Investing in Farmland

SEPTEMBER 2012CALLAN INVESTMENTS INSTITUTE

Ask the Expert

After years of being relegated to the “Back 40,” farmland is now fertile ground for institutional real asset portfolios. Unprecedented interest in the asset class is hardly surprising. Farmland’s financial pastures seem to grow steadily greener with each passing quarter, despite instability in the economy at large. Iowa farm-land was up 34% in 2011, and the fourth-quarter market value of the NCREIF Farmland Index gained 12.3% annually for the last five calendar years.

Bill Howard sat down with Jamie Shen to discuss institutional investors’ in-creased appetite for farmland. Jamie has overall responsibility for Callan’s real asset consulting services, including research and implementation of real estate, timber, infrastructure and farmland. She grew up on a farm and currently owns one herself, making her intimately acquainted with the asset class. All of this gives Jamie a unique perspective on whether or not farmland can maintain its bumper performance.

A Conversation with

Callan’s Jamie Shen,

Senior Vice President

and Practice Leader of

Alternative Investments

Consulting

Interviewed by William C. Howard, CFA, Senior Vice

President, Fund Sponsor

Consulting

Investing in Farmland

Looking to Buy the Farm

2

Bill: Callan has covered farmland for more than a decade, with little activity for the majority of that time. What has been the trajectory of this asset class?

Jamie: Farmland has gained a much higher profile recently, but it has been around for more than 20 years. The

NCREIF Farmland Index, which tracks institutional investment in farmland, debuted December 31, 1990.

However, there was minimal interest in farmland until quite recently.

Callan began covering farmland in 2000, and we had one search in our first 10 years. Things changed

dramatically about two years ago, when we saw an explosion in client interest. Suddenly we had three

searches in an 18-month span. Three searches is a big number for farmland, because it’s such a small

asset class compared to commercial real estate. One farmland search for $400 million is enough to move

the market. As a result of these searches, we are now very actively working with clients on developing

approaches to investing in farmland.

The institutional presence in the U.S. farmland market is still relatively small. As of December 31, 2011,

the NCREIF Farmland Index had a market value of just $2.9 billion. The overwhelming majority of roughly

$143 billion in U.S. farmland is still held privately. Institutional ownership represents no more than 2% of

the market, suggesting there is significant opportunity for investors to purchase more farmland that is pres-

ently in the hands of individual owners.

Bill: What do you think is responsible for the pickup in interest? Have the characteristics of the asset class changed?

Jamie: In a sense, it’s what hasn’t changed with farmland that makes it suddenly attractive. In a normalized mar-

ket, farmland investments return 7% to 9%, including income. Back in the 1990s and 2000s, stocks were

earning double-digit returns, and that type of return generally did not attract investors. However, today’s

investors are looking at a bond market where the prospective yields are very low. Suddenly an investment

that could return 7% to 9% with an income component has become much more appealing.

The asset class has undergone one significant change, however. Farmland used to be either a standalone

investment or part of a real estate allocation. Achieving a substantial allocation to farmland—somewhere

around 5%—in the domestic market was difficult, as the market was not large enough to support meaning-

ful institutional capital. In the last couple years, farmland has been recategorized as part of the real assets

bucket, thereby shrinking the size of what is considered a meaningful allocation. Now we’re seeing alloca-

tions as low as 1% of the total portfolio.

Given this new context, a 10% allocation to real assets might be comprised of real estate, timber, agri-

culture, infrastructure, and maybe even commodities and TIPS or private energy. In this bucket, farmland

may only need to be 1% to 2% of the total portfolio, which is much more achievable than a 5% standalone

allocation.

The final reason for the increased interest in farmland is simple supply and demand. The population de-

mographics are stronger in this asset class than most other capital market strategies. Population growth

has created a true demand for agricultural land and the goods it produces because productivity gains in

3Knowledge. Experience. Integrity.

agriculture are no longer outpacing the demand for food. In 40 years, the global population is expected to

grow from 7 billion to 9 billion. Food production will need to increase exponentially just to keep up. On top

of that, people are improving their diets and want more protein, especially in emerging markets. For exam-

ple, there is a thesis that as people in China become wealthier, they will demand more protein. Therefore,

investors can put assets directly in the production of protein crops like soy and nuts where the U.S. has

competitive advantages. Australia has competitive advantages in meat production, but meat production

requires feed, which is another area where the U.S. is strong. Some investors focus on the direct crops,

while others gain exposure indirectly by producing inputs like feed, or related products like oil or seeds

used to cook the meat. This fundamental idea of supply and demand is something institutional investors

and public pension fund boards can really get their arms around.

