Farming Profitability

2012 was a very difficult year for agriculture and its effect will be felt for some time, although good commodity prices have helped alleviate some pressure in the arable sector. The livestock sector has not fared so well as the high commodity prices impact directly on feed costs. The implications of a very difficult 2012 harvest and autumn are:

• lower yields and quality – forward selling contracts unfulfilled

• higher costs
– sprays (fungicides)
– fuel/energy from slow harvesting, extra spray passes and crop drying
– feed

• tax bill in 2013 from previous good years

• more spring cropping

• forage quantity and quality down

These factors will potentially result in a difficult cash flow situation in 2013 leading to increased debts, which may increase supply, adding pressure to the rate farmland values increase. This may be more pronounced in the livestock sectors.

However, for good quality commercial farms we expect demand to remain strong. We anticipate that there will be little change in interest rates in the short-term providing money, if required, at competitive rates for farmers looking to expand and investors.

In fact, our research shows that cash is the main source of funds for farm buyers, and borrowed money is only a significant feature in around a quarter of transactions, this is unchanged since 2006.

Farming Outlook

• Defra expects farm incomes for 2012/13 to fall slightly from the previous year in the arable sector due to higher input costs combining with lower yields and poor quality crops.

This is despite wheat prices reaching record levels, and although they might ease back by £20 to £30 per tonne over the next year, they will still be high relative to the average of the past few years.

• The dairy outlook, especially for large herds, is brighter. The latest EU Commission Report (11 Dec 2012) predicts favourable medium and long-term prospects for the sector, in line with population growth. In the UK, September 2012 was the first time since October 2011 that the milk auction price rose above the average farm-gate price. The downside is costs and concentrate price rises, which tend to lag wheat prices. Cheaper alternatives may be available, but given the rise in other costs ,margins are likely to be under pressure.

• Beef and sheep farmers have both suffered increased costs, but positive price growth has only been sustained for beef stock, with sheep prices falling below 2011 levels. This may result in an overall squeeze in incomes for grazing livestock farms.

Investment/Ownership

As the capital value of farmland increases, income yields come under pressure. Historically, income yields from farming have been around 2%, but when commodity prices peaked, income yields on capital invested reached 4% to 5%.

Income return is only part of the investment performance equation. It is strong capital growth and therefore total return that has pushed farmland’s investment performance above alternative assets over the past 10 to 15 years. As with all investments quality, location and timing of purchase are important and can make a huge difference to overall performance, although this will be a factor driving land acquisition and ownership, it is by no means the only factor. The drivers for land ownership are diverse and often it is not easy to separate them, but they include:

• Lifestyle Ownership provides somewhere to live and fulfils an aspiration; ‘to own a piece of the countryside’.

• Taxation advantages

• Income From farming and diversified enterprises.

• Development potential Especially where land borders settlements.

• Capital availability Assets, such as minerals, residential properties, off-lying land, can be used to release capital. These demand factors, combined with the global fundamentals and limited supply, will ensure the outlook for farmland values has more upside than downside, and a significant correction in values is very unlikely.

We are noticing that some landowners are considering divesting from land, following the unprecedented growth in values over the last decade. This is in order to take advantage of other asset classes with good income yields and scope for improved capital growth in the medium-term.