Investing in Farmland | Part I Welcome to the next topic on our series of blogs on Food and Finance.
The farmland and forestry complex asset class is fairly young and is yet to become mainstream for two main reasons: It does not lend itself so well to a ‘hands off’ or ‘mass investment’ model, because of its specific nature. There can be scalability issues, when it comes to amassing and managing enough farmland, to make it worthwhile for a significant investor.
Having said all the above, the benefit of its youthfulness is its dynamism, because it is evolving very quickly to reflect the diverse and nuanced demands of the global food and energy sectors.
Before starting, it is worth making a few remarks about assets and investments in general.
- Firstly, when we as financiers or investment professionals speak of assets, we are speaking primarily about a stream of cash flow. When most people think of assets, they think of ownership and/or control. While these can play a part, assets is all about cash flow. An example of this, is a person that leases a whole building from the owner and subleases the building to tenants. Purely from a cash flow perspective, this will be an asset for the lessee as well as for the lessor.
Of course, in such circumstances, there are other considerations like the type of lease, cash flow consideration, but from a commercial perspective, as long as the lessee is making profit - that is an asset to him.
In looking at farmland, these concepts are very important, because in many circumstances, the cash flow arising from the land and the ownership is bifurcated and there are different streams of cash flow arising from the same land, which can belong to various parties.
- The second remark I will like to make, is simply to say that, investing in farmland is not for the disinterested investor, or those simply looking to balance a portfolio or hedge against inflation (both of which farmland does very well). You really need to love agriculture and love the land, because even if an investor is not managing the land, they have to think strategically about the highest and best use of the land and test that hypothesis continually.
- The third remark I will make, is that farm land investment is a LONG TERM investment. This type of investment is for the patient investors, but not necessarily the bigger investors. There are many avenues for investors with a modest amount of capital, to gain exposure to the ‘farmland forestry’ asset class, or more broadly, the ‘broader food supply chain’. It suits investors that want to invest in an asset with steady returns over the medium to long term.
- The fourth and final preliminary remark, is about yield. Many people try to entice or deter investors by throwing about various nebulous indication of yield.
However, I want to emphasize that there is no real indicative yield in farmland. Yield in farmland and in every investment class, is primarily related to the price of the investment, the method of financing, investment and operational strategies, and the rate of compounding, if any.
Farmland has the best yield in the hands of a passionate and knowledgeable strategic investor.
I will now introduce some topics, into which I will delve in much deeper in this series. My goal is to evangelize the benefits of investing in farmland, whilst also shining a light on some of the potential pitfalls to investing in this asset class.
Goals As with anything, the goals are extremely important. Farmland investment is not for everyone, but for those who can realistically wait for a period of at least 10 years, to start seeing full yield. My idea of a full yield, is returns from a farm that has fruit trees, permanent crops and vegetables, grains or row crops.
Value Drivers As an investor assessing a potential investment, this is the first question to ask oneself. I learnt this the hard way years ago when I pitched an investment opportunity to a VC firm. As an entrepreneur, I thought I had created value by combining three complementary companies into one entity and my figures were impeccable, but when the partners of that particular firm began to question me in depth about the value drivers, I was stuck because up to then, I had not really thought about it.
The value driver is like the engine of the car, it is what gives energy and impetus to the complete entity.
The business model and strategy are built around the value driver. Value drivers by nature are those key actions that drives the long term valuation of the investment, which is what we are looking for as investors, to eventually realize capital gains.
Value drivers could be access to cheaper or better sources of capital. We spoke earlier about, how the type of financing is one of the drivers of yield, and a prime example of this at work is Warren Buffett, who has access to extremely cheap sources of capital through the insurance operations of Berkshire Hathaway.
Other examples of market drivers are market strategy/branding and product service offerings. Therefore, in assessing a potential agricultural or farmland investment; what are the value drivers that will differentiate us in the long term?
This value driver cannot simply be, that the land is very fertile. This is primarily the reason, why investors in the ‘Chernozem’ or Black earth farmland, located in various parts of the Former Soviet Union, failed. They simply thought, that just because the land was very fertile, the investments will be very successful.
The problem they faced, is that greater productivity does not necessarily mean success in agricultural investing, because correct management of the investment object is more important than simply growing more products. One still has to think about logistics, export quality, storage, land management etc.
We see this even today in the outrageous logistics prices exporters have to pay, to export grain out of the Ukraine. A senior official, in one of the international development bank, confided in me during an agriculture and forestry conference I chaired in London several years ago. He said, that the problem is that organizations like his, spent many years increasing productivity of the Ukrainian land, without paying attention to the infrastructural deficits in transporting products, especially during the export of grain.
Ukraine is a prime example of this imbalance with ports in cities, like Odessa and Kharkiv. Choke full of vessels waiting to exit and with badly damaged roads and an ageing railway infrastructure, which has a perpetual shortage of wagons.
This is the case also in the other Former Soviet States, especially those in the CIS, including Kazakhstan and Uzbekistan and of course without forgetting Russia, that has always had legendary logistical issues despite vast tracts of very fertile land and very able and knowledgeable people.
These challenges is also evident in Africa, which possibly has the greatest potential for agriculture anywhere in the world, but still remains bedevilled by structural challenges.
These challenges reduces the value of land, because in an equal world, Africa should have the most expensive agricultural land in the world, because unlike other regions, it also has the climate to potentially harvest all year round at much lower costs than any other region on earth. Does this challenges mean, that as an investor, I should not be looking at agricultural investments in these regions? Definitely not, but one will be looking to adjust their risk/return profile accordingly.
The investor must look at all these risks and use wise risk mitigation techniques to reduce investment risks and also feed in these risks to the investment model, so it is accurately reflect in the terms of the investment and the financing, so that as the investor, one is not exposed to all the risks but the risks and returns are shared more fairly between the buyers and sellers.
This is also where value drivers come in useful, because a key value driver is the product offering, this could mean choosing to plant more valuable products, rather than simple commodities like wheat and corn.
It could also mean going fully organic or pursuing a vertically integrated strategy where you can plant, package, brand and sell, therefore capturing much more value across the supply chain, which is a good way to make bigger profits while having the disadvantages of poorer logistics and location.
I will speak more about these strategies and investment methodologies in the next several blogs and I will also speak more about how investors can use some of the same techniques used to assess and value commercial real estate to also value farmland.
Conclusion In conclusion, it is worth noting, that investing is a business and a business is investment as the objective of both is the same which is sustainable profit.
As investors, one must understand marketing, sales strategy, management, accounting, operations and so on, because the yield even in farmland investing is hidden in how well these are done. Too many times as investors, our mind set tells us to keep things in their boxes, but to succeed in farmland investing, you have to think in an integrated way, as there are no low hanging fruits in this business.