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Summary:
1. Farmland and Gold, historically, have delivered statistically similar yearly returns. However, Farmland has superior long-term growth rate (geometric mean).
2. Gold has a higher long-term variance compared to Farmland, and thus is a riskier investment.
3. Farmland related securities may have seen an appreciation recently, however, securities are not the right method to invest in this opportunity.
5. Detailed discussion related to this investment opportunity is provided in the report.
Keywords: farmland compared to other investments, farmland investment analysis future analysis should i buy, farmland investing strategy adding to portfolio, Farmland Partners Inc (FPI) analysis, FPI analysis, farmland stocks and ETF analysis.
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Can you earn a higher yield by investing or adding Farmland to your portfolio? Are returns expected to be higher than Gold? Is it a good investment? This report analyses 30 years of data for definitive answers. The returns, risks, and prospects of the two in question are analyzed in this report. Further discussion is also included in this report.
"Gold, of course, is the most widely recognized and accepted unit of account, medium of exchange, and store of value, in the entire world. Touted as the 'flesh of the gods,' interest in Gold has been elevated since 2019, due to rising concerns of the start of a contractionary phase of the business cycle since 2018, and since 2020, due to unprecedented increase in the money supply by all key central banks through Seigniorage, which is the printing of new money.
Concerns are, of course, high regarding the stability of Fiat currencies, especially of the currencies in the SDR (A SDR (special drawing right) is a basket of four leading currencies: Japanese yen (JPY), US dollar (USD), British pound (GBP), and euro (EUR)). This has increased demand for safe-haven assets." (Link)
See also:
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So, which yields/yielded a higher return, Farmland or Gold?
The yearly appreciation (geometric mean) for Farmland (cumulative, all types included, including cash rent and land appreciation) for the last 3 decades stands at about 12%, which means an average nominal yearly yield for Farmland stands at 12%; inflation-adjusted yield has been 8.4% (inflation in assessed period = 3.4%). (Link)
The yearly appreciation (geometric mean) for Gold for the last 3 decades is 8.12%, which means an average nominal yearly yield for Gold stands at 8.12%; inflation-adjusted yield has been 4.72% (inflation in assessed period = 3.4%). (Link)
We can clearly see that Farmland's YoY yield is substantially higher than that of Gold. However, these parameters may be considered overly simplistic; therefore, statistical testing has been employed to test the returns and risk below:
H0: μfl – μxu = 0 versus Ha: μfl – μxu ≠ 0.
, where
μfl – the mean returns of Farmland(FL).
μxu – the mean returns of Gold
Pooled variance test:
Two sample t-test (pooled variance), using T distribution (DF=56.0000) (two-tailed) (validation)
1. H0 hypothesis
Since p-value > α, H0 is accepted.
The average of FL's population is considered to be equal to the average. of the Gold's population.
In other words, the difference between the average of the FL and Gold populations is not big enough to be statistically significant.
2. P-value
p-value equals 0.0524737, ( p(x≤T) = 0.973763 ). This means that if we would reject H0, the chance of type I error (rejecting a correct H0) would be too high: 0.05247 (5.25%).
The larger the p-value the more it supports H0.
3. The statistics
The test statistic T equals 1.981317, is in the 98% critical value accepted range: [-2.3948 : 2.3948].
x1-x2=0.058, is in the 98% accepted range: [-0.07000 : 0.02491].
The statistic S' equals 0.0291
4. Effect size
The observed standardized effect size is medium (0.52). That indicates that the magnitude of the difference between the average and average is medium.
What does this mean, simplistically? Is Farmland a more profitable investment than Gold?
While the yearly geometric mean of Farmland is higher than Gold, Statistically, the returns are the same, and we cannot proclaim that one has statistically higher monthly returns compared to the other. This condition is explicable by understanding that, the statistically insignificant yet persistent, small variations in Farmlands' favor (including cash rent and land appreciation) have resulted in the long-term geometric mean, or growth rate, of Farmland being higher than that of Gold. Still, an investor, in terms of yearly returns, as per the statistical test, should be indifferent when choosing one over the other.
It is also worth noting that the returns presented above include cash rent and land appreciation. Only land appreciation stands at about 4.3%. If we compare land application only, Gold has superior returns, as nominal Gold returns stand at 8.12% and inflation-adjusted, real returns, stand at 4.72%; inflation-adjusted returns of land appreciation only stand at about 1.3%.
