WHAT’S YOUR RIGHT RENT FOR ‘08?

Howard Doster

August 3, 2007

As a management teacher-coach, I enjoy helping owners and tenants create and nurture a long-lasting relationship, starting by getting rents right and keeping them current, almost automatically. As a long-time Extension Specialist, I couldn’t take sides. Now, I can be an advocate for either party. Either way, I like to start by creating a Purdue-like budget for the subject farm. Why? I prepared Purdue’s crop budgets for thirty years, I’m familiar with the process, and it’s a good starting point. I negotiate from that number for the benefit of the person I’m working for.

When you hire me, I’ll show you how I adjust the rent, either straight cash rent or my adjustor lease, almost automatically, to keep it current each year. While I enjoy writing this, it’s even more fun when you pay me.

You start where you are.

What is your ‘07 rent?

Do you want a rent that’s current

Or a rent that lags economic conditions?

If your rent was right for ‘06, it is wrong for ‘07.

Right rent for ‘06 now looks to be wrong for ‘08, ‘09, ‘10.

Terminate now before it’s too late for ‘08.

Educate yourself and your significant others.

Then create and negotiate.

Landowners create rental terms.

But, they must find a tenant who accepts the terms.

Perhaps you’ve had the same landlord/tenant

For many years.

Somehow, adjust your lease

To current economic conditions now

To nurture your relationship

And increase the likelihood

You’ll stay together in the future.

As an economist,

I observe how persons trade with each other

And predict how they will trade with each other.

Like many of you,

I missed seeing the new ethanol-related corn demand.

Now, given the government mandate, and the plants coming on-line,

I predict prices will average much higher, with still higher drought related price spikes.

I think right rents reflect expected higher input costs in ‘07 and beyond as well as expected much higher crop prices, thanks to the new ethanol demand for corn. That’s making current adjustments after first considering owner’s wishes, soil types, drainage, fertility, field shapes and sizes, distance to markets, and competition for land.

The adjustments for ‘07 and the foreseeable future are so large that much higher privilege payments are also in order for share rents, and some land that was sub-marginal for crops in ‘06 will now be planted to corn/beans/wheat, at least for awhile.

Of course, operators can expect input suppliers to find all kinds of reasons, including increased demand, to raise their prices.

But many persons had wrong rents for ‘06. At least, that’s my conclusion from looking at the data. What data? My answer is partly based on what I read in three reports; the annual Purdue Crop Guide budgets published each winter by Purdue Extension Specialists, and the Purdue Ag Economics annual June Rent Survey, both reported on the Purdue Ag Economics website, plus the USDA annual Indiana rent survey.

I consider the numbers for the average soil corn/bean rotation farm in the annual Purdue Crop Guide to be a good starting point for estimating right rent as of the date the calculations are made. Why? Yields are expected average trend yields for Indiana. Prices are CBOT harvest futures adjusted to local elevator harvest prices. Variable seed, fertilizer, fuel, etc, cost items can be purchased currently. The government program payment is typical for the current year. No matter whether I’m teaching rent economics, or serving as an advocate for a tenant or a landowner, I start with the subject farm, and create a budget similar to the current year Purdue Crop Guide budgets. I prepared the Purdue Crop Budget for thirty years, and even though I’m no longer affiliated with Purdue, I respect the work of the current budget authors.

Speaking on right rents in July ‘06 at the 39th annual Purdue Top Farmer Workshop, I pointed out that the ‘06 Purdue Crop Guide calculations implied that the average rents as reported in the annual Purdue Ag Economics survey were too high, at least since 1998. Why? After estimating expected revenues less all economic costs, including the previous year reported rent, estimated returns were negative again for ‘06, as they had been in the crop guide budgets every year since 1998. I was concerned that farmers had insufficient earnings to cover family living and replace machinery. How else can this be explained?

One possibility is the budgeted overhead charges were too high prior to ‘07. Note on the Ag Economics website that they were reduced in the ‘07 budgets. Caution, also note ‘07 yields were increased more than normal; thus making it hard to compare ‘06 and ‘07 budgets.

One possibility is that many tenants do subsidize their farming experience. After all, no one has to pass a test to get to farm.

Another possibility is the Purdue rent survey is not capturing a representative sample of all Indiana cash rents. I think it is not. Why? I have several reasons. First, I think this survey question is for currently negotiated rents. Further, the survey is mailed to professional farm managers, lenders, and others.

