GET/KEEP YOUR RENT RIGHT?

D. Howard Doster

December 3, 2009

FORWARD

Hello. Perhaps you got here because you read my rent article in the December, 2009 issue of Indiana Prairie Farmer.  Thanks for finding my website.  The rent survey begins on the next page.  This is a preliminary manuscript.  I will revise the flex rent, etc, ASAP, and post it here.

I created what I now call the 0-100 tenant margin cash rent lease in 1997 while a tenant wanting to have a way to update rent to current economic conditions, almost automatically, while I got the option to rent the land annually for up to fifteen years.  Although I didn’t use the term, “tenant margin”, I described much of the current lease in a 1998 Purdue Extension Publication, “What’s the Right Rent?” EC-708.  It’s at www.agecon.purdue.edu/extension/pubs.

No longer an employee, but, a professor emeritus, I’m also a former professional farm manager, and still an Accredited Farm Manager.  I considered, but didn’t start a farm management service when I retired.  By using one of the 100-0, 50-50, or 0-100 tenant margin cash rent contracts I describe in the following survey, I thought I could charge less, and serve more owners than other farm managers.  Instead, my wife and I are doing other things, as described elsewhere on our website.  Also, last summer, I played on four softball teams.

I continue to do what I can to “Revitalize Land Grants”.  See elsewhere on this website.  I am now offering to co-author a version of this survey with Purdue Extension Economist Bruce Erickson.  Bruce is now coordinator of the Purdue Top Farmer Crop Workshop, and is also an author of the Purdue Crop Guide budgets.  I did both jobs for the thirty years before I retired.

Bruce plans to put the survey on his Purdue Top Farmer website.  If enough persons send him their rent bids, perhaps he’ll calculate statistical means and standard deviations for each bid.  He can then add these statistics to future versions of the survey on his website.

As you study the survey, you will note my references to how you could calculate your bids faster and perhaps more accurately, both for your present leases, and for survey contracts, if only you had an appropriate spreadsheet.

I hereby invite you to join me as you “do what you can” to revitalize Land Grants.  Last month, I received a letter from the Ag Economics Department Head thanking me for my $1200 gift to “support Bruce Erickson’s effort in the farmland leasing area.” 

Bruce can use the money as he chooses in his professional endeavors. Maybe he’ll hire a student to program a leasing spreadsheet.  If I like what he does, I may make another gift.

I invite you to also gift to further Bruce’s work, or to further other professors’ work.  $1200 is how much per acre for you?   Suppose 1,000 Indiana farmers gifted that amount annually.  How much difference would that make?  Suppose owners also gifted something.  Email me at howard@dhdoster.com or call me at 765 412 1495, and I’ll tell you more about why I made the gift.  I just think it’s time for more farmers and landowners to gift appropriately.  Why? 

There are still some faculty at Purdue and elsewhere who are able and willing to do high quality, unbiased, soil site-specific cropping system research and management education, and we farmers and landowners can benefit, as our parents benefitted, if Land Grant Faculty do what they still have a comparative advantage doing.  Unfortunately, we’ve about lost that comparative advantage, and few persons have asked why or considered what we can do.

I realize what I’m about to say is a surprise to many persons, but professors just don’t get much, if any, unsponsored research funds to do their work.  Few, if any, companies want to sponsor unbiased cropping systems research or management education.  And, university administrators use their limited funds mostly for salaries and facilities. 

Commercial farmers pay for many other services, often included with products, perhaps causing the advice to be biased.  And, we don’t get some things we need.  For example, even with the recent Land Grant work on corn response to nitrogen that caused many of us to finally reduce N by more than $10 per acre, we still don’t have reliable soil site-specific N application recipes.  And, you and I are not effective or efficient in just doing our own test plots.

I say, you and I can create and carry out something significant, maybe even a non-profit, “Corn Belt Top Farmers”, to coordinate our efforts, as we “do what we do best, and trade for the rest”.  Read more elsewhere on my website. While you can gift individually “whenever”, just as I did recently, I think we could all use our mind/muscle/communications skills and money resources better if we were organized as something like Corn Belt Top Farmers.  While I’d prefer a younger person did it, I could volunteer to serve as an unpaid facilitator until you got the organization going, and hired a regular one.

By now, you’ve figured out why I’m giving you my intellectual property in the following survey.  I have more to give.  Just help start Corn Belt Top Farmers and I’ll share more, including more of my own management education stuff.  What fun!

Howard

 

 

 


GET/KEEP YOUR RENT RIGHT?

D. Howard Doster

November 27, 2009

SUMMARY

With most traditional cash rent, flex rent, crop share, or custom work, there is no provision for updating contracts to current economic conditions.  In this paper, a provision is described for updating these contracts, and new rent contracts are presented, based on changes in contribution margins in a third party budget, such as in the Purdue Crop Guide.  These budgets are prepared early each spring by Purdue Extension Specialists, who are qualified, unbiased third parties. They use the same rules as they update expected input and output prices, trend yields, and government payments. 

Contribution margin is defined as expected revenue minus variable costs.  The remainder is tenant margin and owner margin. Thus, when contribution margins for different years are compared, differences in expected input prices, output prices, yields, and government payments are accounted for in the difference in the two budgets. If the tenant margin is about the same in both years, these differences are mostly accounted for in the owner margin, the rent.  In this paper, once the parties agree to the first year rent, a process is shown for retaining about the same tenant margin in future years, almost automatically.

 

INTRODUCTION

Get your rent right.  Do whatever to negotiate effectively.

Then, keep it current.  Here’s why and how.

Are you satisfied with your rent each of the last five years?  If “yes”, enjoy your situation.  If “no”, read on.  Take the time, perhaps two hours or more, and make the effort to learn a new method for keeping your rent current, once you get it right-from now on-almost automatically.

Learn as you answer a rent survey.  The rent survey includes five parts.  Tenants may bid before deciding to share their bids with a prospective owner.  Alternatively, owners may ask tenants to bid on some or all of the contracts in the first four parts.  A fifth part is optional. 

In PART l, start with what you know.  Bid on traditional cash rent, flex rent, familiar crop share rent, & custom work contracts for each of three soils; low yield, average yield, and high yield. 

In PART ll, learn how to calculate your tenant margin and how to use it to keep your rents current each spring, almost automatically, for each of the contracts you bid on in Part l. 

In PART lll, bid on harvest tenant margin contracts, including a 50-50 flex-like cash rent, and three other cash rent leases; 100-0, where the tenant takes 100% of the risk of the outside the farm gate changes in harvest yield and prices; 50-50, where the tenant takes 50% of these changes; 0-100, where the tenant takes none of the risk of outside the farm gate changes in harvest yield & prices.  All the Part lll contracts are cash rents.  The owner is considered passive at the FSA office, and the tenant does what tenants do best; namely, buy-sell-grow the crop.

In Part lV, indicate how you want to adjust price dates and basis, as well as tenant margin as contribution margin changes.  Finally, tenants, answer how much you will lower your tenant margin bid-raise your rent bid- to get this type lease with its almost automatic update feature.

Tenants should bid on each contract as if that contract is the prospective tenant’s only opportunity for operating the farm.  The difference in a tenant’s bids indicates the tenant’s responsibility/risk/reward preferences.  Owners can also bid on each contract so as to quantify their responsibility/risk/reward preferences. 

