Rural Report
September 2008
Where Are We Going?
The increase in the value of New Zealand farm land has outstripped growth in the farm income generated by the land. Several reasons can be given for the trend. Typically commentators look at rural assets being over or undervalued. Such terms are notoriously hard to define. Less is written about the implications of the change in land values. We provide some background data by looking at the trends in the farm business result and the underlying drivers. We conclude it is the ‘market’ in operation, but ask is it sustainable?
Asset Values
The real price of rural land in New Zealand has doubled in the past seven years – a record since comparable records began (1955).
Graph 1
RURAL LAND PRICE INDEX
Annual Percent Change (Real)
The ‘pure’ economic justification for value is based on the net present value of future (net) income streams. So have the returns from farming land as opposed to holding land supported buyer expectations? Some data suggests not.
Basis for Analysis
It is the overall business return that really matters.
Much of the published analysis about the financial performance of pastoral agriculture in New Zealand only focuses on part of the story. Indicators include the economic farm surplus, net profits or increases in the value of farm land. Other analysis goes into fine detail about the returns per kilogram of dry matter grown or fed to livestock. Economic farm surplus excludes interest, rents and personal expenses. Net profit includes interest and rents but is before personal expenses.
While all are useful measures and part of the ‘economic value’, we argue that it is the trends in the overall farm business result that really matter.
We define the overall business result as gross farm income less farm working expenses less interest and depreciation (i.e. net farm profit) less living expenses, life insurance and income tax. Depreciation is included as a sustainable business must be able to renew assets as they wear out. The business has to consistently cover all items if it is to be sustainable in the long run. That said, a break–even business result is not providing a return on the owner’s equity which also should be rewarded.
The analysis is drawn from several farm accounting practices. There is some statistical noise in the data and some analytical licence on the part of the writer. The limitations of per stock unit (SU) data are acknowledged but it is a common numeric for all sheep and beef data sets. The data suggests the financial sustainability of the industry can be questioned. But the accountants involved all agree with the underlying trends.
Business Results
Business results have not supported the increase in the value of rural land.
There are strong indications that the average sheep and beef farm is not paying its way and the trend is deteriorating. The declining trend in the business result from sheep and beef farms is the same, albeit at different levels for different classes of country.
Graph 2
SHEEP AND BEEF
Business Return ($/SU)
The business result has been negative in some instances for more than four consecutive years ending 2007. The farming year end 2008 will make it five consecutive years for many. The business result has been negative up to 20 percent of gross farm income.
Dairy farms show similar trends.
Graph 3
DAIRY BUSINESS RESULT
The Southland model had very low costs in year end 2007 and is perhaps an aberration!
All data does include the ‘boom’ of 2001 and 2002. Yes the product prices have been relatively flat in the rest of the period that data is available, costs have gone up and there has been adverse weather in some years. But that is the reality of farming.
Note: The business result does not include off–farm income, which is a relatively small but important part of the income on the average farm.
Underlying Drivers
There are disconcerting trends underlying the business results.
Perhaps lack of scale or not growing the business is an issue, but increasing scale was not providing an offset for Otago sheep and beef hill farms.
Graph 4
SHEEP AND BEEF
Scale (SU)
Stocking rate, per head production and animal efficiency are flat. In other words, has meat and wool production per head or per hectare reached a plateau?
Farm working expenses are trending up. So if productivity gains and business returns are not driving the increase in the value of sheep and beef farms, what is? Changing land use is one obvious answer.
Similar observations can be made for dairy farms. Increased scale was happening, achieved in part by intensifying production per hectare.
Graph 5
SHEEP AND BEEF
Intensity (SU/ha)
Graph 6
EFFICIENCY
Kilograms Product
Graph 7
DAIRY SCALE
Graph 8
DAIRY INTENSITY
So are dairy farms barely making a business return in spite of increased scale
and production? Do the bare break–even business returns justify the increases in
dairy land values?
Average farms of both types are also financially more vulnerable. Underlying
both farm types was a near doubling of debt servicing per unit of production (SU
or kg ms). Debt servicing as a percentage of revenue has increased from 10 to 20
percent for sheep and beef and from 15 to 25 percent for dairy. The increase in
debt servicing is due to a combination of borrowing to increase scale,
increasing interest rates and cumulative business losses.
Rural Report page 2