Our viewpoint here is that if an investor or entity has the capacity to manage Farmland, then yes, Farmland as an investment has superior returns; however, it is worth noting that management of Farmland has costs associated with it.
Thus, for someone who is not in the agribusiness or land renting business, managing an allotment of, say, 200-500 acres should be expensive, compared to a large holder managing a substantially larger land portfolio.
What about the risk? Is Gold riskier than Farmland? Or is Farmland riskier than Gold?
For definitive answers, F test has been conducted to evaluate the difference in variance between the returns of Farmland compared to Gold. The hypothesis is constructed as:
H0: σ2XAU = σ2XFL versus Ha: σ2XAU ≠ σ2XFL,
, where
σ2XAU – the variance of the returns of Gold; and
σ2XFL – the variance of the returns of Farmland:
F test for variances, using F distribution (dfnum=28,dfdenom=28) (two-tailed) (validation)
1. H0 hypothesis
Since p-value < α, H0 is rejected.
The sample standard deviation (S) of Farmland's population is considered to be not equal to the sample standard deviation (S) of Gold's population.
In other words, the difference between the sample standard deviation (S) of the Farmland and Gold populations is big enough to be statistically significant.
2. P-value
The p-value equals 0.001365, ( p(x≤F) = 0.0006826 ). It means that the chance of type I error (rejecting a correct H0) is small: 0.001365 (0.14%).
The smaller the p-value the more it supports H1.
3. The statistics
The test statistic F equals 0.284, which is not in the 98% region of acceptance: [0.4059 : 2.4636].
S1/S2=0.53, is not in the 98% region of acceptance: [0.6371 : 1.5696].
The 98% confidence interval of σ12/σ22 is: [0.1153 , 0.6996].
What does this mean, simplistically? Is Gold a riskier investment than Farmland?
This means that the variance of Golds' monthly returns is higher than that of Farmland; Gold, for the past 3 decades, has been a riskier investment than Farmland, and this is backed by statistical evidence. In the future, it would be logical to expect Gold to remain a riskier investment compared to Farmland. Put succinctly, an investor should know that Gold is a riskier investment compared to Farmland, assessed as per the variance of the last 3 decades. Gold and Farmland aren't the same in nature; Gold is considered a high-grade a safe haven asset, yet this condition also seems plausible for Farmland.
Still, Farmland investment, more accurately, should be classified as an alternative investment, broadly related to the real estate branch of alternative investments, however, not exactly compatible with the nature of real estate (such as commercial real estate and homes).
Putting it all together. Future prospects of Gold and Farmland
Gold
"Gold is an established 'currency,' and a safe-haven investment instrument. This means Golds' demand rises when there is a decline in the yields of sovereign bonds, especially US bonds, as institutional money has historically shown a preference towards Gold in a low yield environment; Golds' demand also rises as overall financial risk perceptions increase, and institutional money moves into safe-haven assets, when this happens, Gold, usually, is on the top of the acquisition list.
However, there isn't significant evidence backing the assumption that Golds' price increases due to increased industrial demand, or is impacted by increased mining (this condition remains plausible with a significant increase in industrial demand or significant improvement in technology that substantially increases Golds' supply, such as novel extraction techniques making oceanic extraction feasible, or asteroid mining, for example).
Gold should be considered a currency with a 0 real rate, essentially. This means, as per the covered interest parity theory, if the real interest rate in the US, for example, increases, Gold should rise in relation to USD. Due to these properties, we can state, deductively, that Gold is an investment-grade currency, one that is the oldest, most persistent, and most renowned" (Link}. With a real yield of about 5% in the last 3 decades, Gold stands out as a prominent high-yielding investment instrument.
Farmland
Farmland (FL), as assessed in this report, should not be considered as 'purely an investment,' as FL and returns associated with FL require some degree of management, which, of course, demand more time than an allocation of, say, 15% in Gold in a portfolio.
Therefore, one should also consider that there is a cost associated with management. For a family office with a substantial holding, this cost may be reduced by subcontracting with an agricultural company, for example. However, for an individual investor, with a relatively minor holding of FL, this cost would be much higher. Thus, scale gains importance in this investment.
Yes, there are ETF, trusts, etcetera, that can be used as a vehicle to invest in FL, and these, theoretically, may reduce management costs; however, our analysis of top Farmland related (or including) ETFs and trusts, such as Farmland Partners Inc (FPI), etcetera, revealed that these options are highly volatile and do not follow the value of Farmland on a yearly basis. To invest in such options would be antithetical to the principle of Farmland investing. Therefore, we do not recommend adding these options to the portfolio.