For their own farm, perhaps some owners will ask some prospective tenants to bid on specific contracts and give their bids to the owner.  The owner can then compare bids and pick the contract and tenant applicant that best fits the owner’s responsibility/risk/reward preferences.  That’s why the author wrote this survey.

Both tenants and owners are asked to submit their survey bids to the author.  Why?  The author wants to calculate statistics for each contract, indicating means and standard deviations for each bid.  These statistics will then be added to the survey for future users to consider as they make their bids.

Part V, which tenants won’t share with owners, includes five types of questions. The author asks you to calculate the 2010 expected tenant margin for each of your leases.  This will be easier to do with a spreadsheet. Then, tenants are asked to rate their own production performance. 

Next, the author asks what you think each of the three land parcels would have traditional cash rented for in 2009, and what they will rent for in 2010.  Then, the author asks you to make an offer to purchase each parcel in 2009 and 2010, and, also estimate what you think each parcel would have sold for in 2009 and what each would sell for in 2010.  Then, assume you now own each of the three parcels.  What would you sell each for in 2009 and in 2010? 

Tenants are also asked their minimum tenant margin bids for several of the contracts.

The author wants to learn if these are useful rent/purchase questions. If you and others were to answer them each year, the change in your answers might be a good leading indicator of changes in the land market. 

If an appropriate spreadsheet were available, users could calculate tenant margins faster and more accurately.  Perhaps some persons will offer to help make this spreadsheet available.

Also in part V, owners are encouraged to have a third party earnings appraisal performed for their farm  and offer to show it to prospective and present tenants as they also ask tenants how they might decide who pays and who benefits from land improvements. 

 

PART l

Start Where You Are

First, before learning a new method, bid a current rent for a cash rent, a flex rent, a 50-50 crop share rent, and make two custom work bids.  Tenants should bid as if each contract is their only opportunity to farm the land.  Bid on each of three, say, 80-acre parcels; a low yield farm, an average yield farm, and a high yield farm. 

Remember that tenants pay self employment tax on their earnings from each of these alternatives.  However, owners pay self employment tax only on their earnings from participating crop share and custom work, and owners are non-participating for IRS and passive at FSA office for cash rent and flex rent contracts, perhaps unless the owner shares in the actual yield on a flex rent. 

After accounting for these differences, most tenants will likely bid least for traditional cash rent, since they are taking the most responsibility, and risk. Then, most tenants are expected to bid more on flex, still more on crop share, & most, by offering a low rate, on untimely custom work.  

Both owners and prospective tenants do their own earnings appraisal of their subject farm, which they do not share with the other party.  In the survey below, assume an owner has selected one of the budgets for three soils in Table 1, as his so-called “Benchmark Budget”.

Prospective tenants are expected to base their bids on the benchmark budget and adjust their bids to match their expected so-called “tenant margins” for each contract offered.  As you will learn below, after a tenant margin is agreed to, it can be used to adjust rents, from now on, using a then current third party benchmark budget.

Consider the budgets in Table 1. as being benchmark budgets for each of the three 80-acre parcels that you will bid on in each of the first three parts of the survey.  They are based on budgets prepared each spring for the current year, and each fall for the next year, using the same rules and then current expected input and output prices, by unbiased Purdue Specialists.  Expected yields are average all-season yields for a typical tenant who has a set of timely equipment.  Thus, his best date yields are higher and his last date yields are lower.

While your expected performance may be better or worse than the typical tenant, you will plant/harvest any added land, or some of your present acres, on less timely dates than you now plant/harvest any of your present land.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Table1. POSSIBLE OWNER’S BENCHMARK ROTATION CORN-BEAN BUDGETS, THREE SOILS                                                                           

Values from Preliminary 2010 Purdue Crop Guide, September 4, 2009 1/                                          

Except Revised using  CBOT Closing Prices on November 27, 2009                                                            

For 2010 December corn, less a local $.30 basis and November Beans, less a local $.45 Basis

 

Soil                                                        Low Yield                 Average Yield                 High Yield

Crop,                                                    Corn   Beans             Corn   Beans                  Corn  Beans                                                                                                               

Yield,                                                    127       39                  159      49                       191     59                                                                                              

price,                                                   $4.15 $10.03           $4.15  $10.03               $4.15  $10.03                                                 

sales,                                                   $527  $391               $ 660   $491                  $793   $608                                                  

Less variable costs, 

Fertilizer                                             $105    $53                $114     $64                   $124    $75

Seed                                                        78      52                      94      52                        94      52

Pesticides                                               37      29                      37      29                        37       29

Dryer fuel                                               19      NA                     24      NA                       29       NA

Machinery fuel @$2.70                       20        9                      20        9                        20         9

Machinery repairs                                 14      10                     14       10                       14       10

Hauling                                                    11        4                     14         4                        17        5

Interest                                                     7         4                       8         5                          4         5

Insurance/miscellaneous                     26       21                     26       21                       28        21                                                                                                                               

 total variable costs                                   $317   $182                $351   $194                  $367    $206                                                                             

Sales minus variable costs             $210   $209                $309   $297                  $426    $402                                               

DCP                                                            17                                 20                                    25                           

Rotation Contribution margin            $227                            $323                                $439

1/ Purdue Crop Guide Budgets are posted at www.agecon.purdue.edu/extension/pubs .

 

 

 

Contract Terms

While payment percentages and dates affect rent comparisons, ignore them in this survey.  Later, if the author creates a spreadsheet for persons to use to compare rents, payments on different dates can be discounted to net present cost based on the user’s stated interest rate.

Make all your rent and custom work bids based on the revenues and expenditures in Table 1, the owner’s benchmark budget.  Later, in Part lV, you will have an opportunity to indicate how you prefer to adjust Table 1. price dates, local basis, and some other things.  Using a spreadsheet, you can make these adjustments quickly.

Traditional Cash Rent

Question1.  Suppose the Table 1 crop budgets for each of the three soils-low, average, and high yield- represent three 80 acre farms that you are asked to make a cash rent bid on for 2010.  What is your per acre bid?   

 For low yield, 127 bu. corn-39 bu. beans; $______.

For average yield, 159 bu. corn, 49 bu. beans; $______.

For high yield, 191 bu. corn, 59 bu. beans; $______.

Please describe how you arrived at your bids.______________________________________ __________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

 

Compare your per bushel bids.  For years, there was no difference, per bushel, in reported bids for the three yields in annual Purdue rent surveys. How much per bushel of corn did you bid on high yield versus low yield land? 

Low yield $ .    per bu. ;  Average yield $ .    per bu. ;   High yield $ .    per bu.

In theory, high yield land will rent for more per bushel than low yield land.  Why?  As stated below, marginal land is farmed only at zero rent; thus, slightly above marginal land rents at $.01 per bushel, and slightly better land, at $.02 per bushel, etc. 

Perhaps land in any community tends to be rented at the rate for the average land in the community.  Perhaps this causes rent to be relatively “too high” on poor land and “too low” on good land.  Think about this observation as you proceed with this survey.

Recognize there is a huge difference in the productivity of prospective tenants.  Also, recognize that a prospective tenant may not bid what he can afford; he bids only as much as he needs to bid to win the contract, while still being better off than using his resources in any alternative way.  Also, some prospective tenants may choose to subsidize their bids from non-farm sources, and some prospective tenants may choose to exit the industry and use their mind/muscle/relationship skills and material resources where they have a comparative advantage elsewhere.