-16%

-12%

-8%

-4%

0%

4%

8%

12%

16%

NCREIF Farmland Index NCREIF Total Index MSCI Emerging Markets Index

Barclays Aggregate Index S&P 500 Index

0.6%

2.7%2.1%

-8.8%

-2.8%

-15.7%

15.7%

12.0%

7.5%

5.4%

12.3%

2.5%

0.2%

6.8%

0.2%

15.4%

8.3%

14.4%

5.6% 5.3%

Last Quarter Last Year Last 5 Years Last 10 Years

Exhibit 1Farmland Returns Compared to Other IndicesPeriods ended 6/30/2012

Sources: Barclays, Standard & Poor’s, MSCI Inc., NCREIF

4

Bill: Farmland returns have been really remarkable. The NCREIF Farmland Index returned 15.4% over the last 10 years (Exhibit 1). Nearly half of that figure came from income.

Jamie: That’s right. The income component over the last 10 years has always stayed above 5.5%. On a calendar-

year basis, the worst total return during that period was 6.3% (Exhibit 2).

We also haven’t seen a correction in farmland values like we did in real estate. Farmland had a slight

negative appreciation of 2.7% in 2001 and 0.14% in 2002, but those are the worst appreciation years the

asset class has seen in the last decade. Farmland has yet to experience a truly awful year—in fact, all

calendar years have produced positive total returns. You can’t say that about many asset classes. There

is a lot of appreciation happening in the market now because of investor demand, as well as improved

commodity prices.

Returns depend on strategy and geographic region. For U.S. farmland, managers are estimating returns in

the 7% to 9% range over the next five to 10 years. One thing to keep in mind is that farmland is a long-term,

illiquid asset class. It is probably not the right asset class for investors who are looking to judge returns

over the next one to three years; it will take that long just to build a portfolio.

-10%

0%

10%

20%

30%

40%

Appreciation Income Total

6.9%

4.76%

-0.1%

2.0%

-2.7%

7.0% 9.7

%1.9

%7.7

%

20.5%

10.5%

9.5%

33.9%

21.7%

11.1%

21.2%

12.0%

8.6%

15.9%

7.1% 8.4

%

15.8%

8.5%

7.0%

6.3%

0.8%

5.5%

8.8%

1.4%

7.3%

15.2%

7.9%

7.0%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Exhibit 2NCRIEF Farmland Index Calendar Year Returns

Source: NCREIF


Bill: In attempting to build diversified farmland portfolios, do investors focus first on crop type or geography?

Jamie: Crop type is the priority. Investment managers try to build diversified portfolios around the two types of

crops, which are row crops and permanent crops. Row crops, such as corn, soybeans, rice and wheat, are

planted on an annual basis. Permanent crops are planted once and then produce fruit or nuts for multiple

years, like an orchard or vineyard. Permanent crops are found more in the Pacific West and Northwest,

while row crops tend to be in the Delta states, like Mississippi, Arkansas and Louisiana, as well as the Corn

Belt, which spans Indiana, Illinois, Missouri, Nebraska and Kansas.

The two crop types have different return and risk profiles. Row crops are more flexible and tend to have

a very stable income component that ranges from 4% to 5%. They generally have less risk, because you

can adjust in the event of inclement weather, drought or other extenuating circumstances. They also have

less commodity risk because you can change the crop the next year if for some reason demand lags and

pricing isn’t as robust.

Permanent crops exhibit a bit of a J-curve, especially if you’re involved in the initial development phase.

You have to buy the property, go through a planting cycle and then wait for those crops to mature. The

appreciation comes once those crops start producing.

Bill: That brings up a critical point: the nitty gritty of actually running a farm. How do investors manage the property? Do they do it themselves or outsource?

Jamie: There are three ways to go about it. Typically investment managers buy farms and then, to avoid unrelated

business income tax (UBIT), they lease the properties out to farmers. Those farmers pay rent and take on

the operational risk of farming, shielding the investor from external factors like weather and drought.

