Increasing property prices are causing more farmers to consider leasing land, rather than buying. However there is often confusion about what is an acceptable lease rate and which party covers the various costs.
For landlords, generating a reasonable return and engaging tenants with good management skills who will preserve or improve the land, are key objectives when offering land for lease.
Landlords are responsible for provision of fixed assets and infrastructure such as land, fences, yards, buildings and sheds as well as payment of council rates and insurance of fixed assets.
Tenants are usually responsible for general repairs and maintenance of fixed assets, provision of livestock and machinery assets as well as provision of labour. They also cover payment of operational costs incurred in generating a return, insurance of livestock, machinery and public liabilities.
Speaking at a Grains Research and Development Corporation grower update at West Wyalong, New South Wales Holmes Sackett director John Francis said variations to these standard conditions occurred by mutual agreement but clear and open communication was critical throughout the duration of the lease.
Leases are successful if the term allows the tenant to implement a management program and benefit from the investment. The tenant’s primary goal is operating profit while the landlord’s is to achieve capital gains plus a rental income.
Landlords should not rely on the tenant as a source of property improvement.
The advantages of leasing include the opportunity to:
n Engage in farming without the high capital expense of land ownership. It allows an entry point or expansion for a farm business which might otherwise be impossible because of land costs.
n Expand farm operations with lower additional overhead costs which provides an advantage in scale by spreading the same amount of overhead costs over a greater number of production units.
n Be rewarded for exceptional farm management ability.
Leasing does have disadvantages. There are no capital gains in leasing which is the surest way to acquire wealth in agriculture over the long term. There is a higher finance risk because of the cash cost of using the land and if the tenant experiences a loss, they may not be backed with equity in a large asset base.
Mr Francis said there was no “one size fits all” rate when it comes to leasing. The rate would depend on the level of productivity, the costs to generate the productivity and the efficiencies in scale that can be generated.
Mr Francis advised farmers not to be tempted to pay current market values if they did not provide adequate returns.
He says pricing lease rental on a percent of land value is an inappropriate method for valuing leases. Paying market prices of 5pc of land value is unsustainable.
An increase in land value leads to a decrease in leasing margins where lease price is based on land price. This occurs because the productive capacity of the land stays constant but the lease rental increases. Profit is maintained at the same level but the lease price increases so margins decrease.
Economic valuation is the preferred method for valuing leases where a rational basis for determining the worth of leases is sought. Economic valuation differs from market valuation because it places a value on the lease according to its productive capacity and ability to provide a pre-determined return. The level of return required is dependent on the level of risk assumed.
Mr Francis says Holmes Sackett have developed an internet-based tool to calculate the internal rate of return for leases. Using information such as the typical rotation, costs of growing a crop, average yield and price, an internal rate of return can be generated allowing growers to assess the economic viability of the lease. The outcome is dependent on the lease cost, inputs costs, additional overhead costs, the level of productivity and the percentage of total area cropped.
The top 20pc of farm managers can afford to pay more for cropping lease land than average managers because they turn more rain into grain. Cropping leases provide reasonable returns because they have relatively low up-front costs. Returns of more than 30pc are required for cropping leases to account for the risk.
Mr Francis advises farmers not to be tempted to pay current market values if they do not provide adequate returns - it won’t make financial sense.
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