Equitable Farmland Cash Leasing

Equitable Farmland Cash Leasing
Pivot in field at sunset.

About 50% of Nebraska farmland is leased each year by crop producers from a wide variety of landowners. Equitable leasing agreements are those where landlord and tenant achieve their goals, acknowledging the needs of the other party, and employ practices to preserve the productivity of the land. The definition of equity may differ for each party though. Likely, each agreement will be different based on the needs and desired outcomes of the parties involved.

This article will cover considerations for equitable leasing agreements. Different scenarios exist between landlord and tenant relationships across Nebraska and surrounding states focused on commercial agricultural production. Understanding these unique relationships helps us understand the equity of lease arrangements beyond the cash rent. The following three scenarios bring up common issues arising between an absentee or non-operating landlord and tenant. In each scenario, how could the outcome be improved through better communication or revising lease provisions?

Not long ago, a family had a conversation with grandma about the rent that the neighbor was paying for her farm ground. They learned that he was paying about $25 per acre less for cropland than the average for the county. Grandma owns about 320 acres of irrigated cropland. The family was concerned that Grandma was missing out on $8000 rent income per year ($25 per acre X 320 acres). What the family forgot to ask were the specifics of the agreement. Grandma did not pay any of the upgrade expenses to her pivots that her tenant has provided including variable rate irrigation, new nozzles and motor replacement. The tenant has been taking Grandma to some of her doctor’s appointments and put new roofs on a couple of outbuildings. After adding these expenses together to the property rent, the tenant was paying an effective total rent close to the county’s going average.

A landlord in central Nebraska was at a meeting about rental rates and land values. He was asking what a reasonable rental rate for the upcoming crop year might be. The presenters learned from the landlord that the current rent paid was at the high end of the range of rents for the area and had been that way for several years. The crop rotation was corn and soybeans. Crop incomes had been declining for a couple of years but the landlord said he was going to raise the rent anyway. Property taxes had been rising and he still wanted to earn the same rate of return after his expenses as before.

An older woman wanted to help her great niece start farming. She agreed to a lower rental rate at the beginning and paying for all of the maintenance of the irrigation system costs. This left her with a small amount of revenue after property taxes. It is five years later and prices and yields have increased, but not the effective rent on the property. Property taxes have increased by 50%. She is wondering whether it is fair to ask for more rent given this rising landownership expense.

Background

Several aspects of equitable farmland leasing need to be addressed during negotiations. Utmost in many minds would be the amount of rent to be paid. Several ways exist to calculate a payment rate and the process used should match the goals of the parties involved in the agreement.

Cash rent agreements provide greater management flexibility to the tenant and provide guaranteed income to the landlord. Landlords living some distance from their farm ground are often unable to be involved in management and have moved away from using crop share rental agreements.

Crop share rental agreements better fit the current year economic uncertainty and agronomic situation but may lead to varying degrees of income or effective rent to the landlord based on crop yield, prices, and expenses.

Flexible cash rent agreements can give the landlord a guaranteed base rent subject to adjustments based on yield, price, or revenue that may raise the effective final rent. Flexible cash rental arrangements potentially reduce the annual rental rate negotiation of the lease by fitting the effective rent to variability of economic or production uncertainty.

Different lease types might be used by a landlord with a tenant depending on the type of the property. On irrigated cropland, a tenant might pay cash rent or flexible rent while crop share is used for dryland crop ground.

Once the type of rental payment is chosen, a method of setting the payment rate is determined. The next section will set out processes to estimate equitable payment rates.

Cash Rent Rate

Methods to estimate cash rent rates include adjusting rental market information, return on investment, and cash equivalent from crop share. Making these calculations does not take some things into consideration. For instance, publication of market rates may not necessarily consider productivity applicable to a specific parcel of ground, specialty crop production, or additional non-cash provisions included in the rental agreement. A landowner that has much better- or poorer-than-average soils can expect to receive rates above or below average. Cash rent rates typically relate to soil productivity to be economically viable and equitable. The same can be said when a tenant has been able to obtain a contract to produce high value crops like seed corn. The landowner would expect higher rental rates because of the potentially higher economic returns to seed corn contract versus number 2 yellow corn.

Family considerations can also influence rental rates. It is not unusual for landowners to offer favorable rental rates to family members to ensure continuation of the family farm legacy. The reasons behind the favorable rental rate should be communicated and expressed to other family members involved with the property.

Equitable cash rent rates can be market-based as well as grounded in the production economics of the land. Market rental rate data can be found in two public information sources: the University of Nebraska-Lincoln Department of Agricultural Economics and the USDA National Agricultural Statistics Services (NASS) websites. Both of these organizations report average rates for dryland and irrigated cropland (in addition to grazing land), but a simple average will not fit every parcel of ground.

Two ways to calculate rental rates that fit the economics of cropland include: 1) cash rent equivalent from crop share or 2) tenant’s residual. Crop Share Equivalent calculates a cash rent rate based on the share of costs each party has and the expected yield and crop prices. Net return to the landowner is calculated which then can be the cash rent paid. Tenant’s residual is calculated as the net return for crop production which is termed return to land. This net return can then be negotiated as the cash rent payment. Arriving at a rate that fits a specific farm using these two methods can be done with a worksheet published by Iowa State University “Calculating a Cash Rental Rate”. ( Computing a Cropland Cash Rental Rate, n.d.)

