Written By Kent Thiesse, Farm Management Analyst
FLEXIBLE LEASE AGREEMENTS FOR 2016
Most land rental rates in Southern and Western Minnesota increased by 40-50 percent or more from 2010 to 2014, according to farm business management land rental data compiled by the University of Minnesota. Average rental rates for 2015 were steady to slightly lower in many areas, compared to 2014 land rental rates; however, land rental rates were above breakeven levels for many crop producers. Farm operators and landlords are now in the process of negotiating land rental contracts for 2016, and are trying to arrive at equitable rental rates.
The commodity prices for corn and soybeans dropped significantly in the past couple of years, due to higher levels of U.S. corn and soybean production in 2014 and 2015, and the associated large increases in the U.S. grain supplies. USDA recently released the final national market year average (MYA) crop prices for the 2014-2015 year, which were $3.70 per bushel for corn and $10.10 per bushel for soybeans. The MYA average prices are calculated from September 1 in the year of harvest, until August 31 the following year. The MYA prices in other recent years for corn were $4.46 per bushel in 2013-14, $6.89/Bu. in 2012-13, and $6.22/Bu. in 2011-12. Recent MYA soybean prices were $13.00 per bushel in 2013-14, $14.40/Bu. in 2012-13, and $12.50/Bu. in 2011-12. USDA is currently estimating the 2015-16 MYA average prices near $3.80/Bu for corn and $9.15/Bu. for soybeans.
Current cash corn prices are near $3.30-$3.50 per bushel at most locations in the Upper Midwest, while cash soybean prices are near $8.00-$8.50 per bushel. Forward pricing opportunities for the Fall of 2016 for next year’s corn and soybean crop are very near the current cash grain prices. Many farm operators could face a substantial loss per acre at the current projected commodity prices for corn and soybeans in 2016, if the 2016 land rental rates are not adjusted to lower levels. Crop input costs for seed, fertilizer, chemicals, fuel, and crop drying are not likely to decline significantly for the 2016 crop year, according to most farm management experts.
There can be a big difference in crop yields and crop expenses from farm-to-farm that can cause the breakeven price to either increase or decrease from the average calculations. Final breakeven crop prices for corn and soybeans in 2015 may be slightly lower than projections last Spring for many farms, due to the exceptional yields in 2015. However, as we plan ahead for 2016, with more normal yields and fairly steady crop expenses, breakeven price levels are likely to be higher than 2015 levels.
An alternative to a straight-out cash rental rates that may be difficult to “cash flow” for 2016 may be for producers and landlords to use a “flexible cash lease” rental agreement, which allows the final cash rental rate to vary as crop prices and/or yields vary, or as gross revenue per acre exceeds established targets. The use of a flexible cash rental lease is potentially fairer to both the landlord and the farm operator, depending on the situation, and how the flexible lease is set up. A “true” flexible cash lease allows for the landlord to receive additional land rental payments above a “base” land rental rate, if the actual crop yields and/or market prices, or the gross revenue per acre, exceed established “base” figures. A “true” flexible cash lease would also allow for the “base” rent to be adjusted downward, if the actual crop yields and prices, or revenue per acre, fall below the established “base” figures.
Most flexible leases have been modified in recent years, and only “flex” upward with added rental payment to the landlords, if the “base” crop yield and/or prices, or revenue per acre, are exceeded. The modified “base rent plus a bonus” approach is acceptable if the “base” cash rental rates are kept within a reasonable range. If the “base” rent is set too high, above breakeven levels, resulting in a “loss”, it is very difficult for the producer to recoup any of those losses with a flexible lease.
Flexible leases can work well for newer or younger farm operators that may not be able to afford the higher cash rental rates for farm land, and most Ag Lenders support of the use of flexible leases in order to reduce financial risk in a farming operation. A flexible lease makes it easier for producers to utilize risk management tools such as crop revenue insurance policies and forward pricing of grain. A flexible lease, with a fair base rental rate, allows landlords the security of a solid base rental rate, while having the opportunity to share in added profits when crop prices and/or yields exceed expectations. Flexible leases are a nice alternative for Landlords that want to continue to work with long-standing farm operators, without setting cash rental rates too high to keep the current tenants.
“Base Rent” Determination
One of the biggest challenges with flexible cash rental leases is determining the “base rent” per acre, which in most instances is the minimum rental rate for the year on a land parcel. The “base rate” should be adjusted upward or downward annually, depending on changes in crop price expectations, average crop yields, or the projected “break-evens” for crop production for the coming year. The best way to establish the “base” rental rate is to have a rental rate per acre that is agreeable to both the landlord and farm operator, with an established method of calculation.
Following are some suggested ways to arrive at a “base rent” for a flexible lease” :
The normal percentage used to determine the “base” rental rate would be approximately 30 percent of the APH yield for corn, and 40 percent of the APH yield for soybeans. Since the rotation and crops planted each year change, it is probably fairest to just do a 50/50 split on the calculated rent for corn and soybeans, if both crops are typically raised over a period of years. However, if a farm typically raises almost all corn each year, adjustments might be needed. Adjustments also need to be made for other crops, such as small grains, canning crops, sugar beets, etc. Some rental contracts make all calculations based on corn acres, regardless of the crop that is planted in a given year, in order to keep the calculations easier to understand.
