Published in the January/February 2015 issue of REIT magazine.
In the late 1990s, Paul A. Pittman started investing in farmland in the manner that wealthy individuals have gone about it for years. A Wall Street investment banker at the time, Pittman set his sights on a rural market that he knew well and began buying property there.
He eventually amassed a multimillion-dollar portfolio in Illinois, where he grew up in a farming family, and decided to start a farming operation. In 2013, Pittman and his partner in Pittman-Hough Farms spun off the majority of their land holdings into a separate corporate entity, and in April of last year, the company went public. Farmland Partners Inc. (NYSE: FPI), of which Pittman serves as president and CEO, will elect REIT status with its 2014 tax filing, making it one of only two stock exchange-listed REITs specializing in domestic farmland, a huge and highly fragmented asset class that is still largely owned by family farmers.
Pittman is betting that the REIT will gain a stronger following among a broad range of investors who want a liquid way to play the U.S. farmland sector and, by extension, global food demand. Wealthy individuals, private equity funds and institutions have invested directly for years in farmland, which has been described as “gold with a coupon.” The asset class earned that moniker because its price tends to rise along with overall inflation and it generally pays a steady income. It also tends to have a low correlation to other types of assets in terms of performance.
In the last 20 years, farmland has had impressive returns as an asset class, outperforming major real estate sectors and most other types of investments, notes Kevin Tyler, an analyst with Green Street Advisors Inc. Between 1995 and 2013, the National Council of Real Estate Investment Fiduciaries’ (NCREIF) Farmland Index had an average annual return of slightly more than 12 percent, while NCREIF’s commercial property index and the S&P 500 index each had an annualized return of about 9 percent. Investment-grade corporate bonds had an average annual return of about 7 percent during the same period, as measured by the Bank of America Merrill Lynch U.S. Corporate Index.
“Farmland as a REIT is a new idea, but farmland as an investment has been going on forever,” Pittman says.
Just One of the Farmers
Pittman, who an analyst once described as “a farmer who understands the capital markets,” graduated from the University of Illinois with a bachelor’s degree in agriculture in the midst of the 1980s farm crisis. (The ’80s farm crisis was caused by a combination of factors, including high debt among farmers, spikes in interest rates and low commodity prices, owing partly to the U.S. ban on the shipment of farm products to Russia following its invasion of Afghanistan.) At the time, he decided to pursue a different line of work.
He went on to earn a master’s in public policy from Harvard University and a law degree from the University of Chicago. He spent the early part of his career in law, investment banking and corporate finance.
But Pittman, who is still the majority owner of Denver-based Pittman-Hough Farms, always considered farming his true passion.
“I’m not perceived as a Wall Street CEO, but as one of them, as a farmer,” says Pittman, referring to his interactions with tenants, sellers and other constituents in the farming community. Yet, he does bring a sense of corporate expertise to the business.
Contrary to popular belief, there is still very little institutional ownership of U.S. farmland. As of 2007, about 87 percent of U.S. farms were operated by families or individuals, while 8 percent were operated by partnerships and 4 percent by corporations, according to a Farmland Partners report that cites data from the United States Department of Agriculture. Farmland Partners has demonstrated a desire to try to consolidate those assets.
Food for Thought
Rising global food demand, coupled with a slow rate of growth in the worldwide supply of cropland, also bodes well for both commodity prices and farmland values, according to Farmland Partners. Global cropland area grew by 78 million acres between 1991 and 2011, compared with the 238 million acres added between 1971 and 1991, according to a company report that cites U.N. data. Between now and 2050, the supply of global cropland is projected to grow by less than 5 percent, according to Farmland Partners. The company attributes the low projected rate of growth to urban development and continued water depletion, among other factors.
“It’s all about global food demand and hitching your wagon to the global food demand story. That is a secular trend that will go on for a long time,” says Farmland Partners CEO Paul Pittman, who dismisses the recent hand-wringing about the outlook for U.S. farmland prices.
“Everyone likes to get quoted in the press talking about how the sky is falling, but they are talking about anecdotal evidence or a survey of expectations, as opposed to data points,” he remarks.
Last year, U.S. farmland values actually increased, although not in every market, says Pittman, pointing to the findings of a land-value survey released in August by the Department of Agriculture. The survey reported that the average value of U.S. farmland, which includes both land and buildings, climbed by about 8 percent during the one-year period ended June 2014. The long-term average growth rate is about 5 percent, according to Pittman. In the Delta states of Arkansas, Louisiana and Mississippi, farmland prices were flat to slightly down, and Farmland Partners capitalized on the softness in that region to make acquisitions there last year.
“For the longest period, farms have been owned by families. [Paul Pittman] believes there is a huge opportunity to consolidate farmland in the United States because its ownership is pretty fragmented,” says Simon Yarmak, an analyst at Stifel, Nicolaus & Co. Inc.
