Happy Wednesday! I have been busy with the move this week so this is a good time to run a guest post! Today, we feature a guest post by Scott, who runs the Basic Capital Forum. I don’t really feature guest posts very often despite getting tons of proposals – my fellow bloggers probably know what I’m talking about! But a guest post about an alternative asset class with pretty cool return stats is actually something I like to publish. So, take it over, Scott…
Are the boom times back? Judging from investor sentiment, it looks like they are. Despite some recent volatility, the bull market is still in full swing and according to data from fund tracker EPFR Global, markets attracted $102b into equity funds over the past four weeks. Behind the curtain, the euphoria might be unjustified – there are a few warning signs that investors may be ignoring. Firstly, stocks are over-valued by many measures. The Shiller CAPE hit 31 in January – the same vicinity of its peak in 1929. Warren Buffet’s measure states that stocks are overvalued by 40% as of November. The most over-weights stocks are FAANGs (Facebook, Amazon, Apple, Netflix, Google) with forward-PE-ratios even higher than those in the overall S&P500.
Secondly, the level of private debt is enormous. According to the IIF, global debt hit $233 trillion this month. If global GDP is roughly 73 trillion, the global debt is 310% of global GDP. To put this in perspective, private debt to GDP only surpassed 150% in 1929 and 2008. In this time of overvalued stocks, one could make the case for investing in gold. The issue with gold, of course, is that it produces nothing and it has no inherent value. The enterprising investor, however, could invest in the 21st-century gold: Farmland.
Investing in farmland is a strategy that offers low volatility and returns that are uncorrelated with the stock market. It normally performs well in times of inflation and asset deflation. In the recent financial crisis, farmland was one of the only asset classes which had increased in value by Q4 2008. Farmland has also performed very well over the past twenty years. US farmland had a compounded return of roughly 16% in the past ten years, whereas the S&P 500 had a cumulative total return of 10%. Farmland is also low-cost in comparison to other real estate investments – tax and maintenance costs are both low. [ERN: Cool! in contrast to rental real estate, nobody will call you on Christmas Day because the toilet is broken!]
I would caution investors considering farmland in times of uncertainty without analyzing farmland values, however. A farmland bubble inflated in the US during the 1970s when investors piled into farmland to avoid rampant inflation. Their thesis was simple – food prices are tied to inflation so farmland would hold strong. This insight was probably true in the beginning, however, the number of investors entering the farmland market caused it to overheat. It is incredibly important to find the true value of the farmland you are investing in – no matter how you’re investing in farmland. The words of Buffett hold true here: “What the wise do in the beginning, fools do in the end”.
US farmland has a mild correlation of .23 with commercial real estate and a correlation of .58 with US timberland. It has a mildly negative correlation with S&P 500 index and a very negative return with US long-term corporate bonds.
[ERN: Quite interesting that farmland also has a negative bond correlation. I would have suspected that the negative stock correlation is simply because farmland with the stable yield is simply a “bond portfolio in disguise.” So, if you have a three-asset portfolio – stocks, bonds and farmland – then all three correlations are negative. Diversification Nirvana! Quite intriguing!!!]
Farmland is not just a hedge against uncertainty however, it allows investors to make a play on one market trends – the rise of the global middle class. Between 2012 and 2020, the global middle class is expected to rise from 1.2 billion to 1.5 billion. China makes up a large part of this growth, where the middle class has boomed for the past 20 years. In top-tier cities, the number of residents with income above $29,000 will double in 15 years. The global growth of these consumers will increase the demand for food by 59%-99% by 2050.
We see can see this shifts occurring in markets already. In India, the demand for beef has increased nearly 300% since 2009. According to a US Department of Agriculture report, India’s exports of beef have increased rapidly. Today they represent 20% of trade in the commodity. We see the increasing demand for high-quality consumer goods in developing nations manifesting itself in other ways. In 2000, US almond production was valued at $666.5 million in 2000. By 2012, almond production peaked at $6.5 billion in production value. From 2010 to 2014, price per pounds of almonds rose from $1.79 to $4.00.
