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Investing in Agricultural Land Part IV

23/9/2020

Trusts

Good day All. Today we will look at Trusts, as an effective tool for managing agricultural assets. It is a fact that the key to investment success, is the effective management of an investment portfolio. For families, one of the key requirements is a multi-generational portfolio, this is a portfolio that is effectively passed from generation to generation.

Asset management is so critical and in every type of investment venture, the management system, philosophy and structure is even far more important than the ability to buy or sell individual securities. This is especially true, as algorithms have completely cornered the short term trading opportunities in the financial markets. Therefore, success lies in the ability of an investor to be broader and more strategic in their thinking.

I have said many times before, but it is worth repeating that it is critical to have an investment plan that includes goals, time frames, risk management, portfolio management systems and if an investor cannot do this themselves then it is important to seek professional advice, because one’s financial future must be correctly planned.

Having said that, I must also add that I do not believe in passive investment management strategies, because the phrase ‘passive investment management’ is an oxymoron, because the word ‘management’ and its synonym ‘stewardship’, are words that denotes control, responsibility and positive action to add value through hard work, knowledge, wisdom and experience, so that in the end, the value of what was given has dramatically increased.

The idea of added value - by being passive and simply following the market, then expecting to be handsomely rewarded for that. It is absurd to say the least and the fact, that this has become so acceptable is tragic. The investment management industry has lost its will to fight and to do right for its clients, but it is simply content for taking fees while doing the basic minimum.

There is something so liberating about hard work and having an ethic of excellence which has been lost in our society today, there is comfort in knowing that if I work hard and consistently improve my craft, I will be rewarded, this is my insurance policy. It works because most people only ever reach 40% of what they are capable of without giving up and by doing that little extra, one can become in the top 10% of any field, therefore I find passive investing to be an extremely intellectually lazy concept that does not accurately reflect the true essence of our industry to the general investing public.

What is a Trust?

A trust is a legal device that allows several entities to have ownership rights over the same property. A trust has three main parties: the settlor, the trustee and the beneficiary.

The settlor of the trust is the initial owner of the asset, he/she/they create a trust and selects a trustee to manage the trust, which includes the asset or assets known as the trust property.

The agreement between the settlor and the trustee is called the trust deed and it encapsulates the duties of the trustee to manage the assets in a certain way and according to various legal principles for the benefit of the beneficiary who is now the ultimate owner.

From a property and trust law perspective, at this point, the settlor does not have any more rights to the asset but the legal owner is now the trustee. This can be a bank, a law firm, responsible relatives etc.

The trustees will look to the trust deed, which tells them how to manage the assets and what to give to the beneficiaries and when to give it. In many cases, the settlor adds himself/herself as a beneficiary.

This works very effectively in a family setting, where a settlor is looking to put his estate in order. At this point, as soon as he puts it in a trust, the tax status for him, the trust property and the beneficiaries all change.

There are very different rules across common law jurisdictions and also civil law jurisdictions that have transposed trust law principles into their legal systems, but there are various principles and purposes, which are generally applicable to the creation and use of trusts:

1. The trust enables the separation of ownership and control with the trustee having control, while the beneficiaries have ownership based on the specific provision of the trust deed.

2. The trust is a separate taxpayer for tax reasons and it must file its tax returns yearly.

3. The disposition of the trust property from the settlor to the trust, is deemed to be a sale at fair market value, and a valuation must be done from the time the asset was acquired to the day it was transferred to the trust, and the settlor must pay capital gains tax and depending on the personal circumstances of the settlor, he/she/they could have various capital gains exemptions.

4. There are various tax mitigation rules and exemptions that vary in different legal jurisdictions and based on different types of trusts.

5. The main use of trusts, is tax planning. In jurisdictions, where one has graduated tax rates, whereby as one’s income rises, their tax rises. Trusts are useful, because the income can be split across the family including the farmer, his spouse and their children - as beneficiaries, and they can all be taxed at lower rates.

6. Inheritance Mitigation - upon the death of the settlor, the assets will not need to be reported and assessed for inheritance tax.

7. Creditor Protection. The property does not belong to the settlor, the trustee or the beneficiaries so the assets are protected from creditors.

8. Confidentiality is a benefit, as the trustee conducts business in the name of the trustee or the trust and the beneficiaries do not need to be disclosed.

9. Trusts help to protect against matrimonial claims, as they are ineligible to be considered as matrimonial property, as the beneficiary does not have any interest in the land, so farmland can be protected in case of matrimonial breakdown.

10. Discretion on vesting rights - the trustee is normally required to use discretion in cases where one child wants to keep farming, but the others do not, then the trustee decides which child gets which asset.

