AgriVision Episode 15 – Do the math to see if land purchase makes sense

Katie Wantoch
This is UW Extension’s Farm Management AgriVision Podcast. I am Katie Wantoch, Agriculture Agent with UW Madison Division of Extension. I will be chatting with fellow Extension educators as we answer questions from farmers and share our knowledge and expertise on how you can improve your farm management skills.
Today, I am joined by Simon Jette-Nantel, Professor at UW-River Falls and Extension Farm Management Specialist. Welcome Simon to the podcast.
Simon Jette-Nantel
Thank you Katie.
Katie Wantoch
Simon, today our question is from a farmer whose neighbor got hurt in a farm accident earlier this year. The neighbor already sold his cows and now he wants to know if this farmer wants to buy 120 of his 500 acres located about a half-mile from his farm. He and his son farm 300 acres and milk 100 cows in central Wisconsin. They owe $100,000 on their parlor and freestall barn that was built five years ago, but that is their total debt. This farmer wasn’t really looking to buy more land, but his son thinks it’s a good idea. The land is productive and slightly rolling, and will likely average 200 bushels of corn per acre this fall. His neighbor is asking $5,000 an acre, which is the going rate in our area for good farmland. The farmer’s concern is that they have bills paid, but they do not have much cash to put down on this land. They would need to finance almost the entire amount. What are your thoughts?
Simon Jette-Nantel
First of all, familiar situation, the younger generation they want to invest, the older generation might be a bit more reluctant. And I like that the comment of gentlemen says like, you know the worry, there is about paying the bills. And it’s always, it’s always the same thing when it comes to buying land. Land will, will very rarely generate enough cash to make the payment. So it’s always a cash flow issue like, land is most often a profitable investment. Here in this case, we’re talking about $5,000 that seems to be in the ballpark of the going rate for, for the state. And I’m not sure exactly located in central Wisconsin, but yeah, the question. So right now, the land market has been relatively soft for a few years. But we rarely see land values going down. So right now, it’s kind of plateaued for a while, given the crisis that we’ve gone through in agriculture, but I would expect that in the future land values will start increasing again. And then the gentleman is talking about having to take a mortgage for most of the value to pay for most of the land. And I think right now, I mean, given the interest rates being so low, having you know, taking a loan right now for buying land, or if you can lock in a rate that is low, and like maybe 3%, or something like that. It can be, it can look really good 10 years down the road or something like that, because the rates will probably go up from there. So the low interest rates are definitely a positive here in going forward with that investment. And as I said, I think the price seems to be, seems to be reasonable, and you can expect farmland values to go up in the future. Now, the concern about risk and managing the cash flow risk is always real. And I think there to help them and building a projection, building a cash flow projection, cash flow budget, seems to be like a good idea. And I think it may not, not all farmers are willing or would know exactly how to go about necessarily building a cash flow budget, but I think it would definitely be in the interest of their lenders to help them you know, build that projection and sit down with them to see how things might unfold in the future. Because that’s the type of information that the lender will want to have access to make a decision on lending money for that purchase. So my advice would be to either, yeah, depending on the relationship you have with your lender, but either sit with your lender and ask to try build, their help to try to build a cash flow projection based on the purchase of that land. Or have a consultant that could also come and help with that, to see how much of a risk does purchasing that land put on your cash flow? Some things that will be considered in that cash flow projection? First of all, what’s going to be the revenue, the cash revenue you would get from that land? What kind of yield? And what’s the value of that? So what are you going to be selling more crops or if you’re going to be buying less feed for your cows? The other thing to think about, you know, they mention that they have 100 grand of debt on, on their equipment right now. One of the big questions is how much more needs to be invested in terms of equipment in the coming years? Does it make sense to tie up part of your cash in that land? Or not. If you know you’re going to need to buy a lot of new equipment, you know, whether it’s tractors, harvesting equipment or TMR mixers or whatever else. If you know you’re going to have to invest in the coming years, then you, it’s a much higher risk for you to try to also buy that land. So those are things that should come up in the process of building a projection. What’s going to be the capital required in the coming years to replace existing equipment or to fulfill whatever plans were already in place. So those are some of the key things. And then the last thing is like, you know, if you work with your lender, you’ll see what kind of terms that that lender is willing to offer you in terms of interest. And so that’s going to, to me a be a key factor also in defining how profitable, and how feasible that investment would be. So those are those are all for the numbers, in terms of you know, finding out how much risk you’re really taking and how feasible it is. And then after that there’s all the intangibles of how well, does that 100 acres fits into your plans? What kind of opportunities does that open up for you? There’s two generations here. So obviously, the viability of the farm in the future might depend on having access to more land. But will there be more opportunities in the future to buy land that is nearby, because we’re talking about within a mile here, which is, which is quite valuable in itself to have that proximity. So all of those things need to be taken into account. What opportunities did that, does that 100 acres opens up for you now but also 5, 10 and 15 years down the road?
Katie Wantoch
Yeah, definitely, when you’ve got those two generations on the farm, you not only need to look at the short term, but also that long term profitability in order to really transition that business to the next generation. And they have success in it, so.
Simon Jette Nantel
Yeah, and oftentimes farms have been expanding, and oftentimes the viability of a farm, it always depends on what production you’re willing to get into. But the productivity and the efficiency of a farm depends on, on adding the ability to expand.
Katie Wantoch
Definitely. And, you know, you talked about lender financing, but you know, they can always reach out to the neighbor and discuss if other options, land contract, might be an option besides bank financing or some other financing arrangement. You know, interest rates are low for the foreseeable future, at least. And so, you know, there’s good, low interest costs out there for financing. But going back to that, you know, they currently have a breakeven cash flow, they really need to see is this the right step for them for their business?
Simon Jette Nantel
Yeah, yeah. And that’s what I say like, as you mentioned, there might be other opportunities, maybe there might be other ways to sit down with the owner to build some flexibility in terms of cash flow. How it’s going to affect their cash flow. But yeah, that building that projection is really what’s going to be the key to, to be able to look at scenarios. What if we have, you know, we continue to have low milk prices for a number of years? Or what if feed prices go up, or they go down and look at really how much risk you’re taking by buying this, this 100 acres.
Katie Wantoch
All right. Well, thank you, Simon, for your time today.
Simon Jette Nantel
Thank you.
Katie Wantoch

For more Extension “AgriVision” podcasts or resources to improve your farm management skills, check out https://farms.extension.wisc.edu/. Thanks for listening.