Traditional Flex-rent and 50-50 Crop Share

Flex-Rent

Assuming there is a minimum rent, this is a passive lease at FSA.  This lease is sometimes favored by professional farm managers who often change the required minimum rent or the per cent of the revenue going to the owner each year.  This lease is easier to manage than crop share, and owners are assured a minimum rent, while also getting the opportunity to share in excess revenue.  (If the flex rent includes a provision for the owner to share in the actual yield, the owner may be considered as participating as a crop share owner at FSA.)

For a tenant, this lease is almost as risky as traditional cash rent.  Why?  Like traditional cash rent, the tenant pays 100% of the variable costs.  Like traditional cash rent, the tenant makes a sizable minimum cash payment.  Unlike cash rent, the tenant gets only part of the revenue.  This lease is more risky than 50-50 crop share for the tenant because the tenant is responsible for 100% of the variable costs, and generally pays a sizable minimum rent.  Also recognize some prospective tenants may not bid on this lease for a low yielding farm in expected low contribution margin years, even if they have no other rental opportunities.

Suppose the owner states the minimum rent is as listed below for each soil.  Suppose the harvest price is the average October CBOT price for December corn and November bean futures, less your local average October basis.  Suppose the yield is based on the expected yield for each of the three soils in Table 1, adjusted by the percentage change between the expected county trend yield and the reported county yield.  Since USDA reported county yields are announced in early March, the final rent will be determined about the same time as parties are adjusting their next year rents.  These ways to determine price and yield may be used for other leases later in this paper. 

While there are other flex rent terms, suppose this is a flex rent where the owner gets the greater of a stated minimum rent, or your bid percentage of the calculated revenue. For each of the three soils described in Table 1 budgets, suppose an owner states the minimum rent bid listed below, and asks you what per cent of the revenue you will offer the owner?  Make you bid for each soil.

Soil                                                          Low yield               Average yield           High yield

Minimum rent                                         $80                         $120                          $180

Your revenue percentage bid           _____%                      _____%                    _____%

Note the owner or his farm manager may change the amount of the minimum rent each year.  Also, because your variable costs may change each year, you may want to change your % bid.

 

 

[In a flex rent, an owner may state a minimum rent and ask prospective tenants to bid the corn and bean yield above which they would share the bushels equally with the owner. 

Alternatively, an owner can set the yields above which the tenant would share the bushels, and ask prospective tenants to bid on the amount of the minimum rent when half the land is to be planted to corn and half to beans.  Suppose the owner has set the yields as shown below.  Refer to Table 1.revenues and costs.  What per acre minimum rent do you bid for each parcel?]

[Author’s note:  I will revise all flex rents, and post a new paper on my website ASAP.  I choose to get this posted tonight “as is”.  I will also number all the questions.  Please email me suggestions for other revisions at Howard@dhdoster.com ]

Yield                                                      Low                             Average                               High                                                                                  (corn bu.- bean bu.)    

Your minimum rent bid                $_______                      $_______                          $_______

 

50-50 Crop Share

In this lease, the owner is responsible for buying his share of the inputs, for selling his share of the crop, and has to worry about the tenant’s perhaps untimely performances.  The owner is likely materially participating, and thus pays self employment tax on crop share earnings, and is not passive at FSA. 

The tenant pays all the fuel, repairs, & hauling (Low-$34, A-$35.50, High-$37.50 in Table 1) for a 50-50 lease in this survey. Traditionally, when expected returns are low, owners have sometimes offered to pay for harvesting and hauling their share of the crops. In this survey, you can bid to offer to pay a privilege payment or to receive a privilege payment from the owner.     Refer to Table 1.amounts.  What is your privilege payment bid?         

Yield                                                                 Low                             Average                          High

Bid to pay Privilege Payment           $_________                $_________                  $_________

Or, bid to receive Privilege Pymt.   $_________                $_________                   $_________

Note, expected contribution margin is seldom so low that a winning tenant would bid to receive a privilege payment on the high yield land.

Even though rent is right when the lease is signed, when expected next year earnings changes as it has recently, the next year  rent is wrong, until it is somehow revised.  You will learn a way to revise rents in Part ll.  Likely, once you take the time and make the effort to learn the method and get others to learn the method, you’ll want to use it, perhaps even with one of the new contracts presented in Part lll.

Custom Work Bids

Operators sometimes choose to do specific field work jobs for other operators.  This is the prevalent type of custom work performed in the eastern corn-belt.  However, perhaps increasingly, some owners are asking for, and some tenants are requesting, to bid whole farm custom work bids.  This is the rate requested in this survey.

In Part ll, you will learn that a tenant margin is the return you want for the use of your resources.  Custom work rates are a type of tenant margin bid.  They reflect a tenant’s estimate of his opportunity costs for doing additional crop field operations without taking the responsibility or risk associated with a tenant lease. 

Owners with a custom work contract are materially participating and thus pay self employment tax on their earnings. Instead of renting additional land, tenants may offer a custom work bid when they are no longer eligible for any additional direct crop payments (DCP) at the USDA Farm Service Agency (FSA).

 Owners will take the buy/sell/yield responsibility and risk for crop production if an operator will bid a sufficiently low tenant margin bid for his crop production services to allow the owner to realize a sufficiently higher average, though more risky, crop farming reward.  Thus, the parties can choose to use a custom work contract when they have a different responsibility/risk/reward preference. 

In the eastern corn-belt, most custom work is done last, when expected yields are lowest, after the operator has done the fieldwork on his owned and presently rented land.  If an operator is able to rent other land, his custom work bid is his expected return from added rental, less his preference for not taking the rental risk.

Assume you are aware of similar land to rent, such as the land in this survey.  If you rent it, you will farm it last, after you have plant/harvested your other land.  Instead of renting it, you offer to custom farm it last. 

 

Traditional Custom Rate

Instead of renting it, you offer to do the same jobs as in the other alternatives, but custom farm it last.  What is your traditional rotation corn/bean per acre custom work bid?                          Low yield soil  $______.  Average yield soil   $______.  High yield soil  $_____.

Tenants, assume the same situation as in the previous question, except assume your opportunity cost for renting more land is lower because you have maxed out your payment limitations at FSA. What is your rotation corn/bean per acre custom work bid?                                                           Low yield soil  $______.  Average yield soil  $______.  High yield soil  $______.                        Hint: Note FSA payments in Table 1.

 

Timely Custom Rate

Owners can also ask operators to bid a rate for “timely” field work; that is, whenever the owner wants it done, such as the third day of corn/bean planting and the 12th day of corn/bean harvesting.  When you do custom work on the most timely dates, some of your present land is farmed in a less timely period than at present, and your expected yields are lower.

Although most operators now refuse to do custom work on timely dates, make your bid.  Your bid represents your opportunity cost for doing someone else’s farm on the best dates, causing you to do a comparable acreage of your owned or rented land later than you now complete plant/harvest, when expected yields are lower than if you don’t do the custom work.

What is your rotation corn/bean per acre custom work bid for doing the same field work jobs as in your other alternatives, but on the most timely dates?                                                                         Low yield soil  $_____.  Average yield soil  $______.  High yield soil  $_____.

