1 STRATEGIC INSIGHTS AUGUST 2014 Investment Strategy Investing In U.S. Farmland John L. Taylor, National Farm & Ranch Executive U.S. Trust, Bank of America Private Wealth Management Over the past few years of high volatility in securities markets, achieving diversification through acquisition of U.S. farmland has become an increasing area of focus for high net worth individuals. For investors with access to the capital needed for direct investment in farmland, this asset class offers potentially attractive returns with income streams of relatively low volatility and low correlation with other assets. U.S. FARMLAND RETURNS Looking back at the NCREIF (National Council of Real Estate Investment Fiduciaries) figures for the past 20 years, U.S. row crop farmland has produced an annualized return of just over 11.4% 1. This is a combination of both the current return from the farm lease and the appreciation of the underlying asset. Over this period, the annual current yield has been just over 5% gross with appreciation counting for the remaining 6% or more of the total annual return. NCREIF Row Crop Returns Source: NCREIF Farmland Property Index Past performance is no guarantee of future results. Please refer to index definitions at the end of this report. All sector recommendations must be considered in the context of an individual investor s goals, time horizon and risk tolerance. Not all recommendations will be suitable for all investors. Investment products: Are Not FDIC Insured Are Not Bank Guaranteed May Lose Value U.S. Trust, Bank of America Private Wealth management operates through Bank of America, N.A., and other subsidiaries of Bank of America Corporation. Bank of America, N.A., Member FDIC.
2 Returns on U.S. farmland show little correlation with other assets. Farmland Correlation Source: NCREIF Farmland Property Index, Bloomberg L.P., U.S. Trust Past performance is no guarantee of future results. Please refer to index definitions at the end of this report. WHERE FARMS FIT IN AN INVESTMENT PORTFOLIO U.S. farmland can produce an annual yield and a fairly consistent return similar to a bond. But, unlike a bond, the annual income is not fixed, other than for a three-year period in a cash lease. So, there is more variability in the farmland s potential income stream than in a bond s. When commodity prices trend up, as they have in the past, leases, which are typically renegotiated every three years, may be renewed at higher rates. Thus, unlike a bond, a farm may provide an income stream that can grow over the years. In addition to the potential for an increasing income stream from a farm over time, the underlying value of the farm may also grow, as seen in the NCRIEF data. HYPOTHETICAL POTENTIAL RETURNS ON U.S. FARMLAND BASED ON NCREIF HISTORICAL RESULTS 1 On the right is an example that illustrates what would happen if: A farm is purchased that has an annual appreciation of 6% At the time of purchase, a cash lease is negotiated that yields a net 4% to the account At the expiration of each lease, the lease is renewed at a rate which will continue to return a net 4% current yield based on the then-current market value (MV) of the property Assumptions Appreciation percent 6.00% Gross lease rate 5.20% Fees, taxes and insurance 1.20% Net initial current yield 4.00% Lease term three-year cash lease STRATEGIC INSIGHTS 2
3 U.S. Farmland returns hypothetical example detail Value of Farm Annual Appreciation Total Appreciation Annual Income Cumulative Income Current Yield on Current MV Current Yield on Initial Cost Initial price beg. of year 1 $2,500,000 $0 $0 $100, $100, % 4.00% Value end of year 1 $2,650,000 $150,000 $150,000 $100, $200, % 4.00% Value end of year 2 $2,809,000 $159,000 $309,000 $100, $300, % 4.00% Value end of year 3 $2,977,540 $168,540 $477,540 $119, $419, % 4.76% Value end of year 4 $3,156,192 $178,652 $656,192 $119, $538, % 4.76% Value end of year 5 $3,345,564 $189,372 $845,564 $119, $657, % 4.76% Value end of year 6 $3,546,298 $200,734 $1,046,298 $141, $799, % 5.67% Value end of year 7 $3,759,076 $212,778 $1,259,076 $141, $941, % 5.67% Value end of year 8 $3,984,620 $225,545 $1,484,620 $141, $1,082, % 5.67% Value end of year 9 $4,223,697 $239,077 $1,723,697 $168, $1,251, % 6.76% Value end of year 10 $4,477,119 $253,422 $1,977,119 $168, $1,420, % 6.76% Source: U.S. Trust This chart is a hypothetical example meant for illustrative purposes only. It does not reflect an actual investment, nor does it account for the effects of taxes, any investment expenses or withdrawals. Returns are not guaranteed and results will vary. Investment returns cannot be predicted and will fluctuate. Investor results may be more or less. It is not intended to serve as investment advice, since the availability and effectiveness of any strategy are dependent upon your individual facts and circumstances. Hypothetical Farm Investment 6% Annual Appreciation Source: U.S. Trust This chart is a hypothetical example meant for illustrative purposes only. It does not reflect an actual investment, nor does it account for the effects of taxes, any investment expenses or withdrawals. Returns are not guaranteed and results will vary. Investment returns cannot be predicted and will fluctuate. Investor results may be more or less. It is not intended to serve as investment advice, since the availability and effectiveness of any strategy are dependent upon your individual facts and circumstances. STRATEGIC INSIGHTS 3
