RENT OPPORTUNITIES
HANG ON
FOR THE MOST IMPORTANT CLASS
IN MY LIFE, AND MAYBE YOURS,
(FROM NOW ON)
Barbara/Howard Doster
Howard@DHDoster.com,
www.DHDoster.com
Phone 765 412 1495
16th National No-Till Conference
Updated 1/16/08
Rent
Analysis
I
want to start this class by asking you to take a quiz.
What
rent would you, did you bid for a nearby, say, 80 acres, 157 bu. corn?
in
06______, in 07_______, in 08_______.
Below, use your rents to calculate your budgeted so-called tenant margin
for each year. Is it too low for you to
thrive, or too high to expect to gain/retain the lease?
[The
tenant margin in the 08 Purdue Crop Guide, prepared October 19, 07, was $84 per
acre, and the authors noted typical tenants had considerable non-farm
earnings. Personally, I often use a
higher tenant margin, while also noting that the Purdue Crop Guide (PCG) budget
is for typical operators, not for superior producers who realize higher yields,
and thus more tenant margin than shown in the PCG.]
“Rents
are too high!” That was my theme at the
July 06 Purdue Top Farmer Crop workshop.
“Reported rents are too low!”
That’s been my theme since I collected local harvest prices on November
15, 06, and calculated my 06 adjustor lease.
After reading my March 07 article in Successful Farming, owners
and tenants from 21 states called and emailed me. After collecting 07 harvest prices and
estimating my final 07adjustor lease rent, I again state, “ Most rents are too
low!”
Even
some cash and share leases that were right for 06 were wrong for 07 and are
wrong for 08. In 07, on average
The
“right rent” problem/opportunity continues to increase and is so significant
that I shared my relationship rent formulas on January 9 08 at the National
No-till Conference in
Yes,
nitrogen fertilizer prices are almost four times higher than four years ago,
but thanks to the ethanol demand for corn, crop prices continue to increase
faster than total non-land costs. And,
with crop prices now well above government price safety nets, tenants are
vulnerable to price drops.
I
don’t know about drought, CRP release, trade embargo, cheap dollar, increased
nitrogen production by 09, lower fuel prices by summer, peace, or whatever,
outside-the-farm-gate.
Rather
than offer rent bids that are too low for current conditions, and risk
offending owners and not getting their leases, I offer an alternative solution.
If
the owner is able and willing, let the owner take some outside risk, while
keeping your rent current with current economic conditions.
My
wife, Barbara, and I teach management skills.
-our comparative advantage-
and trade for the rest.
How about you?
First, owners appraise the present and potential
productivity/profitability of your farm.
Learn these appraisal skills and teach them to your heirs and/or hire
the expertise, but somehow do the job.
Learn, then teach your heirs how to do right farm things, how to do
those things right, and how to have fun doing them. If your heirs sell the
farm, they lose, and so do many tenants who could become custom farmers or
tractor drivers taking internet orders from
Owners,
some advisors and magazine writers correctly point out that cash rent tenants
are more at risk for price changes now that crop prices are well above
government support prices. Instead of allowing tenants to increase their
margins to offset this increased risk, I prefer to encourage owners, who are
able and willing, to accept some of this increased contribution margin risk in
exchange for a higher cash rent.
With
my outside adjustor lease described below, the owner has outside-the-farm-gate
input and output price and yield risk similar to an owner with a custom farm
operator, but without the timeliness or other production risk, since the tenant
realizes 100% of his/her inside-the-farm-gate performance.
In
addition, once the owner accepts the tenant’s adjustor cash rent bid, the
tenant’s margin is constant for the remainder of the lease, and the cash rent
is current as of the end of each current year harvest. While owners will receive less rent in really
“bad” years, with my 100% adjustor lease, I received much more 07 rent than my
brother realized with a 50% crop share lease with the same tenant on adjacent,
similar soils.
Based
on current 08 budgets, my 08 adjustor rent will be much more than my brother’s
share rent this year. Why? With perhaps identical government payments,
yields, prices, and variable costs, the tenant’s 08 margin is more in a crop
share lease than in my adjustor lease, unless my harvest contribution margin
(revenue minus variable costs) is very low.
If
an owner wants to directly participate in FSA payments, but have a rent more
comparable to my adjustor rent under most 08, and now likely, 09 scenarios, the
owner should ask for an appropriate up-front privilege payment with a crop share
lease.
First,
tenants, appraise your skills and commitment to farming.
A
few persons are better at doing many things.
Everyone
has a comparative advantage for doing some thing.
If
farming is your thing, do right things, right ways, right now, and from now on.
