they must sell discounted assets. This can also happen when insufficient cash or assets that could be quickly turned to cash are not available to meet debt service and everyday expenses.
Finally, do you have the needed machinery, management abilities, marketing skills, and the infrastructure to ensure the purchase will fit efficiently into the existing operation? Assessing the purchase as it fits into the overall operation is important to avoid cost overruns going forward.
While this list is not comprehensive, it does provide some objective logic to apply to emotional land investment decisions. As a side note, farmland has appreciated approximately 80% of the time in the past century; however, all land values have local influences that affect their price.
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