The difference in your answers to each of the traditional and timely custom rate questions is your opportunity cost for not getting to do fieldwork on some of your other land on the timely days.  You might remember the Purdue PCLP linear program shadow prices per planter or combine hour.  Adjust those amounts to per acre opportunity costs.  Maybe just create a timely custom work opportunity in a PCLP solution, find your total opportunity costs, and then calculate your per acre opportunity costs.  Of course, the third and 12th days aren’t the best every year; thus, you may be willing to do timely custom work for a smaller extra charge above your traditional custom work rate.  But, doing timely plant/harvest custom work may cause you to be untimely with spraying, side-dressing, or non-harvest jobs in the fall.                                                   

By making your bids on each lease type, you started where you are.  Study your Part l bids.  Does the difference in your bids reflect the difference in your responsibility/risk/reward preferences?

 

 

A Search For Right Rents?

Perhaps persons in the market continue to search for new equilibrium rents.  Anyway, in the summer of 2006 sufficient numbers of persons making marketing decisions realized that US ethanol-making firms would soon want to buy much more corn.  This caused a shift in the demand curve for corn, which soon caused a shift in the demand for crop inputs, including for land around the world.  Much previously sub-marginal land for crops would now be cropped, and right rent increased on all cropland, throughout the world.

Rent Theory

Rent is right when both parties sign their lease contract.  Why?  Neither party would sign unless each thought this contract represented the best use of his resources.

No tenant would start to plant a crop unless he expected to more than cover his future costs, including his opportunity costs for using his resources elsewhere.  Land that’s not cropped is evidence of this statement.  It’s called sub-marginal, and by this thinking, land that’s called marginal is land that is farmed only at zero rent. 

 But tenants, acting in their own self-interest, soon bid expected excess earnings into land rent.  Thus, landowners are the residual claimants to crop farming profits.  That’s the theory, perhaps first summarized by David Ricardo, an early English economist, two hundred years ago.

Recent Rent Experiences

If USDA and Purdue reported average rents are indicative of what’s happened recently, that’s not what’s happened. While reported average rents have increased each year, both expected and actual tenant returns, so-called “tenant margins”, have fluctuated wildly, and by record amounts.

As used here, contribution margin is revenue minus variable costs.  It’s the return to the tenant’s resources, the tenant margin; plus the return to the owner’s resources, the owner margin or rent. 

Using Chicago Board of Trade (CBOT) prices less local elevator basis, contribution margins on the average yield farm budget in the February 1st Purdue Crop Guide were $149 in 2005, $ 185 in 2006; $319 in 2007; reached a record $436 in 2008; and dropped to $225 in 2009.

In spite of much lower input prices, the  preliminary 2010 contribution margin was only $216 in the September 4, 2009 Purdue Crop Guide.  Then, crop prices increased dramatically, and, using the same 2010 variable costs, but then current 2010 crop prices, the 2010 contribution margin was $323 on November 27.  

Reported rents have increased each year.  Thus, tenant margins have varied wildly, quite differently from accepted theory that tenants soon bid excess expected earnings into rent. 

The Problem/Opportunity

The change in demand for corn, etc, might be called the cause of recent wildly fluctuating expected and actual tenant returns.  The solution proposed in this survey is to encourage owners and prospective tenants to learn how to use so-called tenant margin cash rent leases so as to keep right rents current, and thus reduce fluctuations in tenant returns, from now on, almost automatically, until either party terminates the lease.

 

 

 

PART ll

From Traditional Cash Rent Bids to Tenant Margin Bids

Now that you have bid on traditional rents and custom work, how do you keep these rents current as economic conditions change?  This is a major problem for many persons currently.

As you consider how to keep rents current, you are ready to start to learn about tenant margins and a new method for keeping rents current, almost automatically.  Perhaps you will take the time and make the effort to get both parties to agree on a tenant margin.

As you, both owners and prospective tenants, answer survey questions, you will learn why and how to prefer so-called “tenant margin” bids over the more traditional cash and share, including flex and crop share, rent bids, as well as custom work rates.

Your first assignment was to make a traditional cash rent bid for 2010 for each of three farms.   You used your present method, whatever that is, for calculating each of these three bids. You referred to three 2010 contribution margin budgets(expected revenue minus variable costs) from the most recent Purdue Crop Guide, adjusted to November 27, 2009 futures prices.

Now, subtract your rent bid from the contribution margin found in Table 1, the adjusted Purdue budget.  The remainder is called your “tenant margin” for traditional cash rent.

Yield                                                      Low                             Average                       High

Table 1. Contribution Margin        $227                              $323                          $439

-Your Traditional cash rent bid     $_____                           $_____                      $_____

Your Tenant Margin                       $_____                           $_____                      $_____

From now on, for at least some of your bids, perhaps bid your tenant margin instead of bidding a cash rent.  How?  An owner can select a third party budget, such as one of the budgets in the Purdue Crop Guide as his so-called “benchmark budget”.  Then, when you calculate what you want to bid for his farm, just subtract what you want as your so-called “tenant margin” from the contribution margin in the owner’s benchmark budget.  The remainder is his rent. 

As cited later in Part lV, the owner will want to adjust his benchmark budget, and the tenant will want to adjust his tenant margin before doing this calculation.  However, to learn the tenant margin bidding process, just use the Table 1. numbers as the owner’s benchmark budget.  In Table I, the authors have already updated the crop prices to November 27, 2009.

Tenant Margin Uses

As shown in Table 1 budgets for each of the three soils,                                                                                                                                           contribution margin is expected revenue minus expected variable costs.                                   Also, contribution margin is returns to tenant resources plus returns to owner resources (rent).                                                                                                                                         

Three financial margins are used in this lesson;                                                                              contribution margin (CM), tenant margin (TM), and owner margin (OM or rent).                           

If a person knows any two of the margins, he can calculate the third margin.                                                              Equation A. Contribution margin equals tenant margin plus owner margin (rent).                                                            Equation B. Tenant margin equals contribution margin minus owner margin (rent).                                                 Equation C. Owner margin (rent) equals contribution margin minus tenant margin.

In this lesson, equation A is found in a budget prepared by qualified, unbiased third parties, such as the authors of the Purdue Crop Guide, who follow the same rules each time they make a budget.  They post a preliminary crop guide each fall for the next year, and a final crop guide about February 1st each spring. 

The authors encourage owners to choose the Purdue Crop Guide budget, with yields similar to the owner’s farm, as their benchmark budget.  Prospective tenants will then adjust their tenant margin bids appropriately to account for their expected performances, as well as what they expect their competitors to bid. 

You used equation B as you subtracted your traditional cash rent bid from an owner’s contribution margin as found in a Table 1. benchmark budget. The remainder is your traditional cash rent tenant margin.

Equation C is used each spring to find the new year rent or owner margin.                                  New year cash rent = new year spring benchmark budget contribution margin – tenant margin.                                

An after harvest outside the farm gate contribution margin is calculated for the new tenant margin cash rents described Part lll. Then, equation C is used to find the final rent.                                            Final rent = after harvest contribution margin – tenant margin.

With a tenant margin lease, your tenant margin remains about the same amount each year.  Any change in contribution margin changes the rent by about the same amount.  A constant tenant margin, perhaps with exceptions cited later, is consistent with economic theory.