4 Hypothetical Farm Investment 4% Annual Net Yield 3 Yr Leases Source: U.S. Trust This chart is a hypothetical example meant for illustrative purposes only. It does not reflect an actual investment, nor does it account for the effects of taxes, any investment expenses or withdrawals. Returns are not guaranteed and results will vary. Investment returns cannot be predicted and will fluctuate. Investor results may be more or less. It is not intended to serve as investment advice, since the availability and effectiveness of any strategy are dependent upon your individual facts and circumstances. In summary, a 4% current yield and 6% annual appreciation for a total annualized return of 10% would mean that, at the end of 10 years, the farm, under these assumptions, would potentially produce total income back to the investor of $1,420,756 (equal to almost 57% of the total purchase price), and appreciation of $1,977,119 (equal to about 79% of the initial value of the farm). Again, these are hypothetical returns based on the assumptions above, but which tend to be in line with past returns as shown by the NCREIF Row Crop Farmland Index. Clearly, as with any investment, farmland returns can always vary. As the old adage goes, Past performance is no guarantee of future results. INVESTING IN FARMLAND WITH U.S. TRUST Typically, a direct investor in U.S. farmland forms a limited liability company (LLC) to hold the farm or farms. For investors with U.S. Trust, the LLC opens an Investment Management Account with us. The farms may also be held in existing trusts, including generation-skipping trusts. Or, the shares of farmholding LLCs may themselves be held by various trusts. Once the investor has determined the account or structure where the farms will be held, we begin the process of finding and purchasing the properties for their account. It is a process that we know well. U.S. Trust and its predecessor trust organizations have been managing farm and ranchland for over 50 years. We are one of the largest fiduciary managers of farms and ranches in America. Our experienced and dedicated farm and ranch managers all have agricultural degrees and direct agricultural experience with many holding advanced degrees in agriculture or post graduate certifications. Most members of this team come from second, third or fourth generation farming or ranching families. STRATEGIC INSIGHTS 4
5 Farmland investing for us is a focused, return-driven process. Farmland historically has traded (and in our view, should trade) as a function of the income that an acre of farmland will produce. Today, as we look to acquire good farmland, our goal is that at time of purchase, based on a three-year cash lease, the farm will provide a 4%, or better, current yield relative to the purchase price, after allowing for annual management fees, property taxes and insurance expenses for the farm. This typically requires a gross cash lease of around 5.25%. As one might expect, locating farms that will meet these return objectives requires completion of a considerable amount of due diligence, both on the farm itself and the proposed farm tenant. Once a farm is located we look at historic yields, soils, rainfall and/or irrigation and any buildings and equipment. We seek a good-quality farm tenant at an acceptable cash rental rate that will produce the targeted initial current yield. In our view, the due diligence on the proposed tenant is just as critical as the due diligence on the farm itself. We look at the tenant s experience, agricultural operations and practices and financial capacity. Finally, once all of this work has been completed, we move to acquire the farm, negotiate and execute the lease and close on the purchase of the farm on behalf of the acquiring entity. This property then becomes another asset in the investor s account similar to a stock or bond. All of the annual revenues from the lease and the expenses related to the farm are received and processed and accounted for at the farm level on our system and posted to the investor s account. Many investors prefer a cash lease, which moves the risks of weather and commodity price fluctuations to the farm tenant (and essentially allows a net return for the term of the lease). For investors who want to achieve direct commodity exposure, we can negotiate either a crop share or a flex lease. However, the latter provide more volatility and risk with respect to returns. In Summary Farmland is an uncorrelated asset of relatively low volatility that has historically (over 10-year periods) generated around a 10% annualized rate of return, including a current yield of around 4%. In response to the financial market uncertainties of recent years, achieving diversification through farmland has become an increasing area of focus for many of our clients with access to the amount of capital needed for direct investment in this asset class. 1NCREIF Farmland Property Index For more information, please contact your U.S. Trust advisor today. STRATEGIC INSIGHTS 5
6 This publication is designed to provide general information about ideas and strategies. It is for discussion purposes only since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Nonfinancial assets, such as closely held businesses, real estate, oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and involve risks including total loss of value. Special risk considerations include natural events (for example, earthquakes or fires), complex tax considerations and lack of liquidity. Nonfinancial assets are not suitable for all investors. Always consult with your independent attorney, tax advisor, investment manager, and insurance agent for final recommendations and before changing or implementing any financial, tax, or estate planning strategy. Client eligibility may apply. Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa. Diversification does not ensure a profit or protect against loss in declining markets. U.S. Trust operates through Bank of America, N.A., and other subsidiaries of Bank of America Corporation. Bank of America, N.A. and U.S. Trust Company of Delaware (collectively the Bank ) do not serve in a fiduciary capacity with respect to all products or services. Fiduciary standards or fiduciary duties do not apply, for example, when the Bank is offering or providing credit solutions, banking, custody or brokerage products/services or referrals to other affiliates of the Bank. Bank of America, N.A., Member FDIC Bank of America Corporation. All rights reserved. ARVYVHGC BRO /2014 STRATEGIC INSIGHTS 6