Farmland Partners has undertaken a spate of acquisitions since its IPO, deploying the capital it raised much more quickly than some analysts anticipated. Its initial portfolio consisted of 38 farms, totaling about 7,300 acres. Most of the farms in its initial portfolio are located in west and central Illinois and are leased to operations affiliated with Pittman and/or Jesse Hough, a consultant to Farmland Partners and general manager of Pittman-Hough Farms.
By the end of the third quarter, Farmland Partners had grown the size of its portfolio to 60 farms, including some properties under contract, totaling about 38,000 acres in Illinois, Nebraska, Colorado, Arkansas, Louisiana and Mississippi. As of the third quarter, the company had closed on nearly $36 million in acquisitions since its IPO and had another $33 million in deals under contract. Contingent on raising additional capital, Farmland Partners plans to double the size of its portfolio each year over the next couple years, Pittman said.
Working Faster, Not Harder
Farmland Partners, which raised $44 million in a secondary offering last summer, invests in institutional-grade primary row crop farmland. Primary row crops include corn, wheat, rice, soybeans and cotton. The crops, most of which are used to feed livestock and produce food for human consumption, are essential components of the global food supply. Primary row crops directly account for more than 65 percent of the world’s caloric consumption, according to the Food and Agriculture Organization of the United Nations.
Farmland Partners rents land to farmers on a triple-net basis, meaning that tenants must pay nearly all property-related expenses, including taxes, maintenance, insurance, water usage and costs related to farming the land. For decades now, many American farmers have been renting a portion of the land they cultivate in order to free up capital for their operations.
Technological improvements in farming equipment and the use of genetically modified crops have allowed farmers to plant and harvest larger areas faster and with less labor, making it more cost efficient for them to scale up their operations. At the same time, the cost of farmland has risen sharply in many U.S. markets. The average price of U. S. cropland per acre surged by more than 58 percent between 2007 and 2013, according to the U.S. Department of Agriculture.
Thanks to its recent acquisitions, Farmland Partners is now more diversified in terms of its tenant mix, crop type and geographic footprint than it was when it went public. “The promise of this business is to consolidate the very fragmented institutional-quality row crop market. Consolidation is what it really offers to investors, and a way to play the institutional-grade farmland market. Until recently, there haven’t been many options available to investors who wanted to play that market,” says Dave Rodgers, an analyst with Robert W. Baird & Co.
Harder Than it Looks
Pittman and his team have been able to capitalize on their deep connections within the farming business to source and compete for acquisitions, as well as their knowledge of agriculture and local markets to evaluate deals.
“Not everything you look down on from an airplane when you are flying across the country is of equal value,” Pittman says. “There are huge variations in the productivity of soils based on soil composition. You also have to have an understanding of water availability, both in terms of rainfall and irrigation, and of local markets in terms of the types of commodities that can be grown there and the delivery points for those commodities.”
In some cases, the company structures acquisitions as sale-leaseback deals. This allows farmers to free up capital without having to disrupt their operations. The company can also use its operating partnership units as currency for acquisitions, giving it a competitive advantage among sellers who want to defer potential capital gains taxes and diversify their holdings.
While farm leases are typically short-term, farmers are keen to rent land that they can cultivate for long periods, often generations, Pittman explains. Farmland Partners’ leases typically span three years, but the company focuses on cultivating long-term tenant relationships and plans to retain its properties indefinitely, according to Pittman. That approach has given it a leg up over other types of buyers, such as private equity funds, particularly when it comes to doing sale-leaseback deals.
“We are perceived by farmers as better than most institutional investors because we are a long-term investor, not land flippers, and are buying high-quality assets,” Pittman says.
Commodity Prices a Key
Despite Farmland Partners’ strong execution since its IPO, the company has been battling investors’ concerns over declines in commodity prices and the outlook for farmland values. Corn prices fell by 34 percent during the three-month period ending September 2014, and they were trading at their lowest point since 2010 in early September. Soybean and wheat prices also suffered sharp declines last year.
Nonetheless, many American farmers had a profitable year in 2014 thanks to high crop yields, according to Pittman. What’s more, many farmers have balance sheets that are strong enough to sustain them through a couple bad years, says Luca Fabbri, Farmland Partners’ chief financial officer. Crop insurance also helps to protect farmers against losses resulting from natural disasters and declines in the prices of agricultural commodities.
“Farms continue to be profitable, even though commodity prices are low, because crops have been so good. We don’t see any pushback on rents,” Pittman says.
Farmland Partners has sought to insulate itself against volatility in the farming business by structuring the vast majority of its leases so that annual rental payments are fixed and due in cash before the start of each spring planting season. “In the near term, low commodity prices have little or no impact on our profitability as a REIT” because of the structure of our leases, Pittman remarks.
Pittman remains bullish about the long-term outlook for commodity and farmland prices, given the projected growth in the global population and, thus, worldwide food consumption. The United Nations estimates that the global population will grow by almost 12 percent to nearly 8 billion people in 2020, he notes. Rising incomes in emerging markets are also expected to bolster worldwide food consumption and drive stronger demand for milk, cheese, meat and other types of foods associated with Western-style diets.
