The Nuances of Cropland Markets: Estimating Prices and Rental Rates and a Look through Time at the Farm Business Sector during Cycles
Abstract
Land values are a central part of the farm business sector and are the vast majority of assets on the farm business sector’s balance sheet. Land is the single largest collateral backing for agriculture debt with farm real estate representing about two hundred billion dollars of debt. In total, U.S. farm real estate is valued at over two trillion dollars. Farm real estate, and in particular, cropland values, have historically driven changes in farm business sector assets.
In the past century, the farm business sector has witnessed three major boom-and-bust cycles, land values being at the center of each. Once again, cropland prices have increased at record rates. The recent growth in prices has brought into question the sustainability of the market price for cropland.
This work addresses major shortcomings and gaps in the previous literature on cropland valuation. The work here has three goals. First, develop a model that replicates market land prices by addressing characteristics of the market that have previously been overlooked. The model uses a relative pricing approach which addresses the incomplete market structure of cropland markets. The approach implements the good-deal bound methodology to calculate the value of land given yearly rental income discounted by a stochastic discount factor. The model also uses a dynamic optimization framework allowing state variables, which determine each of the contract prices, to vary over states throughout time.
Second, a further investigation into the determination of rental rates is performed. The outcome from the first analysis and earlier research has shown the difficulty in estimating land prices as a function of the income to land. A consensus has been made by previous literature that rental rates are the best proxy for income to land. The difficulty in determining rental rate deals with how they are “sticky” over time. The second analysis uses an error correction model to test the existence of asymmetric price transmissions between rental rates and crop prices. The error correction model tests for the presence of asymmetric price transmission between change in the income to land and the cropland prices. The model also allows for analysis on a short-run and long-run basis.
Third, the paper discusses the connection between the current boom in cropland prices and previous cycles in the farm business sector. The analysis addresses the likely causes of the contractions of these markets by looking at capital expansion leading to unsustainable credit risk in the market. Capital expansion is analyzed structurally to allow for forecasting possible future changes in it. Data from the Federal Reserve Bank regional surveys are also considered to understand the creation of credit risk both from the perspective of the lenders and borrowers. Addressing both the demand and supply of debt considers, holistically, the composition of financial risk in agriculture markets and how both the demanders of debt and the suppliers of debt create and manage risk in the farm business sector.
Subject
Cropland valuationgood-deal bounds
real options
dynamic optimization
asymmetric price transmissions
rental rate determination
boom-and-bust cycles
Citation
Hardin, Erin Marie (2017). The Nuances of Cropland Markets: Estimating Prices and Rental Rates and a Look through Time at the Farm Business Sector during Cycles. Doctoral dissertation, Texas A & M University. Available electronically from https : / /hdl .handle .net /1969 .1 /173240.