Commentary: Why investing now in farmland makes sense

Farmland has long been considered a safe and reliable asset class, particularly during times of economic crisis, given its low levels of correlation to other asset classes. When trying to navigate the current crisis, investors are looking for alternative sources of income and farmland could be added to the list of potential investments given its properties as a diversifier and stable source of returns.

The inflation-hedge characteristics of farmland are another consideration for investors. With food security moving up the agenda of governments and potential for further supply chain disruption, the risks of food shortage and resulting food price-driven inflation are in play. Even with consumer consumption habits changing as global lockdown measures around the world have forced people to transition to home cooking and away from dining out, farmland returns are not expected to alter significantly.

Alongside the benefits farmland offers to portfolios given the impact of the coronavirus pandemic, there are further long-term benefits to investing in farmland in addition to technology-driven productivity gains and the associated influence on farmland returns.

When we look at the world today, financial markets are still reeling from the effects of what started as a global health crisis before swiftly morphing into a severe economic downturn. As the current crisis plays out and uncertainty continues, investors are pulling back to the so-called safe haven investments, such as U.S. Treasuries (where yields have dropped below 1%), gold and certain currencies.

Even before the pandemic, farmland investments already provided a compelling alternative to traditional asset classes. Farmland has historically proven to be uncorrelated to economic cycles, experiences substantially less volatility compared with broad market indexes and traditional asset classes, and has exhibited value durability over time.

During the 2008 financial crisis for example, the most comparable crisis to the current one, the impact was felt across most sectors of the global economy. In contrast, this period was relatively profitable for the agricultural sector, resulting in strong direct-to-consumer profitability and higher agricultural land values. To put it into perspective, in the four-year period before and the four-year period after the 2008 financial crisis, the asset class delivered consistent positive returns, outperforming U.S. Treasuries, the Dow Jones Industrial Average, and the S&P 500 index.

Investors were already searching for returns ahead of the COVID-19 crisis. The low-interest-rate environment of the last couple of years had already significantly increased interest in real assets, including farmland.

This environment has generally resulted in higher farmland valuations over recent years, which in certain cases outpaced the asset's earnings potential and resulted in yield compression. However, despite mild compression, farmland yields remain very attractive compared to other assets.

When investing in farmland, returns do not necessarily mean higher risk and greater volatility. If we look at return volatility, the case for farmland investing becomes more compelling. Farmland investing has experienced significantly lower volatility than equities and a similar level of volatility as 10-year Treasuries, albeit delivering significantly higher yields.

The durability and negative correlation of farmland returns to economic cycles is driven by the inescapable fact that farmland produces the necessities of life. A growing global population, with higher calorific consumption in developing countries, needs feeding.

With the spread of the coronavirus, some have raised concerns that food security could be impacted. However, there is no current evidence to validate this concern.

During other pandemics, including SARS, the avian influenza and MERS, food prices rose. The coronavirus is yet to cause food shortages, and the price of staple crops (like wheat, corn and rice) has remained relatively stable since the outbreak. The impact of economic downturns on the demand for basic food commodities has not been material.

There have also been concerns that land values could be negatively impacted by the pandemic, but we do not see land values being affected in the short term. In the unlikely event that disruptions in supply chains (Brazil has exported record tonnes of soybeans to date in 2020) cause significant falls in commodity prices, the ultimate impact on land values will depend on whether the market views the dislocation as temporary or not. If viewed as temporary, farmland markets would not price in lower commodity prices, but if viewed as a longer-term issue, lower commodity prices could be reflected in farmland values, all else equal.

A negative impact on farmland values prompted by lower commodity prices is likely to be offset by technology-driven productivity gains and the low-interest-rate environment, with central banks around the world actively implementing monetary stimulus measures.

The current crisis and past performance of the asset class during periods of economic downturn highlight the benefits farmland offers investors, providing a steady alternative to other safe heaven assets. That aside, now is also a compelling time to invest in agriculture given the expected gains in productivity, as farmers adopt data-driven technologies.

Tracking total factor productivity, which measures changes in the efficiency by which inputs are transformed into outputs over the last 50 years, clearly demonstrates that the introduction of key agricultural technologies has impacted farmland productivity. For example, the introduction and adoption of genetically modified corn doubled total factor productivity in the 1990s to just over 1.5% a year, relative to the 1970s and 1980s. The current rate of agricultural technologies being introduced is unparalleled and, though there is a lag between the introduction of these technologies and the subsequent impact on productivity and returns, this time the delay is becoming shorter.

Fundamental return characteristics of this asset class remain intact despite the current challenging market conditions, with upside potential on the horizon in the form of productivity advancements. All these factors combined create a compelling case for the inclusion of the asset class in a diversified investment portfolio.

Martin Davies is president and CEO at Westchester Group Investment Management Inc., Chicago. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.