Estimating Cash Rental Rates for Farmland

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1 Estimating Cash Rental Rates for Farmland Tenant operators farm more than half of the crop land in Iowa. Moreover, nearly 70 percent of the rented crop land is operated under a cash lease. Cash leases are popular because they are simple, the amount of rent is fixed, and the owner is relieved of making operating and marketing decisions. In addition, the tenant has maximum freedom in planning and developing the cropping and livestock programs. The cash rental rates paid for individual tracts of farmland will depend on the productivity of the land, expected crop prices, costs of production, USDA programs, and the supply of and demand for rented farmland in a community. Determining a Rental Rate for Crop Land Determining a fair rental rate is difficult. Cash rents are likely to be too low in times of rising prices and high yields and too high in times of declining prices and low yields. Several approaches can be used to help estimate a range of values within which a tenant and landowner can negotiate. These estimates do not consider the value of any buildings or storage that the tenant may use, or other unusual factors, however. Share of gross income. Over time, cash rental rates approximate a share of expected gross income. Common shares are 30 to 40 percent of the gross income for corn, or 35 to 45 percent for soybeans, including USDA direct payments. Price support payments, such as loan deficiency and counter cyclical payments, can be reflected in the expected selling price used. The justification for the gross income approach is that land typically accounts for 30 to 40 percent of the total costs of corn and soybean production. However, it does not consider changes in production costs. Using the revenue values from Example 1, Rent for corn = 35 % x $393 = $138 Rent for soybeans = 40% x $313 = $125 Tenant s residual. Another approach is to calculate how much income the tenant has available for rent payments after subtracting all the tenant s costs associated with producing the crop. First estimate yields, selling prices, and direct government payments. Then subtract the operating expenses. Next, subtract the tenant s cost of machinery and equipment ownership. This includes depreciation, a return on investment, insurance, and machinery housing. Some tenants omit machinery ownership costs if added cropland can be farmed without increasing total machinery investment. But in the long run, these costs are incurred on all acres farmed and must be paid. Finally, a charge for the tenant s labor is subtracted. The amount remaining is available for the payment of cash rent. Using the revenue and cost values from Example 1, Rent for corn = $393 $283 = $110 / acre Rent for soybeans = $313 $175 = $138 / acre Example 1. Estimating a Cash Rental Rate for Crop Land Gross Income per Acre Corn Soybeans Expected yield 160 bu./acre 48 bu./acre Expected selling price $2.30 per bu. $6.00 per bu. Revenue from sales $360 $288 USDA direct payments $25 $25 Total gross income $393 $313 Production Costs per Acre Corn Soybeans Seed $35 $32 Fertilizer and lime Pesticides Crop insurance 7 5 Interest and miscellaneous Machinery fuel and repairs Machinery ownership Drying, hauling, storage 46 5 Labor Total nonland costs per acre $283 $175 FM 1801 Revised July 2005

