CHICAGO (DTN) -- The land market is going nuts, contends agricultural economist Terry Kastens, a retired Kansas State University professor who now is a manager on his family's farm. After all, how many times can grain belt real estate appreciate 30% or 40% per year?

His outlook for 2012: Cash rents have a lot more room to rise than land values.

"If times stay good, there is easily room for cash rents to go up 50%," predicted Kastens. "But that's a big 'if.' Strong crop prices depend on demand, especially in emerging markets such as China and India. Let's face it, none of us has a clue on what's going to happen. But land prices are so high, no one wants to miss predicting a crash," Kastens added.

"If we see corn prices drop to $3 per bushel and stay there for six months, that would temper people's desire to bid up land prices and cash rents," he said.

In the past 18 months, bank regulators have raised flags about an overheated land market. Some lenders have imposed per-acre caps on what they'll finance, no matter what the sale or appraised value.

"I like to see people worried about a crash. If you keep in front of people what can go wrong, that makes the fall less severe. If we see a more gradual decrease in prices, we'll adjust as we go," Kastens said. "If crop prices stay high, today's land values are justified and rents will go up a lot."

Currently, farmers who want to expand their farm operation view bidding up the price of one parcel to buy land as less risky than increasing their rents on all their parcels of rented ground. "If you rent 3,000 acres and own 3,000 acres, you're willing to buy 100 acres at a slightly overpriced value, while trying to keep the rents on your leased land at a low level," he said.

Also, most farmers' alternative investment to land is a Certificate of Deposit at the bank. Interest rates are so low, farmers flush with cash are turning to land and equipment.

Hedge and pension funds are interested in buying land, also. "In some cases, they are the second highest bidder because, in general, farmers are the ones buying farm and ranch land," said Kevin Dhuyvetter, agricultural economist at Kansas State University. "We're also seeing 'quasi farm investors' -- those who have family or friends in farming and who are disenchanted with the stock market over the past few years."

The two ag economists do not envision a crash like we saw in the 1980s. "There's not a chance of that happening at this point," said Kastens. "I don't think there is any chance of dropping land values 50% from today's values. We would need to see many more speculative purchases. What causes a drop of that magnitude is people dumping land. We might see a flattening out and a slight downturn, but not a hard crash from here. In the 1970s to early '80s, land prices peaked at the interest rate peak -- that's quite the opposite this go 'round if we are peaking now. What will take place will be different than the 1970s and '80s, because every situation plays out slightly differently."

Both Kastens and Dhuyvetter are investors themselves but are becoming more cautious now than even a year ago. "I'm not extremely bullish nor bearish," said Kastens. "It's hard to buy land now. But I'm always looking to buy land. It's hard to be a market timer in the land market. The most important thing is to find the deal that fits you, no matter what the macro-economics are doing. I don't want to make a stupid purchase relative to what's out there. Sometimes, you have to look around at a wider location to get a deal that works for you."

Farm buyers can take some of the emotion out of purchases by simulating what would happen in some worst-case scenarios if today's purchases mirrored the last land crash in the 1980s. Kastens compared buying land in 1971 (when land prices just started to take off on a 10-year rally), 1976 (huge annual increase in land prices) and 1981 (peak in land values). Then he calculated the 20-year impact on return-on-equity at different leverage amounts and if you paid more than the going rate for land.

"Of course, anything you bought in 1971, even if you paid the going rate with 75% leveraged, or were 50% leveraged and paid 50% more than average land price, you came out with a positive return on investment," Kastens noted.

"However, leverage was a killer if you bought land in 1976 (at 75% leverage) and especially in 1981 (at 50% or 75% leverage)," said Kastens. "On the other hand, you still had a positive return if you only borrowed 25% of the market-rate purchase price, even if you bought land in 1981."

Overpaying for land was even more detrimental if you had to borrow money, according to Kastens' figures. "If you were leveraged 50% and paid more than 25% above market value, you lost money over 20 years, even if you bought the ground in 1976 and especially if you bought land in 1981.

"I will admit I'm not finding any land to buy right now at these prices. Maybe I'm too conservative, but I'm willing to wait for something that works for me," said Kastens.

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Editor's Note:

You can find Kastens and Dhuvetter's land buying analysis worksheet at http://www.agmanager.info under Decision Tools in the left column.

For more discussion about land and rental trends, join DTN and Kevin Dhuyvetter in person Feb. 17 at the Louisville Farm Machinery show. Our session, "Cash Rents: The Good, the Bad and the Ugly," runs from 11:30 a.m. to 1:00 p.m.

To see a video interview by DTN's Bryce Anderson with Kastens and Dhuyvetter, go to http://bit.ly/…

Each year, DTN presents an outlook series on what is expected for the year ahead in various areas of agriculture. This is the third story in a series DTN will continue in the next few days that looks at what farmers can expect in commodity markets, farm finance, land prices, ag and the environment, agricultural policy, crop input prices and livestock prices. We welcome your feedback on what you think the year will be like attalk@telventdtn.com.

(MZT/ES/AG)

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