On the other hand, the annual USDA survey goes to tenants, only, and it asks for a rent.

No wonder the average Indiana rents reported in these two surveys show a quite different average rent with the Purdue rent survey always higher.

After adjusting for higher input costs and much higher expected prices, my calculations show average Indiana soil ‘07 right rents $45 per acre higher than ‘06 right rent as of today, subject to changes in yields and prices between now and harvest. Three weeks ago today, before the price drop, that number was $120 higher. Who knows what it will be IF we get a big rain soon or IF we don’t. Because some persons adjusted their ‘07 rents this year, I predict a record difference between the two reported average rents for ‘07. Further, I think both reported rents will be lower than my right ‘07 rent calculation.

Oh, I’ve also done a rent survey, which I reported in the 1998 Purdue Publication, What’s the Right Rent?, which I think is still on the Purdue Ag Economics website. I asked tenants attending the 1997 Purdue Top Farmer Crop Workshop to calculate what they expected to make on each of their rented farms, after including their rent and other costs. On average, these tenants reported they expected to make $50 more on their most profitable lease versus on their least profitable lease. Apparently, many of them had a sweetheart lease as well as a high cash rent lease.

Among your choices for adjusting rents almost “automatically” is using one of the survey rents. However, as I suggest above, I think you’ll mostly lag current economic conditions. Further, if you’re the tenant, you face the risk of someone out-bidding you.

I predict more tenants will lose their leases for ‘08 than at any time since the early seventies when crop prices also increased faster than non-land costs. Most of these turnovers could be avoided if only present tenants would do something nice for their owners. Perhaps tenants will want to check with their local FSA administrator to see if they can revise their ‘07 leases up until the end of August.

I don’t provide legal or marketing advice. I do think FSA made a significant interpretation of their rules in a nine-page directive dated April 2, ‘07. It’s significant to me because I think it makes the outside-the farm-gate adjustor lease I described in the 1998 Purdue rent publication a non-participating lease. Thus, as a retired landowner, I think I can place my rent on Schedule E, and it’s not subject to self-employment tax. But check with your FSA and your tax advisor.

Why do I like my outside adjustor lease? It’s current. I base it on the Purdue Crop Guide expected trend yields, and the guide variable costs and government payments, adjusted to my farm for a corn/bean rotation. Then, I adjust the final rent by the local harvest prices at my elevator on my pre-agreed dates, and I adjust yield by the percentage change between my farm’s trend yield and the USDA reported county average yield.

Note, none of the rent is based on my tenant’s actual performance. I don’t care whether the tenant grows corn or beans or when the crops are plant/harvested or marketed.

In my case, I’m able and willing to accept 100% of the outside the farm gate yield and price variability between the date the lease is negotiated and the date the final rent is calculated. Some owners may want to accept a lesser percentage. When I surveyed Top Farmers, they told me, on average they would pay $13/acre more rent for a 100% adjustor lease and $6+ more for a 50% adjustor lease. Some tenants may see this as a cheap form of crop insurance. Perhaps a Land Grant professor will analyze this issue.

Currently, I’m still thinking about the crop insurance question. First, some analyses show some of the types are so highly subsidized that, averaged over several years, it’s almost a zero net cost. Second, if the cash rent tenant deducts the premium along with his other variable costs as he is deciding what rent to bid, who should receive the insurance payment in my adjustor lease which is based on the county average yield, as is the insurance payment on some policies? At the moment, I’m suggesting that tenants not include the government crop insurance cost as they calculate what to bid.

If I’m working as an advocate for the owner, I may suggest the owner place some limits on tillage type, and maybe crop mix. I might even suggest the owner commit to applying a specified amount of lime or P or K, just to make sure the fertility is maintained. Of course, if the owner applies fertilizer, the tenant bids a higher rent.

Suppose the Purdue Crop Guide yields are for a good, but not the best, tenant. After I prepare a crop budget like the crop guide budget for the subject farm, I ask prospective tenants I’ve chosen, to offer their cash bids, based on my budget with trend yields and the then current fall bid prices, and based on the assumption that prices and yields will be adjusted after fall elevator prices are known and county yields are reported.