Prospective tenants will also adjust their tenant margin bids to account for their responsibility/risk/reward preference.  This preference, and thus their tenant margin, is different in each of the contracts in this survey.

Adjusting Tenant Margin Bids

Also, prospective tenants need to adjust their tenant margin bid to match the owner’s benchmark budget contribution margin.  Why?  The yields, prices, or perhaps price basis in the owner’s budget may not reflect the tenant’s situation.  Therefore, a tenant needs to adjust his tenant margin.  When his adjusted tenant margin is subtracted from the owner’s contribution margin, the tenant wants the remainder rent to be the rent he wants to pay.

For example, suppose a tenant wants to bid so that his actual tenant margin is, say, $50(This is just an example number.)  If a prospective tenant thinks the owner’s benchmark budget contribution margin is $60 too large, the tenant just increases his tenant margin bid by $60 to $110.  By this process, a prospective tenant can accept using a benchmark budget that does not reflect the owner’s farm exactly.  This is one reason why the authors encourage owners to pick one of the budgets for the three soils in the Purdue Crop Guide as their benchmark budget.  Other reasons include:  It’s unbiased, and, using the same rules, it’s updated annually.

Prospective tenants will also adjust their tenant margin bids to account for their responsibility/risk/reward preference.  This preference, and thus their tenant margin, is different in each of the contracts in this survey.

 

Tenant Margin for Flex Rent

Now, try calculating your tenant margin for your earlier flex rent bid, by again using a Table 1. contribution margin.

First, expected rent= Table 1. Revenue – (excess yield X price)/2.  [No, not complete]

Yield                                                  Low                               Average                          High

Revenue                              [change something.]

Minus (Excess yield X price)/2           [change something here.]

Equals expected rent

 

Second, tenant margin = Table 1.contribution margin – rent.  [no, not complete]

Contribution margin              $227                                    $323                                $439

Minus expected rent

Equals tenant margin

Then, for a new year, subtract tenant margin from new year contribution margin to find new year rent.  And, calculate new year revenue from ½ excess bushels.  Then, new year rent minus revenue from ½ excess bushels equals minimum rent payment. 

Wow, even though this calculation can be performed quickly in a spreadsheet, once you learn how to bid on a 50-50 flex-like tenant margin cash rent lease in part lll, you’ll likely prefer it to a traditional flex rent.  Of course, tenants may not want any flex-like lease.

 

Tenant Margin for Traditional 50-50 Share Rent

In this lease, the tenant pays 100% of the Table 1 machinery fuel, repairs, and hauling.  This is $34 in low soil, $35.50 in average soil, and $37.50 in high soil budgets.  The parties share equally the remaining variable costs and the revenue. Therefore, the tenant margin calculation is as follows.

Contribution margin (CM)       $227                                   $323                                 $439

-Tenant’s extra variable costs   $34                                      $35.50                             $37.50

Remaining CM                           $193                                    $287.50                            $401.50

One half remaining CM                96.50                                  143.75                              200.75

Plus or minus privilege pymt. $_____                                  $_____                            $_____

Equals expected rent                $_____                                 $_____                            $_____

Then,

Expected CM                              $227                                      $323                               $439

Minus expected rent                $_____                                  $_____                           $_____   

Equals Your Tenant Margin     $_____                                  $_____                          $_____

Then, for a new year, subtract tenant margin from new year spring contribution margin to find new year rent.  [Adjust privilege payment after first adding/subtracting change in extra tenant costs.] 

Remember, the owner is likely materially participating and thus pays self employment tax, and needs to buy/sell and worry about the tenant’s actual perhaps untimely performances.

 

Custom Opportunity Cost Changes

Earlier, you learned that your custom work bid is a tenant margin.  When a new year contribution margin is different from the previous year contribution margin, your opportunity cost changes for using your labor/management/machinery resources to plant/harvest your other land on the best dates. 

Suppose a new year expected contribution margin is “low”, what is your minimum custom rate bid?

Question Low yield soil  $_____.  Average yield soil  $_____.  High yield soil  $_____.

Compared to the previous spring contribution margin, what per cent of the contribution margin change above your minimum bid do you want to add/subtract to/from your traditional custom rate bid?

Question Low yield soil  $_____.  Average yield soil  $_____.  High yield soil  $_____.

While recognizing you would never bid less than your untimely custom work bid, compared to the previous spring budget contribution margin, what per cent of the contribution margin change in the current spring budget do you want to add/subtract to/from your timely custom rate bids?     Question   What _____%?

 

The Tenant Margin Bidding Process

Once owners and prospective tenants learn the process, you can bid your desired tenant margin, for future year rents, both for farms you presently rent, and for farms you want to bid on, perhaps as much as a year in advance, long before you know what the variable costs will be for that spring. 

First, somehow decide what you need to bid to win the lease and still be better off than using your resources in any other opportunity.   Then, use your tenant margin to keep rents current with current economic conditions, almost automatically.  

The parties need to agree on the contract type and the tenant margin for that type.  Then, you merely subtract the tenant margin from the contribution margin in the owner’s current year Benchmark Budget.  The remainder is the rent for a traditional cash rent.

Because of differences in your responsibility/risk/reward preferences, you will bid a different tenant margin amount for each of the leases in this survey.  Once you and others take the time and make the effort to learn and use the tenant margin process, a prospective tenant may want to bid his tenant margin for any or all of the contracts in this survey.  A prospective tenant can ask an owner to also answer the survey so at to quantify his responsibility/risk/reward preferences. 

After comparing his answers with answers from a prospective tenant, an owner can pick the contract and rent that best maximizes his return to his resources.

An owner can also initiate the process by asking prospective tenants to bid on any or all of the survey contracts, as if each bid is the prospective tenant’s only opportunity to operate the farm.  After answering the survey himself, the owner can pick the contract and tenant that best fits his goals.

 

 

 

 

 

 

 

 

 

 

PART lll

Now, you are about to learn some new tenant margin cash rent leases.  Once the parties agree on the tenant margin for the lease you decide to use, you subtract that tenant margin from a harvest contribution margin.  The remainder is the cash rent.  All the following leases can be considered as using a harvest contribution margin to calculate the rent.  However, in the 100-0 tenant margin cash rent, since the tenant takes 100% of the risk of price and yield change after the rent is set, the rent is not changed once it is set each spring.

 

Spring Versus Harvest Contribution Margins

Earlier you saw how spring contribution margins, and likely, most tenant margins, varied over the last five years.  Now consider how poorly spring contribution margins predicted harvest contribution margins. No wonder many owners now consider shifting to flex rent, crop share, or custom work. 

Actual contribution margins increased from spring to fall harvest in 2006 and again in 2007.  Then, on July 3, 2008, average farm expected contribution margin reached a record $701, before falling to under $200 by harvest.  Even though spring contribution margin for 2009 was much lower, at $225, than the previous spring’s $436, it dropped still more to $123 on Sept 4 before increasing to $235 on November 27, before accounting for yield changes.  Thus, each July when some persons start to negotiate next year rent, an outsider might have said, “Rents are ‘too high in summer 2006’, ‘too low in summer 2008’, and ‘too high in summer 2009’.” 

Perhaps some tenants did not bid up rents because of this variation in returns.  Perhaps this also indicates why some owners were interested in shifting to crop share, flex rent, or even custom hire recently.

