Farm to market: Taking stock of the agricultural land grab

The farmland bubble may have burst in some Corn Belt states, like Iowa. But acreage prices proved resilient across the U.S. and, if not a bumper year in 2015 — an average increase of 2.4 percent and increases in land value of 8 percent or more in some states — it looks better when compared to the flat year for equities.

But individual investors, for the most part, have stayed away from the big agricultural bets being placed on global food demand increasing over time, driving up land prices even further. Institutions, like the mega pension fund TIAA-CREF, the super-wealthy investor set and overseas agricultural giants are still snapping up land this year, and potentially scouting what will seem like bargains years from now as farm real estate values have started to decline.

The situation leaves Paul Pittman, CEO of Farmland Partners (FPI) REIT, frustrated. His company's stock price has been badly beaten up — down more than 20 percent since its 2014 IPO. Yet the dividend has been hiked up three times, Pittman said, and now yields close to 5 percent.

The farmland REIT continues to acquire more acreage. Farmland Partners currently owns 257 farms with an aggregate of 107,838 acres (including 126 farms totaling 32,963 acres under contract), including acreage in Arkansas, Colorado, Georgia, Illinois, Kansas, Louisiana, Michigan, Mississippi, Nebraska, North Carolina, South Carolina, Texas and Virginia. And Pittman is continuing to bag more land in undervalued areas, like the Southeast.

"There's an excess amount of water there," said Pittman, whose REIT doesn't own farmland in water-challenged California.

Yet the stock trades at a substantial discount to its net asset value, according to Daniel Altscher, a senior research analyst at FBR Capital Markets. He has a buy rating on the stock. "Everything is going well," he said.

"This is a new asset class, and so it's misunderstood," said Pittman, a former investment banker. "These are still early days for farmland REITs."

Farmland REIT Gladstone Land Corp. (LAND) has also been hit hard — the stock price has sunk 30 percent in the past year. Yet it owns 34 farms in five states, including California, where vegetables and berries are grown. The REIT has also been snapping up more farmland in California, Florida and other states.

Due to its large landholdings, Gladstone is also very undervalued, said Maxim Group analyst Michael Diana in a recent research report. He has a target price of $14 on the stock, which yields 5 percent.

Pittman doesn't like the comparison to other farm REITs, and the Farmland Partners CEO has a point: His REIT's shares are only down 5 percent in the past year, compared to the 30 percent dive in LAND shares and 27 percent decline in shares of American Farmland (AFCO).

"We are trading ... let's say, less disappointing than the others," Pittman said.

All the farmland REITs suffer from one key headwind related to stock market dynamics: They are small REITs and can be volatile and illiquid in trading. Buying just 1,000 shares in Farmland Partners can move the stock up or down by a lot.

"That's a risk," Altscher said. It's also a risk exacerbated by the lack of institutional money in these REITs. Because they are micro-cap stocks — with market caps ranging from $75 million to $125 million — institutions cannot easily invest. Most institutional investors are barred from holding large stakes in any one stock, and the size of these REITs makes it impossible for institutions to invest without breaching single-stock holding limits.

"These are relatively small market-cap stocks, so attracting broad-based institutional attention is much tougher than retail," Altscher said.

Farmland Partners does have more than 20 institutions in its stock and said its shareholder makeup is at least 40 percent to 50 percent institutional, but Pittman said there are no "household names" among those investors. "Someone who has to make $20 million allocation can't come into a $120 million float company," he said.

Right now the biggest issue for Farmland Partners and the other farm REITs is crop prices, which have plummeted. These REITs generate income by leasing its land to tenant farmers. But rents can slump when crop prices are soft. And wheat and corn prices, among other crops, have all plummeted.

Pittman said the entire agricultural stock complex, from Deere and Monsanto to the farm REITs, has been hit in the commodities slump. "The rate of growth is going down, but not consumption," he said. "It's not too low demand, but it's too much supply while the increase in demand growth is slowing."

The average investor may assume it's a one-to-one relationship, and bad corn price means bad results for all agriculture, from tractor and seed sales to the farm REITs, but Pittman said it's not that simple.

"The farmer still has to rent. The farmer can decide they are not buying another tractor, and the farmer can fight about rent, but can't just say, 'No, I won't rent land."

Crop insurance, which has become more sophisticated in recent years, protects rent in the short term, though longer term, if they remain low, "crop prices will impact farmland rents," said David Rodgers, senior real estate analyst at Robert W. Baird.

Farmland Partners is also diversifying into less volatile specialty crops. Now corn, soybeans and wheat are mostly grown on the REIT's farms, said Pittman. But lately Farmland Partners has been buying up blueberry farms in Michigan. The company has also started doing solar power projects on land it owns, as well as natural gas pipeline easements.