Room for Rent Growth
Some analysts question whether farmland prices will continue their long bull run, but generally agree that there certainly appears to be room for rent growth. Nearly 40 percent of U.S. farmland is leased by farmers, and rent growth has lagged that of land prices, according to Kevin Tyler, an analyst at Green Street Advisors.
“Near-zero vacancy rates and low rents as a proportion of farm revenues, 15 percent more recently versus nearly 30 percent in the early 2000s, suggest room for rent growth,” he says.
The average rent for U.S. farmland prices has been steadily increasing—at a nearly 5 percent compound annual growth rate—over the past 16 years, up from $66.50 per acre in 1998 to $141 per acre in 2014, according to a report by Stifel, Nicolaus & Co. that cites figures from the Department of Agriculture.
As CEO of the second-ever stock exchange-listed farmland REIT, Pittman has been working to educate investors and analysts about the often-misunderstood sector. He wants to convince them to look beyond the recent gloomy headlines about commodity prices and farmland values.
“If we end up with multiple years of poor economic results for farmers, in general, rents and land values will come down, he says. “But this certainly hasn’t happened yet. Farmers drive this market and value land and set rents based on a three- to five-year view of the farm economy, not what corn is worth this month.”
Given the relatively small size of the company, some big investors are taking a wait-and-see approach. If Farmland Partners is able to grow the value of its portfolio even more significantly, to say $1 billion or more in assets, it is likely to attract greater attention from institutional investors and spur the creation of copycat farmland REITs, notes Tyler, the Green Street analyst.
Pittman is undoubtedly aiming high. “This can be a multi-billion-dollar business, and that is our goal,” he says.
Gladstone Land: The First Listed Farmland REIT
Last year, Gladstone Land Corp. (NASDAQ: LAND) marked its first full year as the country’s first-ever publicly traded company investing in U.S. farmland. It also became the country’s first stock exchange-listed farmland REIT.
Gladstone Land Corp. At A Glance
Address: 1521 Westbranch Drive, Suite 100, McLean, VA 22102
David J. Gladstone, Chairman, President & CEO
Terry Lee Brubaker, Vice Chairman & COO
Lewis Parrish, CFO
Gladstone Land, part of a group of investment funds managed by the McLean, Va.-based Gladstone Companies, went public in January 2013 and elected REIT status last fall. As of the second quarter of last year, the company owned 26 farms, totaling 6,439 acres, in five states.
Like Farmland Partners, Gladstone Land leases land to farmers on a triple-net basis. Gladstone focuses primarily on annual row crops that grow fresh fruits and vegetables.
Gladstone’s farmer tenants grow lettuce, tomatoes, berries, strawberries and raspberries and other types of fruits and vegetables. Therefore, the company’s portfolio is concentrated in states that grow large amounts of produce. It currently owns farms along the West Coast, in California and Oregon, and in Arizona, Michigan and Florida. The company has been rapidly expanding its holdings in its existing markets and seeking to expand its reach in the Midwest.
Farmland in California, Oregon and Florida is some of the most expensive in the country and under intense pressure from development, according to David Gladstone, chairman, CEO and president of Gladstone. It is also some of the most productive in the world, he notes. Gladstone Land, he adds, has opted to focus on fresh-produce row crops partly because of the high volatility in the prices of corn, soybeans and other agricultural commodities sold around the world.
All of the produce grown on farms owned by Gladstone Land is sold in the United States. U.S. farmers who grow such produce as strawberries and blueberries face very little competition from foreign importers, according to David Gladstone. For example, 90 percent of the strawberries sold in the United States are grown in California, he notes. Farmers who only sell their products domestically also don’t face currency risk, he adds.
“One of the reasons we don’t like the grain area so much is the extreme volatility in prices. This is an area where you can get hurt if you pick the wrong farmer and they don’t have the wherewithal to sustain extreme price changes,” says Gladstone, who owned one of the largest strawberry producers in the United States and sold it to Dole Food Co. Inc. in 2004. He retained ownership of the land, which became part of Gladstone Land’s initial portfolio.
Gladstone says his firm’s tenants have benefitted from the high demand in the United States for produce, including organic produce, which he says is very profitable for farmers. Produce departments within supermarkets have come to occupy larger and larger amounts of floor space over time, he notes.
Gladstone Land had total revenues of about $1.7 million in the third quarter and adjusted funds from operations of nearly $781,000, up 13.5 percent and 15.6 percent, respectively, from the previous quarter. Gladstone Land values its properties on a quarterly basis in order to produce a total net asset value and net asset value per share.
“By knowing the company’s net asset value per share, investors are able to understand not only what they get in dividends, but what the company would be worth if all the land was sold off and all the debts paid, and they can watch that figure appreciate,” David Gladstone says.