Last August we questioned whether California farmland was overvalued by $70 billion (see our aptly named post: "Is California Farmland Overvalued By $70 Billion?"). Our reasoning was fairly simple, as we argued such a draconian outcome was the inevitable result of large institutional buyers scooping up 1,000s of acres of Cali farmland and massively overplanting almonds because, at least at the time, it was the hottest crop earning the highest returns...and that's what NYC hot money likes.
Unfortunately, chasing short-term returns by massively overplanting a permanent crop with a 25 year useful life and creating a huge supply bubble in the process rarely works out all that well. Here's what we said 9 months ago:
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 acre. Land 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.
And, right on cue, almond prices crashed leaving land owners with a ~4% ROIC, down from 16%, on land they likely purchased for north of $35,000 per acre.
And, as we noted at the time, we would be a bit reluctant to underwrite California farmland to a 4% return. 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.
Now, fast forward just 9 months and indeed it looks as though developed California farmland has already dropped from ~$35,000-$40,000 per acre to ~$25,000 and, at least according to one prominent appraiser in the heart of the Central Valley, we're just getting started. As Michael Ming of Alliance Ag Services told the Bakersfield Californian, he sees California farmland shedding another 20% of it's value in 2017 which would put it squarely at the top end of our previously forecasted range.
A new report on the outlook for Kern County ag land values shows water emerging as a major deciding factor in what land is worth, according to Michael Ming, a broker for Alliance Ag Services LLC.
His report shows that, depending on a piece of land’s water source, the value could decline this year by up to 20 percent — or more.
Such as almond acreage, which shot into the stratosphere in 2015, selling for between $40,000 and $28,000 an acre and have now settled back to between $28,000 and $20,000 an acre, according to Ming’s report.
Ironically, despite record rain in recent months, the next leg down in California farmland will be driven by a lack of water for farmers. In addition to most of the record rainfall in California, what farmers refer to as 'surface water', being washed out to sea and/or reserved for "environmental" purposes the state is also getting ready to restrict farmers' access to groundwater as well...which means land in certain areas will basically be un-farmable.
Meanwhile, as the National Council of Real Estate Investment Fiduciaries (NCREIF) pointed out recently, returns on California farmland actually turned negative in 1Q 2017 for the first time in years.
Of course, while California farmland declines are the most pronounced they're certainly not an anomaly as returns for farmland owners all across the country posted their lowest Q1 returns since 1992.
And, given that large pension funds, like TIAA mentioned above, have been among the largest buyers of farm land, pensioners should brace themselves for the next leg down in the funding levels on their quarterly pension statements.