Farmland as an investment class demands a high level of understanding and very specific knowledge. It requires a clear appreciation of the various strengths, weaknesses and drivers of value. This enables the right allocations to be made in order to optimise investment performance. Farmland is an asset that can produce sharply divergent returns from very similar operations simply as a result of differing management strategies, and expertise. The impact on the bottom line (all 3) of these differences can be dramatic. Success requires an appreciation of both the broad and the granular.
Based on precedent a commodity focused approach with scale acting as the major driver of value is the investment model most familiar and easily allocated to. This is also, counter to prevailing wisdom, the highest risk (agronomic, climatic and market) system to allocate to. It is an example of where the concept of safety in numbers may not prove to be wholly accurate.
The first step in the farmland investment process is determining the enterprise and geographical allocation, i.e. dairy, permanent crops and/or row cropping and their location (NZ, Australia, South America etc.). The second component is the detailed understanding and identification of the operational management finessing at the grassroots level (literally) that creates value and delivers financial performance.
In this paper we skip the first step and drill straight down to step two. The following five ‘operational’ themes are in our view critical to creating a robust, effective and therefore successful management system. When considering what is required to capture the opportunity, these are the factors that must be in optimal condition if long term success is to be achieved.
Resilience is the ability to perform in the face of external challenges. It is achieved through sound ecological and holistic management of farmland. This involves good management of the soil and therefore soil organic matter (SOM), which better enables the retention of water in the soil, draining of excess water and the more efficient use of water, i.e. less irrigation water is required (achieving cost savings as well). Good soil management combines with breeding for healthy, robust and productive animals/crops and diversity within the system, to create resilience. As an example of resilience benefits in practice, research in the United States found organic crop yields achieved levels 31% higher than conventional under drought conditions. Success lies in designing a system that is able to stand on its own without being reliant on inputs to run the production system and to function through the inevitable climatic and agronomic challenges.
A system that performs even in the face of climatic and other external challenges.
A more robust and resilient system generates greater consistency of production, financial returns and a more valuable asset.
The industrial agricultural production system is entirely dependent on a multiplicity of external inputs. These inputs whether herbicides, pesticides (or other biocides), synthetic fertiliser or feed all have one thing in common; their cost is closely correlated to the price of fossil fuels. They also reflect a flawed production system that requires propping up by way of these inputs.
In the case of some inputs, such as synthetic nitrogen, they are enormously damaging from a GHG and water quality viewpoint. Investment capital seeking to achieve optimal GHG outcomes is able to achieve significant ‘bang for their buck’ by supporting the move from synthetic to biological nitrogen (ecological) based farming systems.
Those systems that have less exposure to external inputs, that are more self sufficient in terms of feed, fertility and agro-ecosystem health, are better positioned to deliver consistent financial returns in the face of increased input scarcity and rising costs.
Primary production is reliant on the protection, design and management of biological systems. There is a belief among some that we ‘need to be ruthless’ and part of this ruthlessness involves ignoring the environmental damage caused by food production. This view demonstrates a damaging lack of understanding.
Biodiversity and environmental services as a whole are essential in food production and therefore fundamental to successful investment. As the FAO has noted
“As genetic diversity erodes, our capacity to maintain and enhance livestock productivity and sustainable agriculture decreases, along with the ability to respond to changing conditions. Agrobiodiversity holds the key to increasing food security and improving the human condition.”
- Increases the productivity of agro-ecological production systems in a range of growing conditions.
- More diverse farming systems are more resilient in the face of climatic/agronomic challenges.
- Maintains and increases the soil ecosystem and fertility.
- Fundamental to managing and mitigating the impact of pests and diseases.
- Essential in adapting farming systems to cope with the forecast impacts of climate change.
Biodiversity is a must have, rather than a nice to have.
Most orthodox farming systems are characterised by a lack of biodiversity and a management system that damages biodiversity. These systems are less resilient, higher risk (market, agronomic and financial) and more likely to underperform in an investment sense.
Such systems may reflect the operating and investment ‘norm’ but the lack of recognition of the operational risks they present implies a lack of rigour and depth in the risk assessment process.
If the management system is damaging the environmental capacity of farmland it is damaging the land as an investment. Ecologically poor management limits the ultimate productive capacity of land and therefore its ability to generate income. This approach damages waterways, and the broader environment. Any investment that fails in terms of environmental performance is becoming increasingly unacceptable to the wider community as is happening in NZ currently with respect to intensive dairy farming’s impact on water quality. This will likely evolve into an environment where such operations become untenable. A good thing from an environmental perspective but it may prove challenging for investors in such systems.
Environmentally designed systems are strongly positioned to avoid production limitations (social, regulatory and cost) deliver greater consistency of production and access premium markets for their output.
Profitability not Yield
Discussion of performance in agriculture invariably comes to yield. The raw idea/belief being that high (or ever higher) yield is needed to feed the world and high yield is required for profitability. The first point is overly simplistic and does not hold up to much scrutiny. The increased yield post WWII did not eradicate hunger. If you talk to those on the ground where people are starving they will talk of poverty being the real issue. After all, given the numbers of obese people in the United States, the UK and the ‘developed’ world in general, it hardly seems as if yield is a problem.
The second point regarding profitability is also too simplistic and essentially wrong. Profitability in farming systems is achieved by creating an optimal margin, i.e. keeping costs low and achieving a good yield with a high price. The reality of farming experience tells us that those with the highest yield are not always the most profitable.
This fact is well understood by rural bankers and most professionals in the agriculture sector in New Zealand. The recent milk price drop demonstrated that the high input ‘pushing yield’ intensive systems are the ones that go to the wall when times get tough and that it is the lean ‘low input’ organic and ecological style operations that get through the tough times and are more consistent in their financial performance.
As these intensive systems are also the most environmentally damaging it could be seen as a good thing that they are eliminated as a result of unfavourable market conditions and this could be described as an example of ecology in action.
Scientific evidence demonstrates:
- organic farming can ‘feed the world’;
- in developing regions where food security is most relevant it can significantly increase yields;
- agroecology, if sufficiently supported, can double food production in entire regions within 10 years while mitigating climate change and alleviating rural poverty;
- organic farming’s ability to deliver superior financial performance is well established. It just requires the relevant management knowledge and expertise to execute.
The on-going strength, growth and long-term consistency of the organic market are class leading in the food sector.
It presents an established, sophisticated and undersupplied market for those farmers/investors with the ability to access it. The ability to meet demand is limited through regulation (organic certification) and the lack of knowledge, expertise and understanding of ecological production systems in the farming sector.
We refer here to the consideration of investment in and management of farmland as a genuinely long term commitment and opportunity. It is essential for there to be a plan, a clear vision and strategy of how to manage the asset to enhance its productive capability; not just for the next few years but in the context of definably long-term performance. To create a strategy designed in accordance with an understanding of those pressure points and cycles, that will inevitably impact the farmland and management system. Farmland is that kind of asset and it is that kind of approach that generates performance over an investment horizon and beyond.
This insight and design must be based on the future and not on what has ‘worked’ in the past or perhaps what we have been able to get away with. Agriculture has a history of focusing on the immediate and projecting that into the future while ignoring core ecological truths, with negative consequences. This is no basis for making good invest decisions.
The components discussed in this paper are all integral to the creation of a successful farm system. The strengths of those components and their interaction determines the long-term viability of a farming system.
The following form the basis for long-term success in farmland management.
- System resilience,
- Low exposure to external inputs
- Environmental performance,
- Market/profitability; and
- Design for the long-term