I ask tenants to bid a “tenant margin”, a new term I made up to replace the annual overhead charges in the ‘07 Crop Guide for the corn/bean farm of $82/ acre, for machinery, dryer and handling replacement; and family and hired labor. Tenants need to calculate their own expected revenues and costs, and consider their competition, before deciding what to bid as a tenant margin in my budget. My personal budget is based on a good tenant’s performance. My tenant regularly gets ten or so bushels more corn than I budget. His surplus earnings reflect his superior performance.

Tenants I’ve surveyed have told me, on average there’s perhaps a 20 bushel corn yield difference between the next to best and next to worst tenant they compete with. As an economist, I expect surplus earnings from all but the best tenants to be bid into rent. Some prospective tenants will have to bid more than they can afford.

Of course, everyone has a comparative advantage for doing something, and some persons find their comparative advantage is not in farming, at least not as they have been farming.

To get the final rent, I subtract my budget variable costs and the tenant margin from the government payment and crop revenue calculated after outside the farm gate yields and prices are known.

Note, in the $82 tenant margin in the Purdue Crop Guide that machinery, etc. replacement charges are included for a timely plant/harvest farm. Actually, a tenant has a choice. When the tenant adds another rental, the tenant can trade machinery so as to be timely and continue to get the same average yields, or the tenant cannot add machinery and expect to realize lower yields on added land.

I think this is a teachable moment for right rents. Yes, there’s a lot of education to get the first adjustor lease. Then, there’s not much to do as long as both parties agree to continue. Given the expected payoff to both landowners in terms of higher rents, and to tenants in terms of retaining present farms or gaining new ones, take the time, and make the effort to learn and do right things in right ways, right now.

I may or may not pick the person offering the lowest tenant margin, even though that tenant is offering me the highest rent. I like my tenant because of the other things he does for me.

Now, I’ve given you some things to consider as you negotiate your right rent. Earlier, I said tenants told me they expected to make $50 per acre more on their most profitable lease versus their least profitable lease. Although I don’t work for a share, as an advocate for either the owner or the tenant, I think I can sometimes show reasons for perhaps half that difference.

Remember, when describing how persons trade in a market economy, economists don’t use four letter words like “fair” or “kind”. That’s why I discuss “right” rent. Of course, whatever you negotiate is your right rent. Best wishes.

This year is a once in a generation experience for creating right rents, nurturing your relationships, and reducing your rental transaction tensions. Also, this is a great time to get the next generation involved in rental issues. Just when do you expect a better time to teach them how to do their future business?

If there’s interest, perhaps I can team up with an attorney and/or farm manager to teach rent economics and then to help you follow up on your personal situation. We’ll start by playing my “rent 80 acres game”. We’ll give owners seed corn caps and have them play tenants and tenants will play owners. Expect to forget who you are as you try to win the game. What fun. No one will get mad, and we’ll all learn from each other.

An Accredited Farm Manager and accredited Agricultural Consultant myself, at age 74, I want you to work with other professionals in the future. In Indiana, Barbara and I are starting a Farm Management service. We’ll align ourselves with a young attorney for our teaching, and we’ll somehow add a younger accredited manager to do some of our service.

Even though I want you to somehow get your education from Land Grant Faculty, I am aware they can’t be advocates for either owners or tenants. Get a group of owners and their families, plus tenants and their families, and perhaps counselors of your choice. Invite me. My phone is 765-412-1495, my website is www.DHDoster.com and my email is Howard@DHDoster.com

My wife, Barbara, a former Purdue administrator and current president of our teaching company, and I are expensive; expect this to be a valuable time together

Oh, contribution margin on my average soil ‘08 rotation corn-bean budget is $344 today. That’s $150 higher than my ‘06 budget and $100 higher than my ‘07 budget today. Of course, I’m using Purdue’s ‘07 variable costs in my ‘08 budget. I’ll use their ‘08 variable costs when I get them next winter.

As a final note, I observed in both my ‘07 and ‘08 budgets today that rotation beans are more profitable than continuous corn. I wonder how long this will last as CBOT traders turn their attention more to next year as they compete for corn, bean, wheat, and cotton acres. Long ago, a farmer friend told me he planted the best rotation for his farm, at that time rotation corn/beans. If CBOT price relationships were out of line, he speculated on the board, and not on his farm. I’ve since found that spring CBOT corn-bean price relationships are useless as a predictor of harvest price relationships.

What fun.