Perhaps this also indicates why some owners may be more able and willing to use the below described  50-50 flex-like cash rent, 50-50 share-like cash rent, or 0-100 custom-like cash rent if tenants bid a sufficiently low tenant margin for an owner to justify taking the extra risk.  Learn how to bid a tenant margin for these cash rents now.  You’ve already learned about the traditional share and flex rents.  Perhaps you’ll agree the flex-like cash rent, and share-like cash rent have significant advantages over the traditional share and flex.  You and your owner may also be interested in the 0-100 custom-like cash rent instead of traditional custom hire.

 

 

 

Tenant Margin Cash Rent Responsibility/Risk/Reward Differences

Four tenant margin cash leases are considered now.  They are described in order of the likely size of the tenant margin.  After you bid your desired tenant margins for each lease, you will learn how to calculate the rent for each lease.

In all four tenant margin cash leases, the tenant pays for 100% of the variable costs, including any crop insurance, owns the crop and realizes 100% of his perhaps superior buy/sell/grow performances.  The tenant may or may not have the same risk/reward preferences as the owner.  With the four tenant margin cash rent contracts, the tenant can bid his risk/reward preference for each lease by offering a different tenant margin bid.  Then, the owner can pick the lease type and thus the risk/reward preference that he thinks will maximize his rewards. 

Likely, a tenant will bid his highest tenant margin-and, thus, the lowest rent- for the 100-0 tenant margin cash rent contract.  Why?  The tenant takes 100% of the yield and price risk after the rent is set each spring.  Thus, the change in contribution margin at harvest does not affect the rent.

This lease is really the same as the cash rent lease you calculated in Part ll.  It is included here so you can more easily compare it to the other three harvest contribution margin cash leases included below. If you have a spreadsheet to calculate the other three leases below, you can also use it to calculate the tenant margin for this lease.  How?  For the 100-0 lease, just enter the entire amount of the cash rent in the “minimum rent” cell.  Really, just enter your desired tenant margin amount in the desired tenant margin cell and the spreadsheet will put the entire rent in the minimum rent cell. 

Perhaps a tenant will bid his next highest tenant margin for the 50-50 flex-like cash rent.  Why?  As with the 100-0 rent, the tenant pays all the variable costs, plus a minimum cash rent, but gets only 50% of the outside the farm gate revenue, at least in the version in the survey, and other flex-rent versions have similar features.  

A tenant will likely bid a lower tenant margin for a 50-50 share-like tenant margin cash rent.  Why?  Benchmark budget variable costs are subtracted from the outside the farm gate revenue before the contribution margin is divided 50-50.  

Of the four tenant margin cash rent contracts, a tenant will likely bid the lowest tenant margin for the 0-100 tenant margin cash rent contract.  Why?  The tenant takes the least risk, while still having the opportunity, if he chooses to use it, to try to “beat the benchmark budget” input and output prices and yields.  

Custom rate bids are also tenant margin bids, and, since the tenant takes less responsibility and risk, the untimely custom rate bid is likely lower than any of the four tenant margin bids.  With custom work,  the owner buy/sells the crop inputs and outputs, and pays self-employment tax; unlike with the four tenant margin cash rents where the owner perhaps pays no self employment tax on the cash rent.

 

 Use the appropriate Table 1 Purdue Crop Guide budgets, adjusted by your price preference described in Part lV below, to find each of the four tenant margin cash rents below.

Find four tenant margin cash rents.  The tenant buys/sells/produces and owns the crop in all four tenant margin cash rent leases.  He pays for any crop insurance he chooses to buy, and he gets any insurance payment. 

(If FSA will still call this a passive lease, perhaps some parties will include a lease clause saying, “Even though the tenant owns the crop and pays the GRIP crop insurance, the owner is charged for the same per cent of the crop insurance premium, and gets the same crop insurance reward, as the owner shares in risk; ie, 50% in a 50-50 share-like cash rent or 100% in 0-100 custom-like cash rent.”  To use this feature, the tenant margin can be increased each March, as soon as the insurance premium is known.  Then, when the insurance reward is known, the tenant margin can be decreased by the insurance proceeds due the owner.)

Each of the four tenant margin cash rent contracts includes a minimum cash amount so as to qualify as a passive rent for the Farm Service Agency (FSA).  The rent for the 100-0 cash rent qualifies for the minimum cash amount.

 

100-0 Tenant Margin Cash Rent

100-0 cash rent = spring benchmark budget contribution margin - desired tenant margin.                                                                                                                        

The 100-0 indicates the tenant takes 100% of the outside the farm gate crop yield and crop price change effect after the tenant margin is subtracted from the spring benchmark budget contribution margin, and the rent is calculated.

This is like traditional cash rent, except the tenant’s desired tenant margin is subtracted from the contribution margin. The remainder is the cash rent. 

To recognize the value to him of having an owner offer a tenant margin lease that is updated using a current new year contribution margin, almost automatically, until either party terminates the lease; a prospective tenant may bid a lower tenant margin here than he would have bid in a traditional cash rent.   Your answers to the 100-0 cash rent below are the same amounts as you answered earlier. They are just put in the same format as the other three tenant margin leases.

100-0 cash rent.  Low yield rent = Low yield contribution margin of $ 227 – desired $______ tenant margin = $______cash rent.             

100-0 cash rent.  Average yield rent = Average yield contribution margin of $ 323 – desired $______ tenant margin = $______ cash rent.           

100-0 cash rent.  High yield rent = High yield contribution margin of $439 – desired $______ tenant margin = $______cash rent.

 

Harvest Contribution Margin

Suppose a new contribution margin budget is calculated after harvest, using the spring budget DCP plus outside the farm gate at harvest estimates for yields and harvest prices to find revenue, before subtracting the spring budget variable costs to find harvest contribution margin.

The same harvest contribution margin is calculated for the remaining three tenant margin cash rent contracts; namely, 50-50 flex-like cash rent, 50-50 share-like cash rent, and 0-100 custom-like cash rent. 

Suppose the harvest price is selected in Part lV below. 

Then, harvest contribution margin = {[corn spring budget yield x (USDA reported county yield/expected county trend yield) x harvest price – spring budget variable costs] +[ bean spring budget yield x (USDA reported yield/expected county trend yield) x harvest price – spring variable costs]}/2 + spring budget DCP.

For this survey, suppose the expected county trend yields and the actual county yield reported by USDA the first week in the following March are the same at 159 bu. corn and 49 bu. beans.  Then:

Low yield harvest contribution margin = {[127 bu. corn x (159/159) x preferred corn harvest price] – spring budget corn variable costs + [39 bu. beans x (49/49) x preferred bean harvest price] – spring budget bean variable costs]/2 + $17 DCP payment from budget.

Average yield harvest contribution margin = {[159 bu. corn x (159/159) x preferred corn harvest price] – spring budget corn variable costs + [49 bu. beans x (49/49) x preferred bean harvest price] – spring budget bean variable costs]/2 + $20 DCP payment from budget.

High yield harvest contribution margin = {[191 bu. corn x (159/159) x preferred corn harvest price] – spring budget corn variable costs + [59 bu. beans x (49/49) x preferred bean harvest price] – spring budget bean variable costs]/2 + $25 DCP payment from budget.

Of course, the reported outside the farm gate harvest yields and prices will be different than in the spring budgets.  With a spreadsheet, the above equations can be quickly calculated using the reported county yields and harvest prices.

