Can You Believe Your
08 Contribution Margin?
Thanks to the new ethanol demand for corn, crop prices have increased faster than non-land costs. Few owners have kept their rents current with current economic conditions. However, since neighboring tenants, from near or far, soon run up the rent bids until excess earnings are bid into rents, much misinformation is now circulating in tenant coffee shops and wherever owners meet.
In the 06 Purdue Crop Guide (PCG), posted on the Purdue Ag Economics website in January 06, for an average yielding corn-bean rotation, the contribution margin (CM) was $151. At the time, I said rents were too high. Why? Survey reported average rents, if subtracted from the $151, left too little as returns for the tenant’s family living and machinery replacement.
Most farmers, who postponed sales until harvest or later,
realized higher than budgeted earnings in 06, and significantly higher earnings
in 07, for pricing at harvest or after.
Since 07harvest, nitrogen prices have increased, but 08 corn, bean, and
wheat prices have increased much, much more.
Who knows the future direction of prices, but currently,
08contribution margin is at $417 for an average yielding rotation corn-bean
W Ohio/
Higher risk charges and machinery replacement costs, and temporarily higher tenant opportunity costs, can explain a part of the budgeted $266 CM difference between the PCG 06 CM and my current 08 contribution margin. Tenants soon bid the rest into rent.
As word of this higher budgeted 08 CM gets out, the main consequence is that many owners are going to want to replace tenants who don’t offer more cash rent for 08 and/or 09. Or, owners can ask for up-front privilege payments in order to retain a crop share lease. Owners can also hire their land custom farmed. I might even plant my 80 acres myself, and also rent my brother’s land. Nah, now age 75, I want to play softball.
Tenants can be greedy and risk being gone, or you can use this “best opportunity for the rest of your lives” to rent more land at more nearly “right rent”! If tenants don’t want to outbid your neighbors, you can go further away. Just rent more now, if you ever plan to expand. Since many tenants don’t yet use the largest, and cheapest, per acre, combine, now is perhaps the best time for the rest of your careers, to somehow rent more land and/or farm together using one set of big machinery. Just do it, from now on, or really risk being gone soon.
CM is contribution margin. It is expected revenue minus variable costs. Thus, it’s the returns to your resources; an owner’s land, and a tenant’s labor/management and machinery replacement. Whether you realize it or not, both as an owner and as a tenant, you compare your personal budgeted CM’s as you choose which way to use your resources, from now on. After considering differences in risk and other preferences, you pick those alternatives that, you think, will make you best off.
Partly because of the current unbelievably large CM’s, and my awareness that many persons are likely to lose their leases if they don’t change their ways, I have decided to share two versions of my intellectual property, allowing both parties to create and nurture a perhaps long-lasting relationship lease. In both versions, once a “tenant margin” is determined, it’s used to keep cash rent current, almost automatically, at the beginning of each year. In the second version, owners, who are able and willing, get more cash rent in exchange for taking more “outside” risk. Tenants still take the “inside” risk, and, likely realize a larger tenant margin than if they hired on to do custom farming.
I’ve used this lease either
as a tenant or owner since 1997. Now an owner, my 07 rent was $50 per acre more
than my brother realized from a crop-share lease with the same tenant on
adjacent, similar land, and $150 more than our church charged a different cash
rent tenant on similar nearby land. Oh,
my tenant told me he again beat my budget by 12 bushels per acre, but he priced
his corn before harvest. The budgeted 08 difference for these parcels, all part
of my g-g-g grandfather’s 1814 farm, is now much more. It’s unbelievable!
True, but as an owner, I take the “outside” risks of CRP release, embargoes, or other government changes, fuel/fertilizer and other input and output price changes, peace, etc. and outside “drought” weather changes. The tenant gets his/her “inside” performances.
Take the time, make the effort to do it right. Just find the CM in a current third party budget, such as PCG, that’s similar to your farm. Use it as your Benchmark Budget (BB) CM. You don’t need to see the tenant’s budget, and you don’t care when he plants or harvests your farm. Just subtract your tenant’s rent from your CM to find the tenant margin (T M). Then, next year, subtract this same TM from your next year BB CM to find the next year cash rent. It’s that simple. Make sure your budget authors used the same rules both years, or make proper adjustments.
If your prospective tenant offers enough extra rent for you to take current year outside-the-farm-gate price and yield risk, plus future year changes in variable costs, subtract the tenant’s extra rent bid from your BB CM. The remainder is the new, smaller, tenant margin (T M), still likely higher than if the tenant signed on as a custom farmer. In March after harvest, use the sales prices on the dates and from the pre agreed local elevator, plus the % change between expected and NASS-reported county yields, and re-calculate your BB CM. Subtract the TM to find the final cash rent. Note this rent is current as of harvest. We’ll tell you more on our website, or in a phone call.
Learn more on our website: www.DHDoster.com
Email; Howard@DHDoster.com; phone 765 412 1495.
My wife, Barbara, and I are retired Purdue management teachers.
We work with either owners or tenants. We teach for free and for fun.
When you pay us, we work more, you learn more. We all have more fun.