11. Protection of Beneficiaries. For example, where the trust vest when the beneficiary is over twenty one years.

12. Spousal Trusts. In instances, where the surviving spouse may not be able to manage the property correctly, so the farm is put into a trust, this can also be in cases where the spouse is a spendthrift or has medical conditions that has left them incapacitated.

13. Farm Purification is another useful use of trust, when excess cash is used to purchase non farming assets, which can disqualify it from various farming tax benefits. In such cases, the non-farming assets can be transferred to the beneficiaries directly or a sister company controlled by the beneficiaries.

Conclusion

Certainly trusts are as easy or complicated as the assets, family structure and advisors, who are structuring them, but they remain a very useful asset management vehicle.

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Investing in Agricultural Land Part III

14/9/2020

Good day everyone. Today, I will delve more into the concept of trust, as both an asset management and tax mitigation vehicle.

Tax mitigation is a crucial issue that in many cases can make or break an otherwise strong investment portfolio, especially now with governments around the world borrowing record amounts of money.

A wise man once said: “There is no such thing as a free lunch”. We will all do well to remember this, as people are gladly spending the so called “corona virus relief” because whatever the government gives, it will always take it back from us, our children and grandchildren.

I was asked whether I disagreed with the governments putting so much money into the system to help people at this time, my answer is that wrong fiscal and monetary choices has led us to this point, where most people, even in the so called ‘rich north’ , do not have enough savings to cover their outgoings even for one month.

This is partly to do with people’s irresponsibility, but it is also due to the fact that wages in real terms have stagnated for at least the last 40 years and has barely kept up with the cost of living. This has resulted in many people living from credit cards and short term loans from predatory lenders, which traps them and their families in never ending debt cycles.

This is the same for governments and companies. We have seen that many large companies could not survive for one month without government support, despite reporting large profits year after year for the last decade since the last financial crisis.

We have to become much more fiscally conservative as a society to be better able to manage unforeseen challenges like COVID 19. Therefore, I am advising my clients, both small and large, to pay more attention to tax mitigation, because taxes will rise dramatically whatever the governing philosophy of the reigning governments around the world.

This is especially true in the US, where there is a false narrative being peddled in political circles that one or more of the parties is for lower taxes. That is a mathematical impossibility as the alternative will be that the dollar will lose its global reserve status if it does not balance its books quickly.

There will be no V shaped recovery, we are seeing the Trump administration working with the FED to keep the economy afloat and recession at bay until the US election is over, as no US President has ever been re-elected during a recession. If he returns as the President (which I believe he will), he will have to govern in practical prose and not the poetry of election campaigns.

Many investment portfolios needs to be quickly rebalanced, especially now when we see three key themes playing out in the markets.

Firstly, unlikelihood of a V shaped recovery. Recovery will be prolonged and take between 3-5 years.

Secondly, large investors are taking profit with the market now in weaker hands, this is what we are seeing from the mass sell offs in various markets.

Thirdly, the markets are now seriously discounting the possibility of the Biden victory in November, as they see higher taxes under a Biden administration.

I have already said, that this is a false narrative, as taxes will rise dramatically under either candidate’s government and not just in the US but also in the UK, the EU and across the key economies of Asia.

A nasty side effect to higher taxes, especially corporate tax and capital gains tax, is that it will result in a dramatic fall in the prices of public market securities especially stocks, but more of this later.

This is why investment vehicles like trusts are very useful, this is something I will speak about in detail in this blog, especially in relation to farmland and real assets.

Private Equity
One of the main reasons that I am advocating, for investors to invest in farmland and other real assets. I see that many investors, including clients of ours, have an unhealthy fixation with public market securities.

I see that private equity will be the asset class that will have the greatest growth this decade closely followed by commodities, as demand for food dramatically increase.

Private equity, or more precisely, private capital investments into real assets will grow to fill the gap left by governments, as they cut spending dramatically and increase taxes to balance their books. We will see large swathes of sectors like healthcare, education, correctional facilities and the criminal justice apparatus which includes policing as well as infrastructure completely taken over by the private sector.

We will also see a wave of privatizations, particularly in Europe within the EU, especially in countries like France and Italy. In the UK, we will see the prized National Health Service (NHS) fall into private hands.

As government financial capacity dwindles, so will their ability to administer large parts of the economy and we will see recovery funded by private capital to sustain and revive Main Street.

The public markets will gradually fall into disfavour until it fundamentally changes its approach. We are already seeing this happen with newer exchanges like Long Term Stock Exchange (LTSE) and others. Currently, the information asymmetry gap between owners (shareholders) and the managers of publicly listed companies is very large and within this opaque system, the opportunities for abuse and conflicts of interest is very large.