- Most Land-Grant Universities, and some farm management associations, publish annual average land rental rates on a yearly basis. One possibility may be to take the average of the three most recent years for a county or area as a base rent; however, some of these average rental rates may be a bit high, given the projected lower corn and soybean prices for 2016.
- Many Universities and farm management groups also publish crop budget projections for the coming year, which could also be used as a resource for arriving at an equitable “base” rental rate. A “base” rental rate should allow the farm operator to cover their direct and overhead costs per acre for the coming year.
- Another possibility would be to have a set dollar amount, plus the real estate tax amount, as the base rent, which could be adjusted each year as conditions change. (Example --- base rent would be $150.00 per acre, plus $40.00 per acre (RE Tax), for a total of $190.00 per acre.)
- Another way to determine a “base” rental rate could be to take a flat percentage of the crop insurance adjusted production history (APH) yield on a farm times the expected harvest price, prior to the growing season. The expected harvest price could be the October forward contract price at a local grain elevator or processing plant price on or around March 1st. Others have used the crop insurance base price announced on March 1st, which is based on the Chicago Board of Trade (CBOT) December futures price for corn, and CBOT November futures price for soybeans. The key is that whatever price source is used to set the “base rent” must also used to determine the “final rental rate”, in order to account for the local grain price “basis”, which can vary throughout the year. It is probably best to use a local source, which is agreeable to all parties, to set both the base price and the final harvest price.
APH “Base Rent Example :
Corn APH = 190 Bu./A.
Soybean APH = 47 Bu./A.
March 1st Local Harvest Price Estimates -------- Corn = $3.50/Bu.
Soybeans = $8.25/Bu/
Assumption is 50 % (.50) of each crop.
Base Rent = (Corn) 190 Bu./A. x .30 (30%) x $3.50/Bu. x .50 = $ 99.75/A.
(Soybeans) 50 Bu./A. x .40 (40%) x $8.25/Bu. x .50 = $ 82.20/A.
Base Rent = $182.25/A.
Notes : The projected harvest prices used in this example are estimates (as of 11-01-15), and
prices may change by March 1, 2016.
APH yields are adjusted annually, and there is a wide variation in APH yields from
farm-to-farm. The standard APH yield should be used, which reflects the actual crop
production history on a farm, and not the newer “tend-adjusted APH yield that is used
for certain crop insurance products.
Many flexible leases also contain a “maximum” (and possibly a “minimum”) cash rent per acre, as well as the method that will be used to determine the flexible rent payments. Typically maximum annual rental rates in a flexible lease arrangement are set at $50.00-$100.00 above the base rental rate.
Determining Yields, Prices, Revenues, and Expenses for Flexible Leases
Many flexible cash leases require a “base yield” of some type. The easiest method to get a base yield is to use the crop insurance APH yield described earlier, which is updated annually. Another alternative to determine a base yield for a crop could be using the producer’s actual verified annual production on a farm, which is averaged over a period of years. Actual yield calculation in a given year on the farm can be determined by warehouse receipts, settlement sheets, scale tickets, bin measurements, grain cart weigh wagons, yield monitors, or any other method that is acceptable to both the landlord and farm operator. Many times, yield determination requires a certain degree of “trust level” between the landlord and the farm operator.
As mentioned earlier, the “base price” for a crop could be the projected harvest (October) price at the local grain elevator or processing plant for that crop on a specified date prior to planting (ex. – March 1 or April 1 for corn and soybeans), and the final price is the price for that crop at the same location on a specified date in the Fall (ex. --- October 15). In some cases a weekly or monthly average price at the local level from planting to harvest is used to determine the final price. Whatever method is used to determine both the “base” and final prices should be consistent, using the same grain elevator or processing plant as a source for the local grain price.
With the occurrence of much higher crop input costs in recent years, some flexible cash leases have been modified, and are now based on gross revenue triggers that exceed the cost of production, rather than on crop yield and price triggers. In this type of lease, the landlord only receives additional cash rental payments beyond the “base rent” when the final gross revenue per acre (yield x price) exceeds the established cost of production for the year. Typically, the added “flex” rent payment to the landlord would be a set percentage of the added gross revenue per acre above the established cost of production per acre, which is usually around 30-35 percent for corn, and about 35-40 percent for soybeans, with a “maximum” rental rate per acre.
Just as with crop yields and prices, determining the established cost of production for a crop for the year can be a challenge. Some possibilities would be to use cash flow statements for the year prepared by a farm management advisor, ag lender, or the producer themselves. Many Universities and farm management associations have average cost of production data available. There also probably needs to be allowances in a flexible lease to allow for added costs or expenses due to weather or emergencies.