2 Expected yield. Another approach is to multiply the expected yield under average conditions by a fixed rate per bushel. Surveys done in Iowa show rates for corn have been in the $.90 to $1.00 per bushel range in recent years, while for soybeans rents have averaged from $2.90 to $3.20 per bushel. Using the revenue values from Example 1, Rent for corn = $.95 x 160 bu. = $152 / acre Rent for soybeans = $3.00 x 48 bu. = $144 /acre Corn Suitability Ratings. The Corn Suitability Rating (CSR) is a farmland productivity index. CSR values range from 0 to 100, with the higher the number the higher the land productivity. Each soil type in Iowa has a CSR index rating. By identifying the soil types and acres of each soil type in a tract of land, an average CSR can be computed for the tract. An estimated cash rental rate can then be computed by multiplying the average CSR by the observed rental rate per CSR point. Rents per CSR rating have been about $1.50 to $1.65 per point in southern and northeastern Iowa, and $1.75 to $1.95 per point in the rest of the state. Example: a certain farm has an average CSR index of 75. Rent = 75 x $1.80 = $135 / acre Return on investment. Another method is to multiply the estimated current market value for cropland by an expected rate of return. Surveys show that cash rents for good cropland in Iowa in recent years have averaged about 4 to 6 percent of current land values, before paying property taxes. However, during periods of rapid changes in land values this method is rather uncertain. Example: the estimated market value for a certain tract of land is $3,000 per acre. Estimated rental value = $2,800 x 5% = $140 / acre No allowance has been made for risk due to variations in crop prices and yields in these approaches. With a cash rent lease, the tenant assumes all of the risk. So the tenant should be compensated for assuming the risk. Do this by either using conservative price and yield estimates or adjusting the rental rate downward. Because future yields and prices cannot be predicted with certainty, some owners and tenants prefer to use a flexible cash lease, in which the final rent is based on the actual yields and/or prices at harvest. See Extension publication FM 1724, Flexible Farm Lease Agreements, for more information and examples. Determining a Rental Rate for Hay and Pasture Land Cash rents for hay and pasture land are more difficult to estimate in some ways, because the crop may already be established on the land, and it is often fed to livestock instead of marketed off the farm. Nevertheless, several approaches can be used. By forage value. Estimate the expected pasture or hay production per acre and multiply by 30 percent of the price of grass hay during the grazing season. If the tenant supplies labor and machinery for establishing the crop and pays part of the seed and fertilizer costs, then a rental rate equal to 20 percent of the value of the crop would be more appropriate. Use hay prices corresponding to the type and quality of the stand. Some typical pasture production levels are shown in Table 1. Example: improved bluegrass pasture Rent = 2.0 ton / acre x $60 / ton x 30% = $36 / acre Example: established alfalfa hay Rent = 5 ton / acre x $90 / ton x 30% = $135 / acre Per animal unit month. Some pasture is rented on a per head per month or animal unit month (AUM) basis. Multiplying the price of hay during the grazing season by the appropriate pasture quality factor (Table 2) is one simple way to estimate a rental value per AUM. Multiply this value by the total number of animal units (Table 3) to be grazed to get a monthly rental value for all acres. Example: good tallgrass pasture Rent = $60 / ton x.18 = $10.80 / AUM By carrying capacity. The estimated rate per AUM can be multiplied by the carrying capacity of the pasture in AUM s per acre (Table 1) to estimate a pasture rental rate per acre for the whole grazing season. Example: good tallgrass pasture Rent = $10.80 / AUM x 5 AUM / acre = $54 / acre These approaches assume that the forage stand is already established. Annual costs for controlling weeds and maintaining fertility are usually born by the tenant. Maintenance of fences is often a joint

3 responsibility of the owner and tenant. For example, the owner may pay for materials and the tenant provide the labor and equipment. For leases that call for other arrangements, cash rental rates should be adjusted accordingly. Comparing Rental Rates When information is available, a good guide for setting cash rental rates for land is the rate at which similar tracts in the area have been rented. Extension publication FM-1851, Cash Rental Rates for Iowa contains typical cropland, hay and pasture cash rents for all counties in Iowa. It also shows average cash rents paid by bushel of expected yield and CSR point. The data is collected by surveying farmers, landowners, farm managers and lenders. Other sources of information include newspaper ads, bulletin boards and word-of-mouth. These sources may not reflect typical rates, however, or rates appropriate for your own farm. They may not even be accurate in some cases. Circumstances such as the following may justify a higher or lower rent in specific cases: The percent of the total acres that are tillable Small size or irregular shape of fields Presence of terraces, creeks or roadbeds that affect the time it takes to plant and harvest Difficult or restricted access to fields High or low fertility levels or Ph Existence of contracts for growing seed or specialty grains, or for spreading manure Above or below average grain prices due to transportation costs, proximity to terminals, feed mills and ethanol plants USDA program variables, such as corn base and assigned yields, or CRP and CSP contracts Differences in the quality of land should be taken into account when comparing rental rates. Not all land in a county is of equal productivity. Actual yield history is the best guide for assessing productivity, if it is available. Other Considerations The dates that rental payments are made also affect rates. For example, a $150 per acre rent with $75 due in advance on March 1 may cost the tenant $4 to $5 more than an agreement in which all the rent is due on December 1, because of added interest costs. Storage facilities and buildings are often rented separately from land under a cash rent lease. However, if the use of facilities is included with the land, their value should be reflected in the rental rate. The agreed-on rental rate per acre should apply only to tillable acres. The Farm Service Agency has records of the tillable acres on each farm tract. Acres that are suited only to forage crops or pasture usually rent for a lower rate per acre. Land that is in roads, ditches, timber, waterways or other uses that yield no economic benefit generally has no rental value attached to it. Even though the terms of a cash rent lease may be relatively simple, it is important to have a written lease. A written lease can contain provisions relating to land use, date of payment, renewal deadlines and other considerations, and serves as documentation for income tax and estate tax purposes. Farm lease forms for both cropland and pasture are available from your county Extension office and other sources. Other Resources from ISU Extension FM 1851, Cash Rental Rates for Iowa FM 1838, Farm Building Rental Rate Survey FM 1724, Flexible Farm Lease Agreements FM 1538, Iowa Farm Lease FM 1874, Iowa Cash Rent Farm Lease FM 1564, Improving Your Farm Lease Contract FM 1811, Survey of Iowa Farm Leasing Practices NCR 75, Cash Rental Arrangement for Your Farm NCR 149, Pasture Rental Arrangements for Your Farm

