Investing in Agriculture – what should you think about?
Most of us have probably heard that the we need to increase food production by 70% to feed the world in 2050.
Sounds like an opportunity to make some money. Agriculture is the new black!
Add to that the lack of correlation between agricultural returns and most other asset classes and there may well be an opportunity, particularly if you take the view that some of the other asset classes are currently a bit toppy.
So what are the opportunities for investment in the sector? And how can you do it without speculating too much on it?
There are plenty of ways to gain exposure – through the commodities themselves, through companies that provide inputs to agriculture such as fertiliser or finance, or maybe through companies that take the output, aggregate it, process it and most likely on sell to wholesalers or retailers. Many of these methods of exposure however might be via listed entities so to some extent you do not achieve the objective of diversifying into non correlated sectors.
There is also the option to gain exposure to the land itself. The advantage this offers is it provides probably the lowest correlation to other asset classes. It is also very much in the real assets or alternatives bucket.
If exposure to agricultural land is desirable, it follows there is a range of questions to consider.
First is where should you consider investing? There a few simple guidelines on this:
- If agriculture needs subsidies to be viable, don’t go there. The risk of the government changing the rules is significant. Subsidies can provide a short term sugar hit but they make the agricultural sector lazy and less innovative, neither of which lead to a happy ending.
- If there is a risk that you won’t be able to get your capital back don’t go there. This is probably one of the biggest risks in many countries. Be vary careful if the rule of law is not strong, there is corruption and the country lacks a high quality system of land titles.
- Even if you want to, are you allowed to invest there? For some reason which is often superficially attractive, many countries or states/provinces take a dim view of outsiders investing in their farm sector.
Once you have decided where to invest the second question is how to invest. You can go directly in your own right or invest via a comingled entity such as a fund. There are a few points to consider here:
- A direct investment gives you full control but you have to organise how to manage it. You can exit whenever you want, you can run it as you wish.
- Direct investment will require scale to get optimum performance, say minimum of $10m for Australia. Any less and it makes it hard to be highly efficient so returns are compromised. The downside is that you can end up with asset concentration, that is, all your investment in one farm in one region, unless you can afford a few farms in different regions or sectors. If you lease the farm, scale is less critical.
- A fund has the potential to offer diversity in that you can own a small part of quite a few farms instead of 100% of one farm. This can be a good risk mitigation strategy. With this approach you are backing the manager. Also you will have to pay some fees for management so be careful to look at the total fee structure and ensure there is alignment. The other downside of a comingled entity is that you do forego some control.
Thirdly should you operate the farm or lease it? This is more complex and some of the key questions to consider include:
- How do the returns compare for the two options? It is logical that if you are to take on the operating risk you can expect a higher return compared to leasing it to a third party to operate and just receive massive rental income. This is not however always the case and we see plenty of instances where leasing will provide comparable returns to operating. The reason for this is that leases are often priced at a premium because of the demand from farmers to achieve additional scale. This may make sense for farmers who have high fixed costs which can be diluted by expansion. For example it is common for farmers to overinvest in machinery given the scale of their business but adding another farm may mean that machinery can be used more efficiently and it comes at low marginal cost.
In Australia we see lease rates at 4.0-5.0% gross or say 3-4% net and average operating returns at 4-6% net. It is hard to see the small difference accounting for the very different risk return profiles.
- How does land appreciation differ between the two options? First principles suggest land values should increase at the same rate because the drivers are broadly the same whether the farm is leased or operated. The key issue here is that the tenant must think like an owner, take a long term view and not be in it for the short term returns which can be achieved if for example the farm is poorly maintained or there is skimping of fertiliser and soil fertility is run down.
Growth Farms is a specialist investment manager in Australian agriculture and currently manages approx. $450m of assets for international institutions, family offices and others.