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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.
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.
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.
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.’’