Welcome to Investing in the Agricultural Sector

High net worth individuals, their principles and institutional investors - welcome to the agricultural sector as an up and coming asset class. Look at a few reasons to consider investing in agriculture:

Portfolio Characteristics:

1. Capital retention
2. Hedge against inflation
3. Diversification
4. Attractive rates of returns
5. Rates of return that are uncorrelated with returns of other asset classes such as stocks and bonds and residential/commercial real estate investments

Based on an asset class that:

1. Is consistently profitable nationwide
2. Has a very low debt to asset ratio
3. Historically appreciates in value
4. Is needed to supply the growing need for food worldwide

The U.S economy is three years into the worst financial meltdown in a century. The residential sector has lost trillions of dollars for investors and the commercial sector is getting worse by the day. And there are no economic indicators that suggest things are getting better.

Where are the future tangible investment opportunities for investors?

How about the agricultural sector?

Three years into the recession the agricultural sector is still relatively strong, as seen in the following imperial statistical data. While it would be misleading to say that the sector is completely immune to the financial down turn, the overall picture of the sector is strong. The majority of commodities are still profitable and real estate land values for farm land are holding.

The relative strength of the agricultural sector is not an anomaly or luck. The fundamental strength of the sector is attributed to 1) the necessity for a quality food supply and 2) the responsible lending practices of the agricultural lending industry.

The necessity of a quality food supply - “People have to eat”

During this recession, consumers have changed their food purchasing patterns; however, the agricultural sector is very accommodating and makes the appropriate planting adjustments. Farmers operate as profit maximizing producers. When a commodity decreases in profitability, farmers make an immediate adjustment to their planting decisions. In the case or open land commodities, farmers can alter the crop planting decisions annually if not semi annually for double crops. In the case of permanent plantings, this production cycle may take a few years at times to remove enough acreage of the over supplied commodity to get the supply and demand factors back in balance.

The responsible lending practice of the agricultural lending industry

The current financial losses suffered in the residential lending industry are in part attributed to the overzealous loan products that were available, e.g. the abusive lending practices of the subprime, Alt A and even high loan to values of conforming loan products. When a lending industry does not give sufficient consideration to the repayment capacity of the borrower, the industry is essentially doing what is called “equity lending.” The loans are based on the market value of the security property and the expected future appreciation on the market value. As we have seen recently in the residential sector, values will not always be on the rise and an economic downturn starts a downward spiral in real estate values and correspondingly capital loss to investors.

The agricultural lending industry learned this very painful lesson in the mid 1980’s. In the 1970’s and early 1980’s, agricultural lenders did equity lending to farmers. This is seen on the accompanying USDA graph depicting the debt to asset ratio of farms nationwide from 1950. The D/A ratio peaks in the mid 1980’s and decreases steadily thereafter. During this period of equity lending, agricultural lenders did not sufficiently analyze the cash flow repayment ability of the farming operation. Loans were given on the basis of the market value of the farm real estate, which was appreciating, and the potential increase in the future market value. Sound familiar? The consequences that came to fruition in the mid 1980’s were similar to what we have seen in the residential sector currently, only on a smaller scale. A rise in default rates and the subsequent foreclosures of farms. In fact, the federal government bailed out traditional agriculture lenders to the tune of billions of dollars.

The good news is that since the 1980’s the agricultural lending community has incorporated into their lending models sufficient emphasis on the cash flow repayment of the security property alone and the overall farming operation. These responsible lending practices are a major contributing factor to the current underlying fundamental strength of the agricultural sector. Namely, that the land value of farm real estate is not allowed to get out of proportion to the economic profitability of the commodities grown. For example, if a farmer is attempting to purchase a farm in which the value of the real estate is greater than the commodities ability to generate profit/debt service repayment, the lender will either lower the loan to value to an acceptable level or deny the loan request. These responsible lending practices have to a large extent, prevented volatile swings in land values and buffered traditional production cycles common to the agricultural sector.