While the demand from Asia protects investors from downside risk, there is a significant potential upside. When Michael Burry of The Big Short fame, began winding down his hedge fund in 2014, investors assumed he wanted out of the stock market. Instead, Burry has seen an enormous play by investing in farmland with water on-site. Burry’s basic thesis I simple – the world is running out of water at a rapid rate. The demand for water will rapidly outpace supply. When the coming water crisis hits, governments will not have the finances to build infrastructure to solve the issue. In his opinion, the only viable solution in this crisis period is to transport water through food.
Let’s take India as an example. India’s groundwater in the northern land-locked regions is running out rapidly. Since the 1980s, groundwater has plunged from 8m below ground to 16m. If the water table decreases at this rate, India will not be able to grow crops at all. If the Indian government decided to import the water-intensive crops instead of growing the crops, they could manage their water resources far better. They could then use the water previously allocated for farming as drinking water. Importing crops does not eliminate the problem, however, it decreases the rate of drainage significantly while the necessary infrastructure can be built. In this scenario, the value of water-intensive crops would increase in value significantly. The value of farmland with water on-site would also spike in value. Burry has chosen to invest in almond farms given their high “virtual water” content. However, investors could make this play by investing in farmland growing water-intensive commodities with a high water footprint. The trade is quite complicated; however, we have discussed it at length on the forum.
How Do I Invest In Farmland?
In the U.S., there are a number of Real Estate Investment Trusts (REITs) with a farmland focus. These companies typically buy land from farmers wishing to retire and lease it back to other farmers. Farmland REITs offer investors diversification; however, they are not necessarily a great investment. Investors must look out for solid financials and experienced management with a great track record. Not all of the publically traded farmland REITs fit this bill in my opinion. In the UK, there are a few options for investors interested in farmland – through Braemer UK Agricultural Land fund, Brooks MacDonald Funds UK Farming and the First Stellar Farming LP.
Investors can also look at Private Equity (PE) groups investing in farmland as well. It’s worth noting that almost all of these ventures typically charge a traditional “2-20” pricing model. Aside from earning 20% on all profits, they typically earn an annual 2% management fee. This means that the firm would need to rack up an exceptional rate of return to outperform index funds. If farmland has returned 10% on average in the past forty years, fund managers take 2% for simply holding the portfolio and profits are charged at 20% as well, it is hard to see how your investments will outperform index funds. The S&P 500 has earned a total return of 10% since its inception.
This fee model also calls a fund manager’s motives into question. If a manager is charging exceptional fees for sitting on a large portfolio of assets, a shareholder would have to ask themselves: is the fund manager interested in making money for me, or is he more interested in earning money for himself? In my personal view, the 2-20 pricing model does not align the incentives for the fund manager and investor. Moreover, most PE groups ask for investors to meet accredited investor status. An individual must have a net worth of $1,000,000, excluding the residence of one’s house, or have an income of at least $200,000 to be considered.
The enterprising investor can invest in farmland by avoiding PE groups, farmland REITs and buying physical farmland. There are a few stocks listed in the US, Australia and Canada with enormous portfolios of farmland. It is possible to find these stocks, however, it requires digging. I have found a few myself and have talked about some of them on the forum.
The stock market has proven to deliver returns in the long-run, short-term volatility can unnerve investors. An investment in farmland can iron out rapid changes in the stock market value, potentially hedge against inflation while providing access to an asset class which has traditionally outperformed equities. The enterprising investor would be foolish not to consider adding farmland to their diversified portfolio.
Note: I have an interest in farmland, however, I am not a qualified fund manager. Please consult a qualified financial advisor, before making any investments.
[ERN: Interesting post. In the direct comparison gold vs. farmland, I would most definitely prefer farmland. It’s an inflation hedge like gold, but land at least offers a consistent yield. I personally doubt that the double-digit performance will last forever, though. But even with single-digit returns, a retiree could consider this an interesting supplement to a plain stock/bond portfolio, just based on the correlations!]