Some investment managers operate farms on behalf of their clients. They take on the operational risk, but

gain more upside potential. If the manager benefits from a good crop year or better commodity pricing,

they pass on the profit to the investor. In this case, the investor has to determine if they’re subject to UBIT

and track and pay those taxes. Most tax-exempt institutional investors don’t like to pay taxes, which is why

they prefer the first model.

A hybrid of these two versions exists, as well. A lease can be structured so the farmland owner gets a base

rent and also participates in some of the upside. It really depends on the investor’s goals.

Bill: The perception is that the U.S. has significant comparative advantages in farmland and that we’re the leading country in this space. Are there investment opportunities overseas?

Jamie: Most of our clients have been focused on the U.S. International opportunities do exist, but they have dif-

ferent risk/return characteristics. As I said earlier, global demand for food is outpacing the world’s ability to

produce it. The world often turns to the U.S. to fill that unmet demand. U.S. farmland provides a way to take

advantage of global and emerging market growth without having to actually invest in those markets.

U.S. farms generally set the curve in terms of productivity, but you could argue that Brazil is more produc-

tive because of rainfall characteristics. Brazil can plant two crops per year, and those crops might have

greater productivity per acre than what we have in the U.S.

6

Some believe the price of land in the U.S. is disproportionally high. This is because our farmland usually

comes with the infrastructure—roads and silos—to support it. International investment opportunities of-

ten lack the infrastructure, and as a result are high risk/return scenarios. For example, an opportunity to

convert pastoral land to row-crop land in South America is high risk because there aren’t roads to take the

product out of the area or to silos for storage. Most farmland managers would avoid a scenario like this

because they want an investment that is lower on the risk/return spectrum. However, there are countries

outside the U.S. like Australia and New Zealand with mature, well-developed farmland investment practic-

es. International strategies may appeal to investors seeking return enhancement or global diversification.

Bill: Turning back to the U.S., what is the greatest obstacle to institutional investment in farmland?

Jamie: Simply getting invested is the biggest challenge. I grew up on a farm, and now own one myself. One of

the last things farmers want to do is sell their land. Farms typically become available during some type of

a generational change, which means they’re not for sale very often. When they do sell, the natural buyer

tends to be the neighboring farm owner. Furthermore, a lot of farms are quietly purchased off market. This

is why almost all U.S. farmland is still held outside the institutional market.

We recently surveyed a number of farmland investment managers, asking them, “If you were to receive a

$200 million allocation today, what timeframe could an investor expect to become fully invested?” Answers

ranged from two to four years. So farmland is certainly illiquid.

Capital supply is the chief issue currently. Over $2 billion in investor capital is on the sidelines right now

looking to become invested. Because there is so much interest in farmland, if a $200 million portfolio came

on the market today, it would probably trade very, very quickly.

Another obstacle is the small manager universe. Very few have been in this business for a decade or

more, and there are only around 20 managers with expertise in managing institutional portfolios. How-

ever, investor interest in farmland is causing managers to move into the area. New entrants into farmland

investment management are emerging from multiple sources. Some are long-term real asset managers

with experience in timber or real estate who are looking to hire a few professionals to take them into

the farmland universe. You also have corporate farmers or family farms that now see an opportunity to

expand operations. Because they believe they have a competitive advantage, they are looking to raise

institutional capital.

One misperceived obstacle is the fact that some states prohibit institutional investments in farmland.

Callan doesn’t see this as an impediment. Many of these states are reviewing and potentially loosening

their restrictions on institutional or corporate ownership of farms. Even if nothing changes, we believe

investors can achieve a diversified portfolio without ever having to make investments in these states.1

1 Seven states – Iowa, North Dakota, South Dakota, Kansas, Oklahoma, Wisconsin and Missouri – ban or restrict corporate ownership of farms within their borders. Since 2006, when an 8th Circuit Court of Appeals found Nebraska’s corporate farming ban unconsti-tutional, similar bans in the remaining eight states have been considered vulnerable to challenge. Eleven U.S. states restrict foreign ownership of farms.


Bill: In addition to providing a good income component and a solid return expectation, is farmland an effective inflation hedge? Can it also be considered a source of diversification?