Aging farmers also offer more farmland buying opportunities, Altscher said, adding that the average age of today's farmer is 58, so lots of farmland will hit the market in the next several years as farmers retire.

"We'll keep buying high-quality farms," Pittman said, "and build a large portfolio."

Altscher said a major concern among investors that's kept these stocks down is the chart on farmland prices being extremely high relative to historical levels. Some investors are worried that farmland is in a bubble. "Headlines everywhere are saying asset values are at an all-time high and the price of corn was ripped apart," Altscher said.

He added that from this point of view, things can't end well. If farmland rents go down, then the value of the real estate goes down, and ultimately, a business that operates with as much as 50 percent leverage — considered a normal level of debt in farming — can't continue to operate profitably. "Farmers can sustain a year or two of low prices, but if it's lower for a decade, I would be worried," he said.

Farm sector profitability declined for the second straight year in 2015, according to the USDA's Economic Research Service, with net farm income projected to be $55.9 billion and down about 38 percent from 2014 levels, according to a November 2015 analysis. If the projection is correct, it would represent a drop of 55 percent from the recent high of $123.3 billion in 2013.

Crop receipts were projected by the USDA in November to decrease by $18.2 billion (8.7 percent) in 2015, led by projected declines of $8.6 billion in corn receipts, $5.7 billion in soybean receipts and $2.7 billion in wheat receipts.

A lower-for-longer worst-case scenario explains why analysts say the farmland REITs are trading at below net asset value.

"I don't believe that," Altscher said, but he added the situation could take a long time to sort out, and these are slower-moving businesses. "It's not a get-rich-quick scheme. Owning it is a long-term investment and not a flip."

Pittman said that his company — and its investors — do need to be willing to accept that maybe it can't grow for a while, and the challenge is to get investors to understand that farmland is not going to massively devalue because farmer profitability suffers for a few years. "When you have a bad Christmas sales season, the retailers get dinged, not the mall REITs," he said.

But he said there's no simple answer now, because farmland values could be flat for a few years.

The worst farm bubble ever was in the 1980s and lasted five years.

Some investors have stuck with timberland REITs, which have been around longer and are much bigger. For example, Plum Creek Timber (PCL) has a $7.29 billion market capitalization and yields more than 4 percent. Revenue comes from cutting down trees and selling acreage.

"With these REITs, housing and packaging needs drive demand," Rodgers said.

Morningstar expects lumber consumption to surge for several years, though, driven by significantly rising housing starts, according to Morningstar analyst Daniel Rohr. The housing peak won't come until 2019, the report stated.

Miracle Mile Advisors portfolio manager Duncan Rolph prefers timberland REITS to farmland. "They have been pretty popular," he said. "And they will continue to do well. But it's a bit early for farmland REITs. They need to be more liquid."

Yet year-to-date and in the past one year, Plum Creek Timber has fared no better than Farmland Partners, and it's suffered much more amid the current bearish market sentiment, down 16 percent already this year, to a 52-week low level, and compared to FPI's 7 percent year-to-date decline.

Even Rolph admits, though, that farmland has had double-digit returns for the last 10 years. "That's a nice premium. And farmland REITs have a more attractive yield than bonds," he said. But, he cautions, take a long-term perspective. "Demographics are in your favor," Rolph said.

In November, the USDA's Economic Research Service projected a 1.6 percent decline in farmland values for the full year 2015 (that compares to the 2.4 percent national increase in land value based on actual completed transactions when the USDA-NASS ran farm values in June).

The Farmland Partners CEO said the current on-the-ground view that takes in the entire buying season through December is worse, with land prices down 5 percent in most markets and as much as 10 percent in others, and he is prepared for a further decline this year that could take as much as another 5 percent off land values. "We're in a consolidation phase; things were going aggressively, so it's healthy to take a pause and take out some froth," he said.

He added that farmland prices may not turn around for a year or even two. But Pittman is nonplussed about the current slowdown: "I'm not scared about the fundamental revenue stream underneath my rents," he said. "People will still be eating, and even if crops are not getting sold at same prices."

The Farmland Partners CEO said his current analysis of the market assumes that profitability could be down by 10 percent to 15 percent but it isn't going to zero. "I've done this for 15 years. I've been through these cycles. There's a reason I'm a landlord and not a farmer. It's much more stable," Pittman said.

Pittman said the forward-looking view of global food demand and land scarcity are the big macro drivers. "We think it's a multi-decade trajectory of population growth and GDP per capita growth. If you think there will be no additional demand or declining demand for food, by all means bail on farmland REITs and Deere and Monsanto," Pittman said. "It's awfully hard for me to believe that," he added. "We're not making more land."

—By Constance Gustke, special to CNBC.com