For
example, somehow organize yourself so you spend your scarce plant/harvest hours
using the biggest available field machinery.
That’s the way to be a low-cost producer.
Also
organize yourself to improve your skills and those of your kids. See our website for Corn Belt Top
Farmers. Obtaining and retaining the
best cropping systems and management skill is the only way you can sustain a
competitive advantage over farmers inside and outside our country.
Use
some of your excess earnings to send your kids to the best Land Grant Ag
College-I spell that PURDUE. At Purdue, you can still learn to be a better
farmer. I remember how record numbers of farm kids enrolled at Purdue in the
mid-seventies, the last time crop prices increased faster than non-land
costs. If your kids have high scores,
Purdue offers good scholarships, for both in-state and out-of state students.
The best Land Grant colleges fill up fast, sometimes with non-ag students, so
apply the first day, maybe August 1, maybe electronically, maybe at multiple
colleges, perhaps for $30. Once you’re accepted, you can decide, maybe by the
following May 1, where you want to enroll.
Also,
use some of your excess 07 earnings to do whatever to fix up your owner’s
land. What better time to then ask your
owner to consider offering you one of my relationship leases, perhaps by
re-negotiating 08 and/or getting a lease for 09 and beyond? Nurture your relationship, and reduce your
stress and your owner’s stress.
Finally,
tenants, while some teachers say you must cover your so-called fixed costs,
that’s not the way you decide and act.
Except for calculating taxes, past costs don’t count. From now on, choose alternatives that, you
think, will make you best off, from now on.
Your best alternative may only slightly more than cover your future
costs, from now on. Or, now, until rents
are bid up appropriately as they inevitably will be, your budgeted best 08-09
alternative may show you will get a record high “tenant margin” return to your
resources.
Trained
as an economist I observe how persons trade with each other, and predict how
they will trade. I now predict more
tenants will increase farm size right now than in any future period. Why?
Tenants can easily outbid many of their neighbors right now for 09
leases. If you’re ever going to want
more land, rent it now. If you don’t
want to outbid someone you know, rent further away; just somehow use this
once-in-a generation opportunity. On at
least some of your rentals, limit your downside rent risk with an outside
adjustor lease. You’ll do all the input
and output marketing and your returns should be better than custom farming
returns.
Let
others criticize and complain. Appraise
and act yourself.
Use
one of my relationship leases to make both parties better off. After all, isn’t making oneself better off
the only reason either party would sign a lease? Find the best possible owner/tenant and make
each other better off than any other alternative either party has, right now,
and, from now on.
Take
the time, make the effort to do it the first time; then, realize the benefits
of updating your relationship lease, almost automatically, from now on.
If
you want help, hire us. We’ll try to
show both owner and tenant how to be better off, partly by helping you decide
who pays and who benefits from fixing up the farm, and we’ll help our client
get all but perhaps $1 of the extra benefits.
Let
the tenant be responsible and be rewarded for deciding what to do and doing
what he/she does best, inside-the-farm-gate.
Let the owner take some/all of the outside-the-farm-gate changes in
input and output prices, yields, and government actions. Keep your rent current, from now on.
I’m
now going to show you why I said 06 rents were too high in July 06, and too low
after that. I’m going to do that by
first teaching you some new equations and a method for preparing and using
financial crop budgets.
Tenants
can prepare their budgets however they wish.
They need not show them to owners.
Owners
need not prepare their own farm budget from scratch. I suggest you learn enough about the
productivity of your land to be able to pick a representative third party
budget, such as the Purdue Crop Guide (PCG), which I prepared annually for
thirty years. I now use the average soil, rotation corn/bean PCG budget, for my
Owners,
maybe you’ll just pick either the low yield, average yield, or high yield
rotation corn/bean PCG budget for your “Benchmark Budget”(BB), a term I just
now coined. The expected yields need not
be exactly like yours. Why? As you will soon learn, you will use your
BB’s only to adjust for rent changes, and not to calculate the original rent. You accept the original rent when you accept
the rent bid of the tenant you select.
To
keep the tenant margin right, make sure the budget is prepared using the same
rules each year, or find someone who will adjust former year budgets to new
budget rules. I did this adjustment when
I used PCG 08 rules to re-calculate the 07 and the revised 08 PCG budget below.
The
Equations
Now,
here’s a perhaps new term called “Contribution Margin” (CM).
CM
is revenue minus variable costs.
CM
equals the returns to the tenant’s labor/mgt/machinery replacement resources, a
“Tenant Margin”(T M); plus the returns to the owner’s resources, a Cash Rent
(CR)
Revenue
is government DCP payments plus crop sales.
Variable
costs are seed, fertilizer, chemicals, fuel, interest, crop insurance.
