U.S. Farmland: An Underpriced Asset
As central banks around the world have pumped liquidity into the global financial system, they have inherently created winners and losers among assets. In the United States, the Federal Reserve has single-handedly backstopped mortgage-backed securities, which has put downward pressure on interest rates and aided in the recovery of the housing market. Despite the significant and accelerating recovery of the housing market, other real estate assets remain undervalued in the United States. In particular, land and more specifically, farmland remains underpriced.
Since the middle of the twentieth century U.S. farmland has been systematically transformed into suburban and exurban housing. These housing developments coupled with new mortgage loan structures made homeownership a realistic possibility for most American families. With the “American Dream” within grasp for such a broad swath of the population, the federal government made a point of lowering the barriers to homeownership and promoting new financial instruments that incentivized banks to lend. When the financial crisis hit, in part because of a combination of irrational homeownership incentives and unsound financial instruments, housing prices collapsed. But it was not just housing prices that collapsed; the value of all kinds of real estate in the Unites States declined. While some of this other real estate, like shopping centers and office buildings, reasonably continued to decline in value as they sat unmaintained for several years, the same can and should not be said of farmland.
In his 2012 annual shareholder letter, global finance guru Warren Buffett provided a characteristically brilliant, yet folksy explanation of the value of gold and why he does not believe it is a good investment. Buffett stated:
Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce -- gold's price as I write this -- its value would be about $9.6 trillion. Call this cube pile A.
Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
Most investors took this to mean that Buffett believes gold to be over-valued, but missed the fact that the very first asset to which Buffett compared gold was all the U.S. cropland. Even assuming that crop yields never increase and food demands remain stagnant, this is an undervalued asset.
Although global population growth has slowed in recent years, the world’s food demands are still steadily rising. The combination of better food transportation and increased knowledge about nutrition has created a growing global market for nearly all foodstuffs. Even through the last five years of global economic turmoil, corn, wheat and soy prices all have annualized growth rates over 4 percent. This increased demand will continue to be fueled by emerging markets importing U.S. grown goods, but anti-obesity initiatives by the U.S. government has also incentivized greater demand for whole grains and fresh produce in the U.S. market. Absent any technological innovation, the continued rise in agricultural demand alone would make cropland an undervalued asset. However, history has shown us that when food demand increases, humankind responds with new technology to increase crop yields (the first and second “green revolutions” each dramatically increased crop yields per acre by introducing simple new cultivation techniques, like nitrogen-based fertilizers). Such an innovation may drive down food costs, but it also makes each acre of cultivated land even more productive and therefore, more valuable.
In addition to the value of cultivated cropland, recent traditional and alternative energy innovations have made much of this land extremely valuable. The initial innovation to begin using corn crops to produce ethanol (an ingredient in gasoline) has already driven corn prices up and promises to do the same for less fertilizer intensive crops, like switch-grass. Perhaps more important for future growth, the vast majority of U.S. cropland is in the Midwestern part of the country, an area known for “the wind sweeping down the plains.” This wind can easily be harvested as a form of energy with modern turbines. Moreover, with modern fracking technology, subterranean pockets of natural gas can easily be cultivated from beneath the farmland. Since wind and natural gas are two of the fastest growing forms of energy exploration and the vast majority of this land has yet to be explored and cultivated, this cropland could be a valuable energy supplier, in addition to its traditional agricultural value.
Although a less immediate prospect, U.S. farmland may also serve an important function in preserving the U.S. water supply. As the global population continues to grow and fresh water supplies continue to dwindle, access to clean, fresh water for everything from drinking to farming to industrial processes will become increasingly expensive. Much of the Midwestern and Western United States sits atop the one of the largest aquifers in the world, the Ogallala aquifer. This supply of fresh water and the value of land for rain catchment purposes could serve as a valuable resource as the world faces water scarcity in the future. In essence, this means that the farmland has value as a short term investment based on rising food prices, a medium term investment based on potential energy production, and a long term investment based on rising water costs.
As a result of the financial crisis and five years of monetary expansion, when asked to identify an underpriced financial asset most keen observers will likely point to a particular subset of equities (perhaps financials), corporate bonds or even municipal or national bonds, but U.S. farmland is the kind forward looking investment that has long term growth potential. It can be a lucrative asset simply through maintenance cultivation, but when the energy exploration and water resource benefits are factored in, farmland has superb long term growth potential and little, if any, downside risk.
- Buffet, Warren. “Why Stocks Beat Gold and Bonds.” February 9, 2012. http://finance.fortune.cnn.com/2012/02/09/warren-buffett-berkshire-share...
- Rodgers, Richard and Oscar Hammerstein II. “Oklahoma!” 1943: New York.
- YCharts: The Financial Terminal of the Web. Accessed February 1, 2013. Ycharts.com
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