Flex cash rents are a third way to fit cash rental rates to current economic conditions. Flex rent can use either or both yields and prices to set a bonus payment in situations where price and/or yields are higher than anticipated. A base rent is set which is the minimum payment that is made. This base rent means that the landowner does not have the production or price risk as in crop share rental and the landowner can share in higher incomes if it occurs.

Crop Share

Share agreements historically have followed local traditions or expectations for an area. Over time, those typical or historic shares might not be equitable to either party signing the lease agreement. One way to ascertain if the agreement is out of balance compared to the resources each puts into the cropping operation is to utilize a worksheet from aglease101.org. This website is supported by the North Central Farm Management Extension Committee and contains the publication, Crop Share Rental Agreements For Your Farm NCFMEC-02, outlining aspects of crop share leases. Part III of this publication discusses ways to calculate the crop share amount each party receives. This begins with a crop budget and the contribution percentage each makes toward crop production. The percentage each puts toward crop production can be the crop share or the contributions adjusted to achieve the desired shares. The important part of the process is to achieve a balance between the inputs made by each party along with the share of the production in the crop share agreement.

Additional Lease Considerations

Equitable leasing will also consider these additional areas for negotiation:

1. Cost sharing. - if any costs are to be shared by tenant and landlord, these should be listed in the lease agreement and the method of share calculation specified. This section is applicable to share leases but may also apply to cash rent agreements. For instance, some irrigation equipment maintenance may be the responsibility of the tenant, but major repairs, such as well motor replacement, are paid by the landowner. This situation may be applicable to pasture rent including upkeep on fences or water systems for livestock.

Corn stover or stalks - components of a crop produced from farming in a cash arrangement are enjoyed by the tenant including corn stover. Landlords may want the corn stover to remain on the land or to limit the amount removed. Since the corn stover was produced by the tenant’s cultivation of the land and the possible income lost by the tenant from using stover for feed, landlords may want to consider this in setting cash rent. In a crop share arrangement, the use of the corn stalks is split according to the share rate, unless otherwise specified in the written lease agreement.

2. Maintaining fertility - landowners will be concerned that fertility be maintained or improved while a tenant produces commodities on their cropland. Landowners may require fertility maintenance, including regular soil testing with all parties receiving copies of the results. Also, all parties might receive fertilizer application invoices and statements in the rental contract to ensure tenants are applying removal rates of fertilizer. However, application of removal rates for fertilizer may not be either an economic or agronomic best practice. Some soils may have very or excessively high amounts of potassium or phosphorous already and adding more would lead to off-site nutrient movement and downstream pollution.

3. Weed control, site appearance and building maintenance - appearance and building functionality, even when obsolete, are an important consideration for some landowners and tenants may want to understand those expectations. Expectations may go beyond the cropland itself and include something like mowing around the buildings or road ditches along with keeping machinery parked out of view.

a. Noxious weed control is the legal responsibility of the landowner on cropland and non-crop producing acres. Tenants may be expected, either by the landowner or the community, to control noxious weeds. All of these expectations should be communicated to tenants or potential tenants. The property owner and tenant might agree that materials are paid by the landowner and the tenant performs the activity (or receives reimbursement for the chemicals by the landlord).

4. Land management: Landowners may be interested in the way their land is managed by tenants. For instance, the tenant may be asked or required to use no-till farming practices or that hunting not be allowed. Landowners can have written leases that specify the way farmland is managed or restrictions on how it is managed by tenants.

Conclusion

Rental arrangements can become unbalanced over time if not reviewed periodically. These rates may be unbalanced at the start as well. Reviewing rental rates and matching the financial environment to the rental agreement terms requires a thoughtful process and considers all variables. Just looking at rental rate data or going by traditional arrangements can be financially detrimental to either the landlord or the tenant. Other negative consequences can emerge if the financial imbalances aren’t addressed. Think back to the scenarios that are at the beginning of the article. Which ones equitably compensate both the landowner and tenant for the investment and production activity each brings to commodity production? And what is equitable?

Sources:

2020 Nebraska Farm Real Estate Report | Agricultural Economics . (n.d.). Retrieved May 11, 2020, from https://agecon.unl.edu/2020-nebraska-farm-real-estate-report

Ag Lease 101—Helping both landowners and land operators learn about alternative lease arrangements . (n.d.). Retrieved May 4, 2020, from https://aglease101.org/

Computing a Cropland Cash Rental Rate . (n.d.). Retrieved May 11, 2020, from https://www.extension.iastate.edu/agdm/wholefarm/html/c2-20.html

Improving Your Farm Lease Contract | Ag Decision Maker . (n.d.). Retrieved May 11, 2020, from https://www.extension.iastate.edu/agdm/wholefarm/html/c2-01.html

Selley, R., Johnson, B. B., Jose, H. D., & Cole, J. D. (n.d.). EC00-829 Flexible Cash Leasing of Cropland. 10. https://digitalcommons.unl.edu/cgi/viewcontent.cgi?article=1627&context=extensionhist

USDA - National Agricultural Statistics Service—Surveys—Cash Rents . (n.d.). Retrieved May 11, 2020, from https://www.nass.usda.gov/Surveys/Guide_to_NASS_Surveys/Cash_Rents_by_County/