Thus,
contribution margin (CM) = tenant’s return, a “Tenant Margin” (T M) plus
owner’s “Cash Rent” (CR).
Therefore,
CM= TM+CR
Therefore,
CM- CR= TM
And
CM-TM=CR
Note,
if you know any two of the three parts of the contribution margin equation, you
can find the third part. This is what
you will do as an owner after your tenant makes an acceptable cash rent bid.
Once
the owner agrees on the tenant’s cash rent bid, the owner subtracts the cash
rent CR from the owner’s BB contribution margin to find the tenant margin
TM. Each time the owner calculates a new
BB, the owner subtracts the same TM from the new CM to find current CR. It’s that simple.
While
it takes work to get the first TM, the owner uses it in new BB’s to calculate
new CR, almost automatically, until either party terminates in a timely
fashion. As in any cash rent lease, the
tenant is responsible for inside-the-farm-gate performance.
I
have two cash rent relationship leases, both with variations that I’ll not
share here. In the straight cash rent
lease, the owner prepares a BB each spring, say, in early March, after crop
insurance cost is shown in an updated PCG, or equivalent, with then current
crop prices, representative government DCP payments and variable costs. The owner subtracts TM from CM to get CR. Thus, the cash rent is current as of the date
the owner’s BB is prepared.
In
the outside-the-farm-gate adjustor lease, the owner asks the tenant how much
more original cash rent the tenant will pay if the owner takes some/all of the
change in outside prices-say at pre-determined dates at a local elevator, and
yield percentage change between, say, expected and USDA reported-the-next-March
county yields. If the owner accepts the
extra rent offer, the owner calculates a final BB, and CR the next March,
perhaps on the same date the owner shares the new year BB. With this lease, as with the straight cash
rent relationship lease, the next year rent is current as of the , say, March
date the new BB, with new prices and costs, is used.
Howard’s
Revised PCG Budgets*
(Using
basis Dec Corn @-.25, and Nov Beans @ -.30, for 06 and 07.
Using
basis Dec Corn @-.50, and Nov Beans @ -.80 for 08)
CM -
CR = TM
06 $151 -
$134 = $17
Too little for tenant’s resources
07* 301 -
155 = 146
Too high. Why? Excess earnings.
08 284 -
____ = ____
From PCG, 10/19/07, with my basis.
08** 430 -
____ = ____
*
I used 08 PCG yield, seed, fertilizer rules to revise 07* PCG budget. The 07
PCG CM budget is $269 with wider basis.
Final 07 CM in my outside adjustor lease in March 08 will be much more
than $301.
**I
used 08 PCG rules to revise 08** PCG using January 16, 08 CBOT crop prices and
$725 per ton NH3 fertilizer price.
The
06 and 07 CR are the per acre reported average rents for 157 bushel land in the
annual June rent survey taken by Purdue Ag . Economists. Because some tenants don’t change their rents
much, typical survey rents lag current economic conditions.
Note,
08 CM is now $146 higher than in Oct 19, 07 PCG, with my basis. (This is a dramatically different picture
than was painted in one of the Dec 07 Prairie Farmer articles, just
ahead of my Commentary.) This is
a $161 increase in my 08 rent budget over my 07 revised basis budget originally
created in Feb 07 in PCG, and much more than my final 07 rent, calculated in
March, 08. This is unbelievable, and unsustainable, but this is the current
number, as of 1/16/08, subject to my math errors.
[My
math errors can be avoided if Purdue PCG authors will update their own past
budgets, from now on, both when they change rules, and to recognize current
economic conditions. For example, if
they would also post a then current PCG budget, say, in early March, right
after crop insurance costs are known, owners and tenants could use the
contribution margins to update their relationship lease rents.]
No
wonder some owners are going to be mad when they learn how far off their leases
are from current economic conditions.
You
might ask why I suggest retaining the same TM, once it’s agreed on.
My
first answer is, either party can terminate and recalculate each year.
My
second answer is, for at least the last two hundred years, economists have
observed that tenants bid expected excess earnings into cash rent.
No
one tells present tenants to do this.
If
they don’t, their neighbors, from near or far, will.
This
is my observation of the present situation.
Because
some tenants won’t raise their 09 bids now, their neighbors will.
This
lesson is over.
Now,
for the question,
Do
you want a rent that’s typical or a rent that’s current?
A
typical rent lags, and tenants lose leases going up, and profits going down.
A
current rent leads to a perhaps long-term stress-free relationship.
Use
one of my relationship leases and retain a rent that’s current, almost
automatically, from now on.
We teach for free and for fun.
If you pay us, you learn more.
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We all have more fun.