 

Then, since FSA requires a minimum rent, the next three lease equations include a minimum rent.  It’s whatever the owner demands for the 50-50 flex-like, $1.00 for the 50-50 share-like, and $1.00 for the 0-100 custom-like tenant margin cash rent.

 

[This flex may need to be revised.]

Flex-like 50-50  tenant margin cash rent = $______ minimum rent +[ (outside farm gate harvest contribution margin – minimum rent - tenant margin) divided by 2].  This lease is for owners who want a much larger than $1.00 upfront base rent subtracted from the contribution margin, before the tenant margin is subtracted and the remainder is shared 50-50.  Note below that a tenant is asked to bid both a minimum rent and a tenant margin.  In actual leases, some owners may set the amount of the minimum rent, and the tenant then bids only his desired tenant margin. 

Unless FSA allows a negative minimum rent-unless FSA allows a tenant to receive a privilege payment-a tenant may choose to not bid on one or more of the three soils.  Why?  No one will bid unless he expects to more than cover his future costs, including his opportunity costs.  Using this flex-like 50-50 cash rent lease, in years when the expected harvest contribution margin may be small, the tenant won’t get his opportunity cost returns to his resources.                        

Low yield flex-like cash rent = $______ minimum rent + [(outside farm gate harvest CM of $227 - $______minimum rent – your $______ tenant margin) /2].

Average yield flex-like cash rent = $______ minimum rent + [(outside farm gate harvest CM of $323 - $ ______ minimum rent – your $ ______ tenant margin) /2].

High yield flex-like cash rent = $ ______ minimum rent + [(outside farm gate harvest CM of $439 -$______ minimum rent – your $______ tenant margin) /2].

 

 

50-50 share-like tenant margin cash rent = $ 1.00 minimum rent + [(outside farm gate harvest contribution   margin - $1.00 minimum rent– tenant margin) divided by 2].  The 50-50 indicates the tenant gets 50% of the amount remaining after the tenant margin plus $1.00 is subtracted from the outside the farm gate harvest contribution margin.          

Harvest contribution margin = (outside farm gate reported yield times price) + spring benchmark budget DCP payment – spring benchmark budget variable costs.

Unless FSA allows a negative minimum rent-unless FSA allows a tenant to receive a privilege payment-a tenant may choose to not bid on one or more of the three soils.  Why?  No one will bid unless he expects to more than cover his future costs, including his opportunity costs.  Using this 50-50 tenant margin cash rent lease, in years when the expected harvest contribution margin gets less than twice the desired tenant margin, the tenant won’t get his opportunity cost returns to his resources. Therefore, a tenant won’t bid on this lease.                                                                                                                

Low yield (CM of $ 227 – $1.00 minimum rent - desired $______ tenant margin) / 2 = $_____ rent.                    

Average yield (CM of $323 – $1.00 minimum rent - desired $______ tenant margin) /2 = $______ rent.  

High yield (CM of $439 – $1.00 minimum rent - desired $______tenant margin) /2 = $______ rent.

 

 

0-100 custom-like tenant margin cash rent = $1.00 minimum rent + (outside farm gate harvest contribution margin – $1.00 minimum rent - desired tenant margin).   The 0-100 indicates the tenant gets 0% of the amount remaining after the tenant margin and $1.00 minimum rent is subtracted from the outside the farm gate harvest contribution margin.  

This lease is for owners who want to take 100% of the risk in harvest contribution margin  caused by reported outside the farm gate changes from the spring benchmark budget in county yields and harvest prices.  Thus, the owner risk is similar to custom work, but the owner has less responsibility; and, the tenant owns the crop and does what a tenant does best-buy/sell/produce.                                                                                                                    

Low yield 0-100 cash rent = $1.00 minimum rent + $227 - $ 1.00 minimum rent - $______ desired tenant margin.                                     

Average yield 0-100 cash rent = $1.00 minimum rent + $323 - $ 1.00 minimum rent - $ ______ desired tenant margin.                              

High yield 0-100 cash rent = $1.00 minimum rent + $439 - $ 1.00 minimum rent - $______desired tenant margin.

Did you bid the same tenant margin for low, average, and high yield soil?  Why or why not? 

____________________________________________________________________________ 

____________________________________________________________________________.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PART lV

The pricing alternatives and lease exceptions described below can apply to any of the lease or custom work contracts described in the first three parts.  If/when a spreadsheet is created for calculating the tenant margins and/or rents in this survey, the spreadsheet can quickly include the terms you describe below.

Pricing Alternatives

Question.  An owner may prefer to not use the crop prices in the Purdue Crop Guide budgets.  Why?  They are for one day only.  Also, his local basis may be different than the basis used in the crop guide budgets.  Below, check the price alternative you prefer, and enter the prices.                Price alternatives include: 

lV-1. Check ____Prices as reported in the crop guide budgets.                                                            (Not recommended for any contracts, and not useful for updating after harvest contribution margin for the 50-50 flex-like, 50-50 share-like, or 0-100 tenant margin leases, since there is no stated harvest date.)

 lV-2. Check____ Average February and October CBOT December corn and November bean futures as reported by the crop insurance agency.  With this alternative, a tenant should increase his tenant margin bid to account for the local basis that neither party gets, and also to compensate him for the risk he takes that year-to-year basis change may impact him negatively.  Of course, the basis may also narrow significantly from spring to fall as in 2009.                                                                   lV-3. February corn $_____;      lV-4. beans $_____.                                                                                              lV-5 October corn $______;     lV-6 beans $______.

 

lV-7. Check____ Average February and October CBOT prices, less a current year local basis at an agreed elevator.  With this alternative, a tenant can afford to bid a smaller tenant margin than if basis is not considered.                                                                                                                                                   lV-10. October corn $_____;          lV-11. beans $______.

 

lV-12. Check____ Average CBOT prices for the ten marketing days centered on June 1, less a local basis; and average CBOT prices for the ten marketing days centered on November 1, less a local basis.   With this alternative, a tenant can afford to bid a smaller tenant margin than if basis is not considered.                                                                                                                                                                      lV-13. June corn $_____;    lV-14. beans $_____.                                                                                              lV-15. November corn $_____;    lV-16. beans $_____.

 

lV-17. Check_____ None of the above. 

For spring, use lV-18. Corn $_____;  lV-19. Beans $_____.

For harvest, use lV-20. Corn $_____;  lV-21. $_____.

Why? __________________________________________.

 

Exceptions

In this survey, the authors allow you to bid on two exceptions; namely, so-called margin compression, and machinery replacement.  Prospective tenants should recognize, however, that owners may not select them if they adjust the tenant margin too much.  Both parties should recognize the lease can be terminated after the fall Purdue Crop Guide for the upcoming year is posted; thus, the exceptions can also be re-negotiated at that time, if desired. 

Margin Compression Risk Questions

When crop prices are unusually high, tenants are more vulnerable to “margin compression” loss, since they can’t get the LDP “insurance” until prices fall a long way.  What per cent of any increase in next year contribution margin do you want added to your next year tenant margin to offset this risk?  Question lV-22.  What_____%. 

Similarly, when crop prices are unusually low, tenants can get LDP insurance if prices drop some.  What per cent of any decrease in next year contribution margin do you accept being subtracted from your next year tenant margin?  Question lV-23.  What______%.