Primarily, FL is emergently being seen as an attractive opportunity because of the high equity valuations in the market; fear of a sharp or prolonged crash in equity prices is also prevalent in the market presently. These apprehensions are not gravitating investors towards their usual second alternative, i.e., bonds. It would be a truism to mention that the market expects yields of bonds to rise considerably, and some argue that this rise will take yields above the long-term neutral rate of interest, which, arguably, stands at around 4.5%; this is discussed to be especially likely for longer-dated bonds.
In such a limiting environment, with risk outlooks for almost all financial securities concerning, investors, high net worth individuals, and institutions are eagerly looking for opportunities with limited risk exposure; to that end, FL works well.
In our view, FL is not an opportunity for smaller investors; we cannot recommend exposure through trusts such as the aforementioned Farmland Partners Inc (FPI), the appreciation in FPI, etcetera, represents speculative demand from retail traders, and does not represent appreciation caused by a fundamental factor, for example, improvement in revenues or cash flow, that are proportional to the price appreciation. Adding speculative assets to a long-term portfolio, without a sophisticated strategy, can be damaging, and thus, no professional would recommend such an allocation without a sophisticated risk management strategy.
As retail trading accounts have exponentially increased in the last few years, there is a lot of 'perceptual trading' being carried out by amateur 'traders.' "Buy and sell decisions in these retail accounts are not based on financial modeling or value analysis, rather, on speculative headlines and attention-grabbing developments."
"Decision making by a majority of smaller retail accounts, arguably, is not a scientific process, following a strict testing approach, for example." This class of activity, coupled with allocations by some high-net-worth Individuals, has caused the recent appreciation in the market price of Farmland-related trusts, for example, Farmland Partners Inc (FPI); the appreciation is not based on fundamentals as explained above.
"When greed is, unfortunately, the primary motivation, and hype the primary justification for decisions, financial ruin, one should be aware, cannot be far."
Following what every other retail trader is doing is a recipe for financial ruin. Anyone who studies profits for a living will tell you so.
This does not mean that FL isn't a highly attractive investment. It is. However, it is not an investment similar to acquiring an ETF, for example. It can be profitable and limit risk exposure, nonetheless, it requires management that goes beyond passive investment or financial portfolio management. And, of course, management has agency and financial costs associated with it. For portfolios under $35 million, this option is not very viable in our view, and allocation in the above-mentioned trusts is not recommended by us.
In conclusion, FL is a relatively safe investment that should withstand limited levels of broader economic distress. For larger portfolios or institutions, it is a viable investment opportunity that, nonetheless, involves management and agency costs. For portfolios below $35 million, it is not an ideal opportunity.
We shouldn't overlook the fact that presently, there is a lot of money chasing limited value opportunities. This has increased inflows in many speculative instruments. Once we experience a price readjustment event, which readjusts the value of multiple securities across the board, we will, most likely, see that the excess inflows that might have elevated the price of Gold will retreat—readjusting the price of Gold.
Nonetheless, presently, Farmland, as in, holding actual land and not speculative instruments related to Farmland, arguably, isn't the instrument of choice for speculator; thus, it is likely that price readjustment for Farmland wouldn't be as severe as for some other speculative assets, if there is any price readjustment for Farmland.
Finally, it is also worth noting that for those investors with the resources and capacity to acquire and manage investment in FL, FL also presents a value in terms of real options. "Real options are options in which the underlying asset is physical rather than financial." Investment in Farmland presents the real options of expansion, growth, and experimentation. Put succinctly, investors in FL have options that go beyond the acquisition of a financial security, for example. An investor or firm has the option to get into the agricultural business or experiment with cropping techniques, new crops, etcetera.
This ability or option has a value that the acquisition of FL provides, and this value should be included in a holistic assessment of the value of the FL. Oppositely, FL also provides the option to rent the land to other farmers, or, in terms of real options, the option to abandon operations.
These real options hold value for the investors that must be understood; nonetheless, it is worth mentioning again that these options are more viable for larger landholdings, or, put another way, the value of these real options is 'more valuable' when the landholding is of substantial size. Again, this means that FL is an investment suitable for larger portfolios and not an option for portfolios smaller than $35 million.