Jamie: Whenever an extended inflationary period becomes a real possibility, investors look for alternative assets

that have demonstrated in the past that they will grow in price faster than inflation rises. These investments

have real intrinsic value, and are designed to produce income and preserve capital. Typically, hard assets

are considered strong inflation hedges, and farmland is no exception. Farmland values have continued

to rise for the last 10 years, the demand for food will only increase, and there is stable, consistent income

when leasing the land.

Farmland is not highly correlated to other asset classes, so it does add diversification benefits to an over-

all portfolio (Exhibit 3). It is most often associated with real estate and timber, but still demonstrates a

relatively low correlation with the NCREIF Timberland Index over five years, and the NAREIT Equity Index

over both five- and 10-year periods.

NCREIF Farmland

NAREIT Equity

NCREIF Timberland

Barclays Aggregate

Russell 3000

Consumer Price Index

NCREIF Farmland 1.00 -0.02 0.73 -0.14 0.13 -0.41

NAREIT Equity -0.28 1.00 -0.14 -0.04 0.80 0.19

NCREIF Timberland 0.38 -0.38 1.00 0.06 -0.09 -0.20

Barclays Aggregate -0.09 -0.17 0.35 1.00 -0.30 -0.43

Russell 3000 -0.03 0.86 -0.36 -0.32 1.00 0.15

Consumer Price Index -0.40 0.35 -0.03 -0.49 0.36 1.00

We should note that real, private or illiquid asset classes’ valuations are appraisal-based, and appraisal

bias can be a factor. Farms are valued once a year, and often only once every three years, which de-

creases volatility. Some of the low correlations may be attributable to infrequent valuations. Investors have

to be wary when they look at farmland’s historical standard deviation, because it doesn’t necessarily reveal

the true risks of the asset class.

Exhibit 3

5- and 10-Year Correlations of Farmland to Other Asset Classes

Ended 6/30/2012

5-Year Correlation 10-Year Correlation

Sources: Barclays, Standard & Poor’s, MSCI Inc., NCREIF, CPI

8

Bill: Let’s talk more about implementation. Within the farmland universe, what investment products are typically available for various sizes of allocations?

Jamie: A key benefit of farmland is that a relatively small allocation can still lead to a diversified portfolio. Trans-

action sizes can be as small as $7 million, which is still a large farm, and up to $30 million for very large

farms. You can have a diversified portfolio with $100 million in the asset class, so a separate account is a

viable option for anyone who has $100 million or more to invest.

Commingled fund vehicles are also available. Closed-end commingled strategies vary, from those that

closely mimic separate accounts to higher-octane opportunities like land conversion in South America.

These funds provide investors with great diversification opportunities. However, a closed-end fund is struc-

tured in such a way that the farmland has to be sold at a defined point in time in order to return the capital,

and the sell date might not be the most opportune time to dispose of the asset. We wouldn’t recommend a

closed-end vehicle to an investor seeking a basic farmland investment—one that’s a long-term asset with

an income component.

Open-end commingled funds, on the other hand, are a great way for investors of any size to get exposure

to the asset class without having to own farms directly. These funds also provide an element of liquidity,

should the investor decide to either exit the asset class or invest more in it down the road. There aren’t

many of these funds, though, and wait times can be long.

Fees are typically higher in private, illiquid asset classes, and within farmland, fees are generally compa-

rable with real estate investments at around 1% of the assets in the portfolio.

Bill: How common is the use of leverage in farmland portfolios?

Jamie: You don’t see a lot of leverage within farmland. On the deals that are more fully integrated, you might have

an operational line of credit to smooth the cash flow over the year between the planting cycle and harvest.

But generally speaking, leverage is rarely used in institutional farmland portfolios.

Bill: With all the news about farmland values reaching new highs, are managers still able to find institutional-quality properties at reasonable valuations?

Jamie: Yes, absolutely. We’ve seen some interesting strategies to avoid overpaying for assets, like investment

managers buying farmland in the Delta states where property is less built out and therefore more cost

effective. These managers will bring in the necessary wells and other infrastructure to support today’s

higher-priced commodities, like corn and soybeans.

There is no denying that there are implementation challenges with farmland. Beginning with the simple fact

that it takes a long time to become invested. Investors need to be patient and committed because it is a

hard asset class to access. Furthermore, farmland probably won’t always generate a 15% return.


All in all, we still feel optimistic about farmland. While the value and appreciation spikes we’re seeing are

above historical norms, these increases are driven by good fundamentals. It is unlikely that this is the

beginning of a bubble.