There are many variations to setting up a flexible lease agreement between a landlord and farm operator, including using yield only, price only, or a base crop revenue compared to a harvest crop revenue, with or without using cost of production, and many more. The big key, regardless of the flexible lease agreement, is that both the landlord and tenant fully understand the rental agreement, and the calculations that are used to determine the final rental rate. It is also very important that flexible lease agreements, as well as all land rental contracts, be finalized with a written agreement. Please refer to the attached list of flexible lease examples.
FLEXIBLE LEASE RESOURCES
Iowa State University has some very good resources on flexible cash leases and written cash rental lease contracts, including sample cash rental contracts, which are available on their “Ag Decision Maker” web site, which is located at : http://www.extension.iastate.edu/agdm/. The University of Minnesota has a computer spreadsheet titled “Fair Rent” which is an excellent resource for determining equitable land rental rates, and is available at : https://fairrent.umn.edu. For additional information on flexible rental leases, please forward an e-mail to : firstname.lastname@example.org
Utilizing “flexible cash lease agreements” between farm operators and landlords can be a good management strategy as an alternative to extremely high straight cash rental rates; however, these agreements need to be fair and equitable to all parties. Landlords also need to be willing to adjust the “base” cash rental rates lower, if necessary, as the projected crop margins become much tighter in 2016. It is extremely important that all aspects of a flexible land rental lease agreement, including base rent, yield and price determination, as well as other aspects of a flex lease, be detailed in a written rental contract, which is signed by all parties. Successful “flexible cash lease agreements”, just as any other long-term cash rental agreement, have always involved cooperation, trust, and good communication between the farm operator and the landlord.
Note --- For additional information contact Kent Thiesse, Farm Management Analyst and
Vice President, MinnStar Bank, Lake Crystal, MN. (Phone --- (507) 381-7960) ;
E-mail --- email@example.com) Web Site --- http://www.minnstarbank.com/
FLEXIBLE LEASE EXAMPLES :
- Cash rental contract with a base cash rental rate (ex. = $190.00 per acre), based on the producer’s breakeven level, plus the landlord and will receive an additional percentage (ex. = 35 % for corn and 40 % for soybeans) of the amount that the final crop revenue (ex. = final yield x Oct. 15 local price) exceeds the base crop revenue (ex. = Crop Ins. APH yield x April 1 new crop local price).
- Cash rental contract with a base cash rental rate (ex. = $190.00 per acre), plus the producer will pay the landlord an additional amount (ex. = $25.00 per acre), if actual yield exceeds the APH crop insurance yield by 10 percent or more. (Corn ex. = APH of 190 bushels per acre, and final yield of 209 bushels per acre or higher.)
- Cash rental contract with a base cash rental rate (ex. = $190.00 per acre), plus the producer will pay the landlord an additional amount (ex. = $25.00 per acre), if harvest-time (ex. = October 15) local grain price exceeds the base (ex. = April 1 local grain price) by 10 percent or more. (Soybean ex. = $8.25 per bushel local price on April 1, and October 15 price of $9.08 per bushel or higher.). There could be additional steps built in for higher price levels.
(Example --- Final corn yield of 210 bushels per acre would result in landlord receiving 7 bushels
- Cash rental contract with base rental rate (ex. = $190.00 per acre), plus landlord will receive 35 percent of the excess bushels of corn yields that exceed the APH yield (190 bushels per acre), and 40 percent of the excess bushels of soybean yields that exceed the APH yield (50 bushels per acre). The landlord would receive the harvest market price at the local elevator on those bushels.
of corn (20 bu. x .35) x $3.50/Bu. (est.) = $24.50 per acre. (bonus rent)
Example --- Base Rent = $150.00/acre + $40.00/acre (RE Tax) = $190.00 per acre
- Cash rental contract with a “fair” base cash rental rate that includes the annual real estate tax per acre (ex. = $150.00 per acre plus $40.00 per acre), with a bonus rent if the final corn yield times the local harvest price times 30 percent (.30) exceeds the base rent (the corn calculation would be used regardless of the crop that is raised, and if no corn is raised the APH yield would be used.)
Final Rent = 180 bu./acre x $4.00/bu. x .30 = $216.00 per acre
Bonus Rent = $26.00 per acre ($216.00 - $190.00)
- A “price only” example would be to use the APH for each crop on a farm times the expected crop insurance base price on March 1st, which is based on CBOT futures prices, and then to use the actual crop insurance harvest price (Nov. 1st), along with the same APH yield and formula (30 % for corn and 40 % for soybeans) to determine the final rental rate. If the final harvest price is lower than the March 1st price for both corn and soybeans, the “base rent” would be the final rent.
Base Rent = (Corn) 190 Bu./A. x .30 (30%) x $3.75/Bu. x .50 = $106.88/A.
(Soybeans) 50 Bu./A. x .40 (40%) x $8.75/Bu. x .50 = $ 87.50/A.
Base Rent = $194.38/A.
Final Rent = (Corn) 190 Bu./A. x .30 (30%) x $4.25/Bu. x .50 = $121.13/A.
(Soybeans) 50 Bu./A. x .40 (40%) x $9.75/Bu. x .50 = $ 97.50/A.
Final Rent = $218.63/A.
* These Flexible Lease examples were developed by Kent Thiesse, Farm Management Analyst.