By Jeff Conrad, Managing Principal and President, AgIS Capital LLC
Institutional investment in farmland grew significantly over the last decade. This growth started in the more developed U.S. market and spread to emerging markets around the world. During this time, the NCREIF Farmland Index, a recognized property index for U.S. farmland, expanded dramatically, increasing from $1.1 billion in 2008 to $8.1 billion in 2017.1 This growth had been fueled by a combination of new properties being added to the index combined with increased asset values. The expansion of the U.S. market was complemented by growth in other key markets around the world, including Brazil, Australia, New Zealand, and Eastern Europe. The trends that drove and shaped the growth of the farmland asset class during this period were multi-faceted, but six, in particular, played significant roles.
The Great Recession of 2008—2009: The global economy took a major downturn in the late 2000s, the period that has been dubbed “The Great Recession”. The downturn was broad and extreme and adversely impacted nearly every asset class in which institutional investors participate. However, farmland was one of the few bright spots during the period. Based on the NCREIF Farmland Index, U.S. farmland delivered a 15.8 percent return in 2008 and followed with a 6.3 percent return in 2009.2 This was extremely attractive investment performance for this difficult and dark period for institutional investors. Based on the NCREIF Farmland Index, the sector followed the downturn with several years of solid, double-digit investment performance. The farmland sector, which historically has performed counter-cyclically to the general economy, performed well during this difficult period. Even during challenging periods, people continue to need food and fiber and this demand provided an underpinning for the farm sector during this era.
For those involved in the farmland asset class during its early days in the 1990s, when its capacity to preserve capital and provide portfolio diversification were the attributes that were most frequently emphasized, the performance of farmland during this period was further proof of the valuable and important role it could play in a broadly diversified institutional portfolio. As major banking institutions collapsed or teetered on the edge during and just after The Great Recession, the Farm Credit system remained active and continued to originate loans. In fact, major farmland portfolios were leveraged during this period at very attractive long-term rates. This strong performance during a difficult investment period helped establish the farmland asset class that we have today.
The Faltering Performance of Timberland: For the last 25 years, timberland and farmland, both biologically-based, hard asset investments, have competed for the interest and attention of institutional investors. Both asset classes offer similar attributes in that they have the potential to provide current income as well as portfolio diversification benefits and inflation hedging protection. The timberland asset class became more established in the 1990s based on exceptionally strong investment performance – a result of environmental restrictions being placed on the harvesting of public forests in the Western United States and a massive industry consolidation that led to the liquidation of timberland holdings by the world’s major forest products, paper, and packaging companies. These circumstances provided opportunities for timberland investment management organizations (TIMOS) to become established and to build significant portfolios for institutional clients based in the U.S. and elsewhere. By comparison, the farmland asset class struggled for acceptance because its performance was less compelling when assessed against the temporal case then being made for including timberland in a portfolio. Faced with having to choose between the two asset classes, each offering similar benefits, but timberland offering higher, near-term returns, investors made the easy decision, which led to the more rapid growth of the timberland investment sector.
When The Great Recession hit in 2008, the tables turned for farmland and timberland. Based on data from the NCREIF Timberland Index, after the downturn, the timberland asset class struggled to maintain and regain momentum – generating two consecutive years of negative returns. These, in turn, were followed by several additional years of weak performance relative to the asset class’ most recent trend. This period highlighted the dependence of the timberland asset class on demand for both raw land and building products. Because of weak economic growth, the U.S. housing market floundered for several years after The Great Recession. This led to a decline in land values, especially for timberland assets that were acquired at premium pricing because they were initially assessed as being in the path of residential and commercial development. It also undercut demand for the timberland asset class’ highest value product, sawtimber, which is used to produce dimensional framing lumber. The end result was a prolonged period of weak returns for timberland. TIMOs responded on behalf of their investment clients by allowing their trees to continue growing on the stump – foregoing near-term income in the hope of capturing higher margins from the sale of larger and more valuable sawtimber products in the future. However, this strategy, which was widely adopted because few other options existed for capturing value, only exacerbated the problems TIMOs and their clients faced in the long run because it led to a more sluggish recovery for the timberland asset class. The large supply overhang of sawtimber kept prices suppressed even as the housing market began to show signs of sustained recovery three years ago. Meanwhile, today, the building products sector continues to work through the excess inventory of sawtimber....MORE