Increased Interest In Flex-Leases In Iowa

Increased Interest In Flex-Leases In Iowa

More cropland leases are sharing the risk between landlord and tenant.

The proportion of Iowa farmland operated by the owner has stabilized at about 37%, according to the most recent farmland ownership and tenure survey by Iowa State University. What has changed, however, is the popularity of different types of farm leases. The survey is conducted every five years.

From 2007 to 2012 traditional crop-share leases stayed steady at 12% of total farmland, but flexible cash leases increased from 5% to 8% while fixed cash leases fell by the same amount. To put it another way, 19% of Iowa's cash leases now have provisions by which the rent automatically adjusts up or down each year, compared to only 12% in 2007.

SHARING FINANCIAL RISK: An Iowa State University study shows more flexible cash leases are being used, sharing the risk by landlords and tenants in cropland rental agreements.

Different types of farm leases have different risks and rewards. How have fixed, flexible and crop-share leases compared in recent years in terms of returns to landlords and tenants? ISU Extension economist William Edwards answered that question in a recent article he wrote in the ISU Ag Decision Maker newsletter.

Comparing results using different types of leases
His chart (see Figure 1 below) shows estimated rents per acre for the past 10 years for a corn-soybean rotation. Of course, actual rents will differ for each farm.

Fixed cash rent lease. In his example the fixed rent value is the average cash rent paid in Iowa based on ISU's annual survey.

Flexible cash rent lease. The flexible cash rent values are estimated at 25% of the gross revenue per acre from corn and 35% of gross revenue per acre from soybeans. Gross revenue is calculated by multiplying the state average yields for each year by the state average cash prices in October, November and December of the same year. USDA direct payments and multiperil crop insurance payments received each year are included.

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Crop-share lease. The value of the crop-share rent is estimated as one-half the gross value minus one-half of the costs typically shared by the landowner, based on ISU's typical budgets.

From 2004 to 2006 all rents were very stable. In 2007 a period of higher and more volatile crop prices began. Crop-share and flexible rents rose immediately because they were directly tied to current prices. Fixed cash rents lagged behind for about two years, then caught up.

In the most recent years, all three rents have been very close. Crop-share and flexible rents have been slightly higher than fixed cash rents, which is justified by the increased risk borne by the landowner in each case. In 2013 the crop-share and flexible cash rents both nose-dived in response to lower corn and soybean prices for the 2013 crop, whereas most cash rents were negotiated before the price decline was apparent.

Sharing financial risk with different types of leases
Another ISU study looks at the amount of variation in net return to the landowner and tenant under different lease arrangements, based on yield, price and production cost patterns in Iowa over the past several decades.

Because cash rents are based on expectations of yields and prices for the coming year, rather than actual results, they change more slowly than flexible cash or crop-share leases, notes Edwards.

Many fixed cash rents are not renegotiated each year. This results in a more stable, but slightly lower, average rent over time. The landowner knows with certainty at the beginning of the year how much the rent will be. Any variation in net returns caused by unexpected changes in yields, prices and production costs is borne by the tenant, as shown in the first bar in Edwards's second chart below (see Figure 2).

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At the other extreme, under a 50-50 crop-share lease the tenant and landowner share financial risks equally, as shown in the bar on the far right in Figure 2. Other bars on the chart show how financial risk is shared under several types of flexible cash leases. The "yield index" bar represents a lease for which rent is paid each year depends on the actual yield attained only. The "price index" bar represents a lease for which the rent varies with year-to-year prices only. The yield index lease transfers very little risk to the owner because in Iowa, at least, yields have been more stable than prices in recent years.

Some flex leases set annual rent as a fixed percent
Some flexible leases set the rent each year as a fixed percent of the gross crop income each year. This reduces the tenant's net income variability even more because the rent automatically adjusts up or down with both prices and yields. The "base plus bonus" bar represents a flexible lease in which rent is equal to a fixed base rent plus a percent of the tenant's return over production costs. By incorporating costs into the rent equation, the tenant's net return varies even less, and the sharing of risk approaches that of a 50-50 crop-share lease.

"It is important to note that as landowners take on additional financial risk, their returns will increase in years of higher- than-expected profits as well as decrease when overall returns decline," says Edwards. "Both owners and tenants should select a lease type that reflects their individual abilities and desires to bear risk and reap rewards, versus their needs for more stable income."

For farm management information and analysis visit Ag Decision Maker; ISU farm management specialist Steve Johnson's site is available here.

TAGS: USDA
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