Farm Horizons, April 2014

Landlords and renters; deciding on rent amount

By Myron Oftedahl
Farm Business Management Instructor, South Central College

It seems that hardly a day goes by that I don’t get asked about renting land.

That is OK, but it is frustrating, due to the fact that one answer does not fit every situation, and the answer depends on if I am talking to a landlord or a renter. Often, each person has a different point of view in this situation.

As a landlord, you are looking for a reasonable return on the investment of land ownership. This is often a return on many years of hard work and investment. In some cases, this is your main source of income, besides Social Security. So, what should the rent be?

As a renter, you are looking for additional acres to increase your farm income, and ultimately spread your overhead costs over more acres. You would like this rent value to be as low as possible, thus giving you a larger margin. So, what should the rent be?

Let’s start with the landowner, who needs an income adequate enough to cover expenses, such as real estate taxes and insurance. Anything over that covers family living costs. A typical return on investment would be in the 4 to 6 percent range.

So, $5,000 an acre land should return between $200 to $300 an acre. This return, plus taxes and insurance would be your rental value.

Are there other things that would have value to you as a landowner? Is it important to you that the ditches are mowed, the trees trimmed, the tile lines maintained, the fertility values maintained, or crops rotated?

If these things are important to you, then the 4 percent return is probably more realistic, because the renter is going to have some expenses to do this. These expenses are not directly covered by the crop harvested.

Renters have some responsibilities, as well. They want the rental rate to be as low as possible, because that will give them a larger return, but they need to be fair. Can they afford to pay a return of 4 to 6 percent?

Have you had a discussion with your landlord over what they expect from you as a renter? What is important to them? What is important to their children? Are you willing to share an enterprise budget with them, concerning the profitability of their acreage? Have you developed a relationship with them? A good rental agreement is a two-way street; communication needs to come from both landlord and renter.

I maintain that there are three classes of landlords.

There is the relative, who is trying to give a grandson or nephew a start in the farming business, so this often results in low rental rates.

The next group is looking for that relationship; it is important to them to know that you respect what they have put into their farm and how it looks. They want to see a good crop, weeds controlled, tile lines repaired, ditches mowed, and the driveway cleared in the winter. This group also wants to see you succeed.

The third group wants the top dollar paid. They are not concerned if you make money operating their farm. They are looking for the most that they can make. This is often the land that is rented on a bidding basis.

The first group is often the easiest to work with, because they want to see their relative succeed and will often sacrifice income to help achieve that goal. It is of primary importance to them to see a grandson or nephew take over the farming operation.

As a renter in this situation, you need to be very careful not to take advantage of this. If you have a good year, pay them extra. Grandparents may not accept this, so pay for them to take a trip, pay for their groceries, or make sure that they get to doctor appointments.

You also need to have the discussion with them about what their goals are.

The second group is the relationship group. These might be neighbors or longtime friends. This group will be the ones who will ask you if you are interested in farming their land.

They respect and appreciate the type of farming that you do and respect your reputation. They often will appreciate the discussion about what they want from you as a renter. You will find out if they expect the ditches mowed and having their land maintained. This group will point out to others what a good crop that you have growing. I have even seen some of this group out picking rocks in their fields.

The last group are the owners that are looking to maximize the amount of rent that they receive. This is often land rented on a bid basis. Sometimes, this is the next generation who is removed from the farm and lives out of state. This group needs to understand that because you paid a 6 percent return or higher, that you may need to mine the fertility of this ground.

You, as the renter, will have to be as efficient as possible in order for the budget to be positive. You will not be able to do the little extras. This is often the land that conservation efforts get neglected, because of the need for efficiency of field operations.

You, as the owner in this group, need to be willing to return some of the rental income into the farm in the form of improved tile, cleaning ditches, or removing fence lines. If a renter is paying top dollar, the productivity and efficiency of the land needs to be of top value.

So, what rental value is fair?

Take a look at some type of flex rent, and be willing to pay a bonus on the good years. Flex rents are a version of the old share rent agreements, where both the owner and the renter take some risk. These usually involve a lower guarantee, but offer a bonus if yields or revenue meet certain criteria.

An easy agreement is to guarantee $200 an acre, but add an extra dollar for every bushel of corn over a set value, or maybe the crop insurance for the farm or some other value. Others are tied to revenue or the price of corn or soybeans over the course of the year.

A flex rent agreement can be as simple or as complex as you wish to make it. There are several examples, if you Google “flex rents.” The point is, that both parties are taking some risk with the hope of a good crop and higher returns.

The new Farm Bill will require you to have a conversation with all landlords, because you will have to make some choices concerning different options within the Farm Bill. Which decisions that you make will be tied to each parcel of land for the duration of the Farm Bill, regardless of who farms that parcel. So, your landlord will need to be a part of that decision process.

So, what is a fair rental rate? Rent needs to be fair to both parties. The landowner needs a return on the investment, and the renter needs to show some profit for the risks that he/she are taking or they will not remain in business.

Both parties are responsible for having the discussion over what the goals of the owner and renter are. Both parties are responsible for taking care of the land. Both parties are responsible to relay these goals and responsibilities to the next generation.

A fair rental value needs to consider the productivity of the farm. Some farms are worth more than others, because of higher fertility, better drainage, larger fields, and better soil types.

Iowa has a rating system which takes this into account, the higher the number the more productive the land.

Micheal Swanson, ag economist for Wells Fargo, has a saying, “ Farm the best, leave the rest.”

Do you, as a landowner, want your farm to be among the best, or left behind? Can you, as a renter, afford to farm marginal land? Can you afford to pay top dollar?

For you, as a renter, either question increases your risk. Extra risk in a volatile market can be deadly.

Both parties need to consider what a fair rental value should be. Ideally, you both come up with the same value.

Have a profitable day.

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