Is California Farmland Overvalued By $70 Billion?

Six years ago we wrote a post entitled "Is TIAA-CREF Investing In Farmland A Harbinger Of The Next Asset Bubble?" in which we predicted that "farms (or "real assets" as they are known in polite company) are about to become the next big bubble."  Turns out we were right as Midwest farm prices are starting to crash (see our recent post "Farmland Bubble Bursts As Ag Credit Conditions Crumble"). 

But the Midwest is not the only place where farmland has bubbled over.  California farmland has been bubbling up for years now with unplanted farm ground with "decent" access to water currently selling for $20,000 - $30,000 per acreLand with mature almonds, California's cash crop, is more likely to trade at $30,000 - $40,000 per acre.  This bubble, like so many others, has been caused in large part by institutional capital "reaching for yield" in a low interest rate environment...yet another Fed bubble lurking under the surface.

The plan was relatively simple, in the absence of attractive fixed income yields, large asset managers (like TIAA mentioned above with $850BN of AUM) decided to purchase hard assets like farmland instead.  Farmland could then be planted with the highest value crop, which just happens to be almonds in California, to drive attractive ROICs on invested capital.  A few simple charts illustrate perfectly how the story played out. 

Per the chart below, planted almond acreage in California nearly doubled from 2003 - 2016... 

Almond Acreage

 

Similarly, almond production doubled over the same time period while the industry worked to open up new markets in China and India to adsorb the excess supply.

Almond Production

 

And it all worked really well right up until China stopped buying and almond inventories skyrocketed...

  Almond Inventory

 

...causing almond prices to crash...Turns out if you "grow it" they won't necessarily "buy it."

Almond Prices

 

Now with almond prices at $2.50 per lbs, down from $5.00 per lbs in 2015, land owners are lucky if they're earning a 4% ROIC, down from 16%, on land they likely purchased for north of $35,000 per acre.

Almond P&L

 

We don't know about you but we're not sure about underwriting California farmland to a 4% return particularly in light of that "minor" little drought issue they're facing.  We would be looking for ROICs closer to 8% - 10%, at a bare minimum, which, at current almond prices, implies that acreage needs to come down around 45%-55% from the $35,000 per acre level. 

Almond

 

But the story doesn't end with almond acreage which only represents about 1mm of the total 8mm acres of irrigated farmland in California (see data from the United States Department of Agriculture).  So if we assume that California's 8mm acres are worth $25,000 per acre on average that implies roughly $200BN worth of farmland in total.  Now, even if that number is only inflated by 35% (and not the more draconian 45%-55% we suggested above) it implies that farmland owners, many which are New York institutional buyers, in California alone are sitting on $70BN worth of losses.