Published on May 3, 2021 by Peoples Company
by Heather Welch Puri | Finance Manager, Land Investment
Investments in farmland assets provide many key benefits to investors and serve as a powerful portfolio diversification tool. Farmland investments offer a high level of capital security with low volatility of returns, low to negative correlation with other asset classes, an effective hedge against inflation, and innumerable social and economic benefits. But not all farmland investments are the same. Understanding the different characteristics, as well as the benefits and risks associated with row crops vs. permanent crops, is critical when making farmland investment decisions. For investors with higher risk tolerance and longer time horizons, permanent crops can yield elevated annual cash returns and the potential for significant asset appreciation.
Row Crops vs. Permanent Crops
The USDA estimates that row crops such as corn, soybeans, wheat, and rice represent more than 75% of all planted cropland acres in the United States. These “annual” crops are planted, grown, and harvested each year, sometimes with multiple planting and harvesting seasons per year. Planting row crops annually gives farmers the flexibility to rotate crops to better maintain soil health and manage resources, as well as react to changing demand in the marketplace. Row crop farmland assets also offer investors relatively low-risk investment opportunities, providing stable, annual income with total annual returns (annual cash flows + annual appreciation) in the range of 5% to 10%.
At the other end of the crop spectrum are permanent crops, which are planted once and have a lifecycle of many years, sometimes even decades. These “perennial” crops are grown on vines, trees, or shrubs and include wine grapes, tree nuts, avocados, apples, citrus, and berries. Recent years have seen a significant increase in demand for these types of crops, driven by increased consumer demand for high-quality, healthy, fresh foods that can be sustainably grown. Although these perennial crops represent a smaller percentage of U.S. farmland acres, at the end of Q1-2021, permanent crops comprised approximately 40% of the NCREIF Farmland Property Index, or $5.2 billion in total market value.1
While permanent crops provide investors with an opportunity for higher economic returns, these types of crops bring a unique set of risk factors. Permanent crops do not afford farmers the flexibility to rotate crops and require longer-term strategic planning. Cultivation and harvesting of permanent crops typically are more labor intensive than with row crops, and since permanent crops are irrigated, there can also be a substantial initial investment needed to create the irrigation infrastructure and complicated water rights to navigate. Permanent crops also face the risk of “varietal obsolescence,” meaning that you may have planted a crop with a 25-year productive life cycle, but ten years in, consumer preferences may have changed and there is no longer demand for the product you are growing. Further, finding a partner to package and market permanent crops is a bigger task than with row crops, particularly given the short time window to market and deliver fresh produce; you cannot simply store permanent crops in a grain bin until a buyer is found.
Depending on which stage in the permanent crop life cycle an investment is entered, investors can face additional challenges. Cash returns are delayed until permanent crops are through their “greenfield” or pre-productive period; based on crop type, permanent crops can take 3-7 years to reach full production and generate positive cash flows. If an investment is entered later in the permanent crop life cycle when production decline is occurring, cash flows start to fall as well, and new crops may need to be replanted.
The greater risks associated with permanent crops are not without reward, however. Once cash flows begin, the higher value permanent crops typically produce greater cash-on-cash returns over their life cycles compared to row crops. The increased consumer demand for these products has not only driven profits higher, but also led to greater demand and higher valuations for permanent cropland. Even so, total annual returns for permanent vs. row crops may be more similar than one would think, due to the asset depreciation associated with permanent crops. Both row and permanent crops experience appreciation in the underlying land value, but fruit- and nut-bearing trees, vines, and shrubs have a finite lifespan and tend to lose value (or depreciate) over time, partially offsetting the appreciation in land value.
Tax Benefits of Planting Permanent Crops
Currently, there are special tax advantages available to farmers who plant permanent crops, specifically trees or vines that bear fruit or nuts. The Tax Cuts and Jobs Act (“TCJA”) of 2017 expanded tax benefits to allow farmers to deduct 100% of the cost of planting those trees or vines in the year of planting. Without this special ‘bonus depreciation’ provision, farmers would be required to capitalize all tree and vine planting costs, rather than deduct them. Like other bonus depreciation provisions in the TCJA, this special provision for trees and vines has a phase-down to sunset in 2026:
Through 2022 – 100%
2023 – 80%
2024 – 60%
2025 – 40%
2026 – 20%
2027 – 0%
Investment Opportunities
When evaluating row crop vs. permanent crop investment options, investors first need to assess their risk profiles as well as timelines. Row crop investments offer lower risk, stable returns, and year-to-year flexibility. Investments in permanent crops, on the other hand, come with higher risk, allow for minimal flexibility, and require larger initial investment as well as extended investment holding periods. That being said, investors with a longer time horizon have the potential to achieve higher economic returns from permanent crops along with solid appreciation in underlying land value. With the additional current tax benefits available to those planting permanent crops, now may be a great time to seek out these types of farmland investment opportunities.
Peoples Company has developed a proactive Land Investment Program that can help investors identify investment-grade opportunities in both row crop and permanent crop farmland. Peoples Company tailors its land investment strategies to individual investor needs and provides customized solutions for each asset. Our affiliates – Alternative Equity Advisors, Ag Capital Advisors, DST Farms, and mAgma – strategically enhance and execute these opportunities, positioning Peoples Company as one of the few full-service land transactions firms in the country.
1 NCREIF Farmland Property Index as of 3/31/2021.