4 Crop Land Cash Rent Worksheet Gross Income Corn per acre Soybeans per acre Expected yield, bu. per acre Expected selling price, $ per bu. Revenue from sales (bu. x price) USDA direct payments Total gross income Production Costs Seed Fertilizer Lime Pesticides Crop insurance Interest and miscellaneous Custom hire Fuel, repairs Machinery ownership Drying, storage, hauling Labor Total of all nonland costs A. Share of Gross Income Corn: Gross income x share % (30 to 40%) = $ /acre Soybeans: Gross income x share % (35 to 45%) = $ /acre B. Tenant s Residual Corn: Gross income minus nonland costs = $ /acre Soybeans: Gross income minus nonland costs = $ /acre C. Expected Yield Corn: Expected yield bu./acre x $ per bu. for rent = $ /acre Soybeans: Expected yield bu./acre x $ per bu. for rent = $ /acre D. Corn Suitability Rating Index CSR index: Average CSR x $ per point for rent = $ /acre E. Percent of Land Value Current market value of land $ /acre x % return expected = $ /acre

5 Pasture and Hay Cash Rent Worksheet A. By Forage Value 1. Forage production per acre (Table 1) tons 2. Hay price during grazing season $ /ton 3. Rent per acre (A1 x A2 x 30%) $ /acre B. Per Animal Unit Month 1. Hay price during grazing season $ /ton 2. Pasture quality factor (Table 2) 3. Rent per animal unit month (AUM) (B1 x B2) $ /AUM 4. Total animal units (Table 3 factors x number of animals) units 5. Total rent per month (B3 x B4) $ /month C. By Carrying Capacity Rent per AUM (B3) x AUM / acre (Table 1) = $ /acre Table 1. Forage Production 2 Hay Equivalent, i Ton / acre AUM / acre ii Bluegrass, unimproved Bluegrass, improved, with legume or N Birdsfoot trefoil and grass Orchard or brome grass, alone Orchard or brome grass, with legume or N Warm season grasses Alfalfa, plus grass Cornstalks Table 2. Pasture Quality Factors Table 3. Animal Unit Equivalents 2 Lush, green high-protein.20 Mature cow 1.0 to 1.4 Good tallgrasses.18 Bull 1.5 Fair to good native pasture, Yearling 0.7 to 0.9 mostly shortgrass.15 Two-year-old heifer 1.0 to 1.2 Poor or weedy shortgrass.12 Calf 0.4 Cornstalks.10 Ewe 0.25 Source: NCR 149 Horse 1.0 i Rotational grazing can increase production by about 25 percent. ii For more detailed information see publication PM 1771, Guide for Year-Round Forage Supply.

6 Prepared by William Edwards and Donald Hofstrand, Extension Economists File: Economics and justice for all The U.S. Department of Agriculture (USDA) prohibits discrimination in all its programs and activities on the basis of race, color, national origin, gender, religion, age, disability, political beliefs, sexual orientation, and marital or family status. (Not all prohibited bases apply to all programs.) Many materials can be made available in alternative formats for ADA clients. To file a complaint of discrimination, write USDA, Office of Civil Rights, Room 326-W, Whitten Building, 14th and Independence Avenue, SW, Washington, DC or call Issued in furtherance of Cooperative Extension work, Acts of May 8 and June 30, 1914, in cooperation with the U.S. Department of Agriculture. Stanley R. Johnson, director, Cooperative Extension Service, Iowa State University of Science and Technology, Ames, Iowa.

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