There’s More to Farm Pricing Than You Think
Farmland has never been more attractive as investors hedge against a weak stock market and 40-year-high inflation. But with land sales on the rise and fewer properties available, true comparisons are hard to find when evaluating land.
Then there’s that other, immeasurable factor that often influences a buyer.
“We sell emotion, in all honesty,” said longtime land broker Dan Murphy, of Lake City, Colorado-based M4 Ranch Group. “People here, they want to escape. They want to pull their grandkids away from a digital screen.”
Sales of land in the U.S. reached nearly $100 billion in 2021, up from less than $60 billion in 2020. CoStar’s U.S. Land Index, which tracks sale prices, rose 12.6% in the 12 months ending in June, reaching its highest point in the index’s 24-year history.
There are still some fundamentals investors should use before staking their claim in the great outdoors. But unlike other commercial real estate assets, sentiment carries a lot of weight when looking at rural land, too.
Based on Murphy’s more than 20 years of expertise, here’s a quick guide to the tangible, as well as less tangible, aspects of valuing farmland.
‘A Lifestyle Return’
Emotion is an unpredictable factor priced into farmland. But no matter how you price farmland, be prepared to hold it long-term. Murray said that’s because time equals value on these properties even more so than it does on most other real estate assets.
“What we have is people putting assets away from a lifetime of hard work … to buy something they want to share,” he said. “We’re not selling stuff that has a cap rate return, we’re selling stuff that has a lifestyle return.”
Comps Can Be Hard To Come By
Like other real estate assets, it’s helpful to compare the land you’re eyeing to recent sales to get an idea of pricing. But myriad factors can influence a rural property’s value. Those factors include but are not limited to:
- Existing structures and equipment.
- Soil type.
- Annual moisture.
- Net operating income.
- Commodities prices.
- Amount of timber.
- Water rights.
- Availability of hunting licenses.
- Migratory patterns of wild animals.
Prices can vary widely based on these factors. In southwest Colorado alone, where Murphy is based, prices can range from $2,500 an acre for grazing lands to more than $30,000 an acre for riverfront property. Some factors should be weighted more heavily than others depending on scarcity.
“It’s very dynamic,” Murphy said. “Tons of research and experience [determine how to] establish your highest and best value for these properties.”
Just like with other real estate assets, an experienced broker can put together a competitive market analysis that analyzes your prospective property based on its assets, as well as data from previous and current listings, recent sales in your area and other trends.
But because it’s difficult to value a farm as simply as you would other income-producing real estate assets, farm properties often go to auction, Murphy said.
“Your neighbors know what their cost of operation is and they’re typically your best buyer,” he said. “What you don’t know is how much your neighbor wants that property.”
Still, ‘The Formulas Work’
There are still, of course, several quantifiable ways to appraise an income-producing rural property. Perhaps the most rudimentary is called the income approach, a method familiar to any real estate professional.
To appraise a farm based on its current income, first find the property’s capitalization rate. To do this, you’ll need the property’s prior year’s net operating income (NOI, or annual profit).
Divide that number by the price the property was purchased or assessed at, and try to factor in appreciation. If you have a good approximation of those two figures, you can then divide the NOI by the cap rate to get an idea of the current value.
For example, a 5-cap (or 5% cap rate) farm reporting a $100,000 NOI would be valued at $2 million.
While helpful, this approach has shortcomings as well. Commodities prices are volatile, and so are annual returns from crops and timber. While some investors have succeeded in fixing and flipping ranches, the best returns are usually in long-term holds, Murray said.
“Going out there and trying to make a rate of return on a western ranch is difficult," he said. “It’s typically something you buy and hold and make a return when you sell.”
That may be a different approach for investors accustomed to making a steady rate of return on more conventional real estate assets.