Companies took many poor capital allocation decisions, such as engaging in massive share buybacks with borrowed money in an environment that is much more conducive to borrowing to invest, and when COVID 19 occurred, it emerged that they had no money to survive, let alone take advantage of opportunities created by the pandemic.

These excesses are tolerated by most institutional investors, because they are engaged in an incestuous relationship with these listed companies and regulators. This relationship has given birth to a financial system that breaks every principle of money, such as the mispricing of risk with negative interest that punishes the financially prudent and rewards irresponsible spending.

It is a system that rewards the few at the expense of many, with many pension funds practically insolvent with huge unfunded liabilities and the pensions of hundreds of millions of people around the world in major risk.

It has almost become a new form of feudalism with the peasants being the global population working for the lords of the manor, but the problem with this is, that our world will find ways to balance itself, as the gap between the rich and the poor continues to grow.

Some of the negative ways we will see this rebalancing manifest, will be higher global crime rates and civil disobedience, as disregard for authority grows and social unrest and the breakdown in the social fabric with addictions like alcohol, drug abuse and various forms of immoral behaviour - growing.

This is happening as more people feel that the system is rigged against them and that they do not have a stake anymore in legitimate and respectable society.

This has nothing to do with colour of one’s skin. Poverty and the destruction of the global middle class is an issue currently affecting people of all races, colours and nationalities; issues like childhood hunger and malnutrition is becoming as prevalent in London as it is in Lahore or Lagos.

It is not an issue of racism, it is ultimately about control of people, their minds and ability to become and contribute meaningfully to society, as the system is designed to only to produce masses of wage slaves that only do as they are told.

The media portrays these issues as being issues of race or the colour of one’s skin, which is a false narrative designed to divide people and distract them from the main issues, such as a broken financial system, broken social contracts between citizens and governments, broken relationships between large companies and their broader stakeholders, broken education systems, a broken global food supply chain, a fast disappearing global middle class, a global epidemic of fatherlessness and broken homes with divorce at all-time highs in every part of the world. These are million times worse than any pandemic, especially now we are living in a world full of information but very little wisdom.

These are the real challenges facing our world and while these are bigger than finance, those of us who consider ourselves financiers or finance professionals, have a duty to really examine the choices we make, as to how we allocate assets of clients to ensure that they really achieve positive outcomes.

We need to ask ourselves if this was my pension, how would I want it managed. We are not to buy assets because it fits into our institution’s strategic and capital requirements, but because it will have a positive impact on our client’s financial future. Managing money is not just a job but a high calling, because money managers look after the future of people, generations and nations. It is a grave responsibility that is owed to clients and also to the broader stakeholders in society.

Conclusion
Unfortunately, space does not permit me to discuss trusts and agricultural strategies as planned, which I will do tomorrow.

As I speak to family members, friends, government officials and colleagues, it is becoming more apparent to me that many do not understand the reason why things are the way they currently appear. Friends of mine that are traders, speak about technical analysis – support and resistance, dojis and so on, while the economists speak of velocity of money and real interest rates.

The financial markets is not a summary of the world. The global sentiment cannot be captured in a candlestick or an economic equation of the shifts in global supply and demand.

In Plato’s “Theory of Forms”, he spoke about a physical realm which we see and a spiritual realm which we do not see. The physical realm, is always changing and temporary, but the spiritual realm, the realm of the forms, of ideals, principles - are unchanging and permanent.

In the Bible, St Paul also expressed similar sentiments in his letter to the Hebrews, where he said:
“By faith we understand the universe to have been formed by the word of God, so that the things being seen have not been made from the things being visible”.
Financial markets and economic theory signals today, is a physical representation of forms or an unseen realm that is selfish, self-serving and wicked that shows all of the basest instincts of human beings. As financiers, we must change this, but this can only be changed in the spiritual realm, the realm of ideas, moral laws and principles.

When we do this, money can truly become a force for good in our world today.

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Investing in Agricultural Land Part II

8/9/2020

Once again, I welcome all of the readers of these blogs.

Today, I will like to look at some strategies to use when one is investing in farmland. However, before I do so, I want to speak a bit on key concepts of property rights and land law, to create a legal framework through which we can understand the strategies and cash flow.

If space allows, I may also briefly touch on trusts, as an asset management and tax mitigation tool that is very useful when investors are investing for the long term, especially in assets like agricultural land.

One of the reasons I like the farmland and forestry complex, is that it is such a fantastic asset to help families that want to grow and preserve capital for many generations.