 

Machinery Replacement Costs

Annual machinery replacement costs often increase $1 to $2 per acre.  How many dollars, if any, do you want to increase your tenant margin each year to account for this possible increase?                                                                                                                                             Question lV-24.$______.  For each future year, add this amount to the tenant margin in all of your tenant margin cash rents and both of your custom work bids.

 

Rotation Effect on Tenant Margin Bid

An owner may ask prospective tenants to bid on a rotation corn/bean benchmark budget, or on a corn budget one year, and a bean budget the next year.  How does the owner’s choice of these benchmark budgets affect your tenant margin bid?  Answer by checking only one of the next three questions, plus “Why?”

There is no affect on my tenant margin bid. Question lV-25. ____ (check, if true.)

Question lV-26. I will bid $____ more tenant margin (lower rent) on a corn only budget.

Question lV-27.  I will bid $____ more tenant margin (lower rent) on a bean only budget.

Question lV-28.  Why?___________________________________________________________.

 

Tenant Margin Lease Value

You have now learned how to bid your tenant margin, and how to use it to update your cash rent each spring, almost automatically.  Both owners and tenants can benefit by having less stress. How much is this feature worth to you?  Answer by indicating how many dollars per acre would you reduce your tenant margin in order to have this feature in your lease, versus just bidding a traditional cash rent, with no almost automatic update feature.                          Question lV-29 $_____ .

                                      

 

 

 

 

 

 

 

 

PART V

Calculate your Tenant Margins

Calculate your expected tenant margins for each of your present 2010 leases.   Perhaps use the appropriate equations in the earlier parts of this paper.

Then, what is your highest expected 2010 tenant margin?  $______/acre.

What is your lowest expected 2010 tenant margin?  $______/acre.

Why is there so much difference?_________________________________________________      _____________________________________________________________________________.

This assignment will be much easier if/when you can use an appropriate spreadsheet.

 

Rate Your Production Performance

The author has asked others to rate their production performance many times.  Now, it’s your turn. 

Assume you and other tenants could all farm the same farm the same year using the same machinery, and the same seed, fertilizer, pesticide, etc. recipe.  The only difference between you and the others is deciding when to do the jobs, adjusting the equipment, and doing the jobs.

How much difference in expected corn yield is their between the next to best tenant and the next to worst tenant in the area around you?   _____ bushels/acre difference.

Where are you in that range?  _______.

While there are also differences in buying/selling skills and other things, the above differences suggest why some persons thrive while paying the going rent while others barely survive.

Everyone has a comparative advantage for using his mind/muscle/relationship skills and material resources doing something productive.  If you are not above average, or can’t quickly get above average, in your production performance, exit the industry.   Use your resources where you have a comparative advantage.

Trained as an economist, the author observes how persons trade with each other, and predicts how they will trade.  Corn Belt crop farming is a competitive industry.  To compete effectively, efficiently, and enjoyably, you have to be highly skilled at production, marketing, finance, and personnel management.  You have to somehow use your scarce plant/harvest time operating the largest available field machinery.  If you are not big enough, and choose to not get big enough, to need big machinery yourself, somehow work together with others, and use the largest available machinery.

To learn how, perhaps attend the Purdue Top Farmer Crop Workshop held each July, and the Purdue Farming Together Workshop held each January.  The author helped start both, and then coordinated both for many years.  They are still your best opportunity for learning what they teach.

 

Your Estimate of Market Rent

How much per acre do you think each of the three 80-acfre farms described by the Table 1 budgets would have rented for in 2009?

Question  Low yield, $_____/ac.  Average yield, $_____/ac.  High yield, $_____/ac.

 

How much do you think each will rent for in 2010?

Question  Low  yield, $_____/ac.  Average yield, $_____/ac.  High yield, $_____/ac.

 

Your Estimate of Market Sales Price

How much do you think each of the three parcels would have sold for in 2009?

Question  Low yield, $_______/ac.  Average yield, $_______/ac.  High yield, $_______/ac.

 

How much do you think each of the three parcels would sell for in 2010?

Question  Low yield, $_______/ac.  Average yield, $_______/ac.  High yield, $_______/ac.

 

 

 

Your Buy Reservation Price

How much per acre would you have offered for each parcel in 2009?

Question  Low yield, $_______/ac.  Average yield, $_______/ac.  High yield, $_______/ac.

 

How much per acre would you offer for each parcel in 2010?

Question  Low yield, $_______/ac.  Average yield,$_______/ac.  High yield, $_______/ac.

 

Your Sell Reservation Price

Suppose you owned each of the three parcels.

How much per acre would you have sold each parcel for in 2009?

Question  Low yield, $_______/ac.  Average yield, $_______/ac.  High yield, $_______/ac.

 

How much per acre would you sell each parcel for in 2010?

Question Low yield, $______/ac.  Average yield, $_______/ac.  High yield, $_______/ac.

 

Your Minimum Tenant Margin Bids

Suppose you can still farm another 80 acres in a timely fashion, and had no good alternatives for using your resources.

What is the most traditional cash rent-thus the lowest tenant margin bid- you would now bid for each of the three parcels?

Question Low yield, $_____/ac.  Average yield, $_____/ac.  High yield, $_____/ac.

 

 

 

An Earnings Appraisal

Both owners and tenants have the job of estimating a farm’s expected earnings.  Each do their job before they sign a lease.   However, some owners and some prospective tenants just don’t have a realistic idea.  Further, some farms need lime, drainage, build-up fertilizer, whatever.

Professional farm managers do an earnings appraisal at the beginning of their contract.  They, and/or soil fertility specialists could do a more precise soil site specific earnings appraisal.  It could include expected costs and yields for the transition years until the farm was in maximum economic condition.   They or others could counsel owners and prospective tenants as, together, they decide who pays and how they are rewarded for making improvements.  This could become a win-win solution.

How much more rent would you offer to pay each of the first two years if the owner were to have a soil site-specific earnings appraisal, including soil tests and estimated site-specific yields, done and share it with you before you make your rent bid? 

Tenants only: Question $_____/acre each year.

 

As a potential land buyer, how much per acre more would you bid if an owner would share this information, prepared by a recognized third party expert, before a land auction?                                        Question  $______?ac. more.

 

Please share your farm build-up practices.  Who pays what, and how are they rewarded?

 

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CONCLUSION

What a great way to end this survey!  Thanks much for participating.  In addition to answering the questions, please suggest how to improve the survey, perhaps including how to make it shorter.

Now that you have learned the tenant margin bid method, encourage your other party to take the time and make the effort to learn it.  Then, use it on some of your rentals.  Expect to have a rent that’s current, either each spring or each fall, from now on, until either party terminates the lease.

Once you and others take the time and make the effort to learn and use the process, perhaps many owners and prospective tenants will prefer to use one of the new tenant margin cash rent leases described in Part lll. 

 If/when an owner asks a prospective tenant to bid on specific contracts, each tenant’s bid amounts should cause him to be indifferent as to which contract an owner chooses.

The owner can then determine his responsibility/risk/reward preferences, before selecting the contract type and tenant’s bid that suits him best.  Rent will be right when the parties sign their contract.  And, it will be current with current economic conditions, from now on.

Consider how this process will reduce stress for both parties!  That’s the purpose of doing this survey, and then perhaps using one of the tenant margin contracts.

 

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