University of Illinois at Urbana-Champaign The National Agricultural Statistics Service recently published their 2005 estimates of farmland values and rental rates, indicating that the average value of Illinois farmland increased by approximately 11.1% and generated cash rent of approximately 4.3% of value. Subtracting property taxes estimated at roughly .75% results in a total annual return of roughly 14.65% from the perspective of an Illinois farmland owner whose returns are in the form of cash rent and capital gains, less property taxes. This performance directly follows several years of strong appreciation rates and increasing cash rents, and naturally leads to the question: how does Illinois farmland compare to alternative investments? In evaluating investment performance, the level and variability of returns should be considered as well as the relationship to other investments held, and the role of the investment in protecting against inflation.
To provide a broad context about the returns to Illinois farmland investments, historic returns data from 1970 to the end of 2004 were compiled for alternative real estate investments, traditional equity investments, corporate bonds of different grades, and default-risk free Treasury investments of various maturities, and inflation (both the CPI and PPI).
From 1970-2004, the New York Stock Exchange composite generated an average annual return of roughly 7.4% while 3-month Treasuries generated 6.08%, investment grade bonds yielded 8.72%, and all traded REITS (a common index for commercial real estate) yielded 10.14%, each on a continuously compounded basis. To indicate the risk, the minimum annual returns were -36% for the NYSE composite, 1.01% for the Treasuries and -54.9% for the REITS. The standard deviations of returns over that period were 15.3% for the NYSE, over 20% for REITS, and about 2-3% for the bonds and Treasuries. By comparison, Illinois farmland averaged 9.6% over the same period, with a minimum of -22% and a standard deviation of only 9.98%.
The correlation of returns is also important to assess when holding different assets in an investment portfolio. Generally, low or negative return correlations are desired as that results in asset returns whose highs and lows offset to some degree. With respect to inflation, however, higher correlation is preferred in order to maintaining purchasing power. From 1970-2004, Illinois farmland returns had a -.23 correlation with the NYSE index, -.08 with REITS, -.28 with investment grade bonds, and importantly, .44 with the CPI and .49 with the PPI. Gold is often viewed as an inflation protection investment and has had correlations of .56 and .67 with the CPI and PPI respectively. For additional context, a $100 investment in gold in 1970 would be worth $1,053 at the end of 2004 while that same investment in Illinois farmland would be worth approximately $2,477, assuming current returns were reinvested in the same asset.
The results differ somewhat by time period considered, and there is no guarantee that performance will repeat. So what is the catch? Farmland trades in fairly thin markets and has high transactions costs. Likewise, it is difficult to make marginal adjustments in farmland investments unlike equities or fixed income investments. Still, over the long haul by most indicators, Illinois farmland has stacked up well against alternative investments.