May 19, 2011

Hedge Funds, Mavens of Risk, Grab Newest Hot Investment: Farmland

Land values surge but P/Es are unchanged, though upward trend is likely to continue, Fed survey suggests

In an almost lugubrious address about our depressed economy, one of the nation’s most influential economists could muster enthusiasm about just one investment: farmland. A New York tabloid catering to the high-net-worth and known for following the home purchases and dating exploits of the city’s socialites declares what the happening hedge fund must now own: farmland. U.S. home price deflation has now clocked 57 consecutive months, but farmland is one class of real estate that has reached a 32-year high.

Farmland is what Americans have been leaving for about a century as the United States became more urbanized. Sophisticated investors have tended to look for products emanating from urbanized university research triangles rather than rectangular plots of green acres. Today, farmland is the ultimate alternative investment. In the words of Yale professor Robert Shiller, addressing an audience of nearly 2,000 financial professionals at this week’s IMCA conference, “they don’t make new farmland.” The rise in demand for food in developing nations places a premium on farm-based supplies of agricultural commodities.

“Food prices are driving CPI,” Shiller added in his talk, yet some investors in the hedge fund world active in farmland acquisition believe that the CPI grossly understates true inflation. The New York Observer, which covers hedge funds as something of a lifestyle badge of honor, quotes an unnamed hedge fund manager as viewing an older formula used to determine CPI before 1996 as having greater validity than current calculations. According to this measure, the actual rates of inflation may be as high as 6 to 7%, more than twice the level estimated by the Bureau of Labor Statistics in its April report. Indeed, The Observer cites a blog tracking rising prices at eateries favored by its yuppie readers. The unidentified hedge fund manager is apparently putting his money where he gets his organic kale from, telling the reporter his fund is around the 15th biggest farmland owner in America now.

What a hedge fund manager will boast about anonymously cannot by itself be relied upon, but the hard facts supporting the farmland trend can be taken from the bank — specifically the Federal Reserve Bank of Chicago, which Wednesday released its first-quarter report revealing a 16% rise in Midwestern farmland values over the same quarter last year. Only one other time in the past 32 years did price gains match that level.

The Fed economist who authored the report, David B. Oppedahl, foresees a continuation of this trend, reporting that a majority of bankers reporting to the Chicago Fed hold this view versus only 2% who foresee price declines.“The rapid increase in agricultural land values may not be over,” Oppedahl says.

What makes the farmland price spike particularly noteworthy is that it occurred amid a surge in the amount of acreage offered for sale. Yet the volume increase did not dampen eagerness to snap up land. Significantly, because cash rental rates have been rising commensurately (i.e., 16% in the first quarter), the Fed reports no change in farmland P/E ratios.

Meanwhile, inclement weather — floods in the U.S., drought in Europe — is driving ever higher gains for agricultural commodities, with wheat, corn and soy seeing fresh highs on the Chicago Board of Trade. Of possible interest to those for whom farmland, or hedge funds heavily invested therein, is inaccessible, John Deere (DE) reported record earnings Wednesday on sales of farm equipment. The Moline, Ill.-based company earned second-quarter profits of $904.3 million compared to $547.5 million the same quarter last year. The company said it expected continuing growth in farm incomes and commodity prices.

Although it is often said (not least by Shiller) that you can’t “make” farmland, Kay McDonald reports in her ag blog a significant deforestation trend in Brazil, where an area of rainforest 10 times the size of Manhattan was cleared in just the past two months. Such land typically ends up as cattle pasture. Looks like Manhattan hedgies and Amazon rancheros alike are betting on the farm, in the latter case even making it.

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