The Opportunity Seems to be Only Beginning
Many Canadians are starting to become aware of an investment opportunity right in their own backyard: farmland. Farmland provides many of the attributes investors are looking for, such as stability, liquidity, yield, and massive supply/ demand economics in their favour. It has also demonstrated higher returns than equities with less volatility. Today we will explore farmland from both a global and Canadian perspective, examine the reasons why investors are starting to take notice, and point out areas of potential opportunity.
The Global Farmland Picture
The world is currently facing two points of divergence. On one hand, population is rising quickly. Between 2010 and 2050, the planet will add approximately 277 000 new people daily, equivalent to adding the population of Barbados every single day for 40 years! That is a lot of new mouths to feed. On the other hand, arable land is quickly disappearing around the world. We lose approximately 35 000 square kilometers annually, the size of New York City, every day. To compound the issue, emerging economies such as China and India are becoming wealthier, with a growing middle class. As a result of increased wealth, more people demand protein in their diet, as opposed to grains and rice. Many do not realize it, but it takes 5 times as much farmland to raise cattle as it does to grow crops. Farmland supply is shrinking at the same time demand is increasing. This is a recipe for higher prices.
There is another important factor to consider. The degradation and erosion of farmland may be accelerating globally. Recently 60 Minutes had a segment on drought conditions, the use of groundwater, and it’s impact on California. Many would be shocked to learn that 90% of California is currently under severe drought. This has been occurring for more than 3 years consecutively, and there simply has not been enough rain, causing farmers to take drastic measures. They are digging wells deep into the water table and pumping to save crops. If they did not do this, some of the most fertile land in the world would be lost, and become desert. The segment pointed out that once the water is used up, it may not replenish, and the drought will be permanent. The same conditions due to lack of water are occurring in India and other areas as well.
These conditions provide a compelling case for examining farmland as an investment opportunity.
The Canadian Farmland Investment Opportunity
Canada has some of the best farmland in the world. Despite normal cycles, we haven’t experienced the same level of abnormally dry conditions as our neighbors to the South. Canada has certainly experienced a rise in farmland prices over the past 5 years, however many areas of Canada are still relatively cheap as compared to other areas globally, leading to potential opportunity. Canada has a highly regulated land title system, making our country a more secure place to own farmland, compared to developing nations which offer less stability.
Saskatchewan Offers the Most Potential
As an investor, one wants the highest return with the lowest downside risk, which is the foundation of value investing. Saskatchewan farmland would seem to offer the greatest risk/ reward opportunity to a value investor as compared to the rest of Canada. In order to understand the unique opportunity that is currently present in Saskatchewan, we must take a look back, into the history books. The magic year to consider is 1988. Prior to 1988, for over 100 years, farmland in Western Canada essentially traded for similar prices regardless of province. Saskatchewan has previously experienced governments that were more socialist/protectionist than say Alberta or Manitoba. As a reaction to prices rising five-fold in the 1970’s, and the fear of this happening again, Saskatchewan was the only province to institute the Farmland Security Act of 1988. This effectively shut out all non-Sask. residents from owning Saskatchewan farmland. This tightening of the market, almost immediately, created a gap between Sask. farmland and the rest of the West. Eventually it got to the point where Sask. land was selling for 60% less than identical Alberta land. Then, in 2003, Saskatchewan repealed the act, and the only barrier to price differences across the West was now eliminated. When the lone variable to a price difference is eliminated, the gap that exists creates an investment opportunity. This is the type of opportunity that investors such as Warren Buffet try to identify in publicly traded stocks. The closing of the gap, or discount, is often referred to as the risk-free rate of return. One might assume that prices would rise almost immediately in Saskatchewan, to catch up with the rest of Western Canada, and the opportunity would disappear. Any such gap that occurs in the highly liquid public stock markets would close almost instantly. In order to catch up, as anticipated, Sask. farmland has in fact risen approximately twice as fast as the rest of the West. However, due to the nature of farmland, and its very early emergence as an investable asset class, we are still experiencing a large gap in prices today. Saskatchewan is still pricing identical land 40-50% lower than Alberta today, for example. It would appear that, all other things equal, Saskatchewan still offers the most upside potential.
Perhaps it isn’t a coincidence that our own national pension plan, the CPP (Canada Pension Plan), recently invested $128 Million in Saskatchewan as its first foray into Canadian farmland. The managers of the CPPIB are looking for the highest reward to risk ratio, and their analysis leads them to Saskatchewan.
Why Don’t I Just Buy Agriculture Stocks?
Many investors mistakenly assume that they will gain the same investment benefits described above by purchasing a public agriculture stock or ETF. The problem is that you are investing in something very different than Canadian farmland. The main reason is that public companies cannot own Canadian farmland. In order to gain the full benefits of owning the actual land, you must either buy farmland yourself personally, or purchase units in a private farmland fund.
This is not to say that ag stocks or ETFs aren’t good investments, but as an investor you need to understand the major differences, and limitations, between various investment types.
Farmland is quickly becoming recognized as a legitimate assets class, both among institutional investors, and individuals alike. In my opinion, this is an asset class that is in its infancy, however growing rapidly. Farmland’s low correlation to stocks and bonds can also act as a portfolio stabilizer to smooth out the volatility inherent in most public portfolios. We must also not overlook the importance of the CPP’s recent investment into Saskatchewan farmland, and their stated intention to increase farmland holdings, to increase both liquidity and legitimacy as an asset class. We are currently in the early adopter phase of investment. I would not be surprised if farmland investing become mainstream over the next 5 years.
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