We believe that the overarching supply/demand imbalance supports higher income from farms, and it

makes sense for institutional investors to consider this asset class as part of a real assets portfolio. As long

as we’re in a low-return environment with the potential for higher inflation down the road, investors should

continue to gravitate toward an income-producing asset class like farmland that can serve as an inflation

hedge and has low correlations to other asset classes.

Bill: Thanks, Jamie.

10

Biographies

William C. Howard, CFA, Senior Vice President. Bill is a consultant in Callan’s

Denver Consulting office. Bill works with a variety of fund sponsor clients, including

foundations, public defined benefit plans, and corporate defined contribution plans.

His responsibilities include strategic planning, implementation, performance evalu-

ation, and continuing education. Bill is a shareholder of the firm and a member of

Callan’s Manager Search Committee.

Prior to joining Callan in 2001, Bill was a research analyst for Pritchard Investment Management, a regis-

tered investment advisor specializing in enhanced index strategies. He began his investment career as a

portfolio analyst tracking the performance of investment advisory newsletters at Hulbert Financial Digest.

Bill holds an MBA from the University of Denver and a BA from Vanderbilt University. He has earned the

right to use the Chartered Financial Analyst designation. Bill is a member of the CFA Institute and the CFA

Society of Colorado.

Jamie K. Shen, Senior Vice President. Jamie is the Practice Leader of Alternative

Investments Consulting and has overall responsibility for real asset consulting services

at Callan Associates. While Jamie’s particular focus is on real estate, she oversees

research and implementation of timber, infrastructure and agricultural asset classes as

well. She works directly with Boards and/or Staff in the development and implementa-

tion of client specific strategic and tactical plans, as well as provides ongoing oversight

in the control and monitoring of clients’ real estate portfolios. Additionally, Jamie oversees all investment due

diligence for real assets and chairs Callan’s Alternative Investment Committee. She is also a shareholder

and a member of Callan’s Management Committee.

Prior to joining Callan, Jamie was a Principal with The McMahan Group, a San Francisco based-man-

agement consulting firm specializing in real estate enterprises. Specifically, Jamie consulted to a number

of real estate investment advisors on organizational structure and investment vehicle design. She also

assisted in preparing testimony for the Department of Labor on fiduciary standard of care relating to real

estate investments. Jamie has worked in the real estate consulting groups of both Arthur Andersen and

Ernst & Young.

Jamie received her B.S. in Business Administration from the Walter A. Haas School of Business at the

University of California, Berkeley. Jamie serves on the Editorial Board of The Institutional Real Estate Let-

ter and frequently writes papers and leads discussions for the Institute for Fiduciary Education (IFE). She

is a member of the Pension Real Estate Association (PREA) and serves on the PREA Board of Directors.


Certain information herein has been compiled by Callan and is based on information provided by a variety of sources believed to be reliable for which Callan has not necessarily verified the accuracy or completeness of or updated. This report is for informational pur-poses only and should not be construed as legal or tax advice on any matter. Any investment decision you make on the basis of this report is your sole responsibility. You should consult with legal and tax advisers before applying any of this information to your particular situation. Reference in this report to any product, service or entity should not be construed as a recommendation, approval, affiliation or endorsement of such product, service or entity by Callan. Past performance is no guarantee of future results. This report may consist of statements of opinion, which are made as of the date they are expressed and are not statements of fact. The Callan Investments Institute (the “Institute”) is, and will be, the sole owner and copyright holder of all material prepared or developed by the Institute. No party has the right to reproduce, revise, resell, disseminate externally, disseminate to subsidiaries or parents, or post on internal web sites any part of any material prepared or developed by the Institute, without the Institute’s permission. Institute clients only have the right to utilize such material internally in their business.

Authored by Callan Associates Inc.

If you have any questions or comments, please email [email protected].

About Callan AssociatesFounded in 1973, Callan Associates Inc. is one of the largest independently owned investment consulting

firms in the country. Headquartered in San Francisco, California, the firm provides research, education,

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ness: Fund Sponsor Consulting, Independent Adviser Group, Institutional Consulting Group and the Trust

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Denver, Chicago, Atlanta and Summit, N.J. For more information, visit www.callan.com.

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Investing in Farmland

Economy & Finance