Land Law

I will start with a brief discussion of land and property law from the English law perspective. These concepts has formed the intellectual framework of global financial investments for hundreds of years and English Law remains the most flexible, stable and mature legal system for building an international portfolio.

The basics of land law is to define the supply and uses of land. Therefore, it is about regulating issues of ownership, control and usage interests in the land.

Each person with interests in the land has a bundle of rights called titles and it works like a chain.
The greatest possible property right to land is the fee simple in possession. In such as a case, the holder of this right is the absolute owner of the land to do as he/she pleases with it.

This person has absolute control over the whole land and all of its fruits and is said to have absolute titles to the land.

The next level down is the leasehold title or estate. This is where someone else is allowed to take possession of the land and use it for a certain amount of time and when that time is finished, it reverts back to the fee simple estate.

Depending on the nature of the lease contract, the lessee can also sub lease part of the land to sub lessees for a shorter period of time.

The third level is the ‘easement estate’. This is simply created to give someone a specific right of possession to a part of the land for a specific reason such as when utility companies have to lay part of their infrastructure within someone’s land.

These issues of titles in land may seem trivial, but they are extremely important because they determine ownership of mineral rights and water rights.

I remember spending a lot of time last year with some oilmen from Texas who educated me on the process of how they go about aggregating drilling rights from landowners in areas where they knew oil was present and how they shared the proceeds, because generally, where there is a fee simple owner, he/she or they own the mineral and water rights in what is known as a ‘unified estate’.

This owner can split these rights and convey them through a sale or lease to other parties separately, as I remember that in various parts of Texas, while they were drilling, they came across a lot of water, but the water did not belong to them, so they could not bottle it and sell it if they wanted to, because they were only entitled to the mineral right, specifically crude oil and natural gas.

While investing in farmland, these rights are extremely important. The most obvious is water rights, as in most circumstances one will need to irrigate the land, but also the issue of easements are very important if the access to an investor’s farm from the road, goes through another farmer’s land, then that easement must be investigated to see the terms even before buying, because that can significantly affect value.

Another easement that is becoming more important is ‘air easements’, especially when one is using drones to monitor one’s agricultural fields.

Especially important is to investigate all of the legal implications thoroughly, because rights and titles to land and even usage customs are very hard to change, especially when they have been established for years.

This can even affect the investor’s land, if they intend to plant organic products on their land in instances where the farm next to it is planting conventional products and using chemical fertilizers, which is draining into a shared water source.

An even more challenging is when investors are investing in farmland in developing economies, because in such countries, all of the various titles to the land may not be registered, so it can be challenging to fully investigate the ownership of different rights attached to the land, e.g. ancient animal grazing land or fishing rights when there are significant bodies of water attached to the land, or where access is through the investor’s farmland, like in the Great Lakes regions of East Africa.

This was quite a big problem in Africa, but the AfDB (African Development Bank) are hard at work with African companies to develop full registration of land across the continent. When this is complete, I have no doubt that it will unleash the full potential of African agriculture.

Additionally, there will inevitably be cultural and customary usage or access to water sources for communities, which the investor must take into account while making the investing decisions. It is always advisable to work with a top quality legal adviser in these cases; the money spent on excellent legal counsel is never wasted, especially a lawyer with good commercial awareness that tells the investor how to overcome the obstacles and manages the risks, not one that advises against taking the risks.

Ultimately, it comes down to the goal and strategy, because in any case, it is always good practice to integrate the considerations of the local community into an investing decision framework.

These titles or bundle of rights are the basis of asset creation and cash flow.

Strategies

Before looking further to the strategies, I will briefly mention the types of value drivers we discussed yesterday. If an investor is looking to develop a sustainable farming operation, his value drivers are: price premiums, market access, lower costs, risk mitigation, and consistent yield.

Virtually all of the investment strategies can be summarized under two investment theses, these are:

1. Create value by investing in efficiencies, especially within the ecosystem to enhance the performance of the land.
2. Focusing strategies on meeting the nuanced demands of the food industry e.g. organic food.
Under the first investment thesis, we have strategies like cover cropping, rotational grazing, ecological farming, vertical integration, irrigation, skilled management team and project contracts.

Conclusion

I will speak more about these in the next blog. I will also speak of the main management models and we will look at portfolio management and tax mitigation strategies using vehicles like trusts.
However, I will finish today with one thought:
‘’Farmland is not merely an asset, but it is the carrier of hopes, dreams, identity and future for all of us in some way or form, therefore great wisdom is necessary for those that invest in farmland.’’

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