With many investors now in the process of reviewing strategies and, in some cases considering alternative, non correlated asset classes, Brown & Co are offering an update on current markets, starting with developed markets of the U.S. and progressing through parts of Europe, going through South America and returning to Romania . The following represents a cross section of geographies where Brown & Co are active:
The U.S. market has a very close correlation between land rents and land values. Therefore for those seeking exposure to the commodity market cycle – that direct correlation – in a highly developed market that is relatively liquid (at least compared to other markets) represents an interesting entry point. The value of U.S farmland is expected to reach $2.6 trillion in 2020, increasing from $1.4 trillion in 2000. However, having gone through nineteen positive growth years, the latest NCREIF data shows a net negative Quarterly return of 0.10%, consisting of 0.38% income return and appreciation of -0.49%. This comes as no surprise as Net Farm Income has been under pressure for the last six years and land rents are directly correlated to Net Farm Income. With land rents under pressure, land values have turned negative as farmers make up the vast majority of land purchasers. Fig 1.1 illustrates the USDA Net Farm Income forecast for 2020 and then an adjustment by FAPRI following some early phase work on the impact of COVD-19 and general market dynamics. This results in an estimated $20 billion hit to Net Farm Income for 2020 (largely on the back of commodity prices and livestock prices being reduced) and clearly this has the potential to further soften the rental market and therefore, over time, the land market.
Whilst 2020 may therefore not provide a window of opportunity on entry timing due to softening dynamics, in the long run, the U.S. continues to be considered the most developed, mature and safe investment for those seeking to deploy and shelter capital in these unprecedented times. Executing the exact correct timing is almost impossible due to the number of factors at play and if bounce back from COVID-19 does occur in the latter part of 2020 and 2021 plus if the trading terms with China improve, the market will respond quickly, particularly with interest rates at their historic low.
Poland has been the macro economic success story of the region and has matured over the last 25 years into a key player within the EU and region. Before the coronavirus outbreak hit the global economy, Poland was among the fastest-growing economies in the European Union (EU). Household consumption, fuelled by increases in budgetary expenditures, a tight labour market, and rising wages, continued to fuel growth. Despite a very limited recession between 2012 and 2013 annual GDP growth remained strong over the last five years (average 5 year GDP of 4.1%) leading up to the first quarter of 2020, thus demonstrating the country’s robust underlying economic strength. In the previous 2008 global financial crisis Poland remained the only country in the EU not to go into recession and it seems well positioned to emerge from COVID-19 ready for the next phase of economic development.
The agricultural sector witnessed unprecedented levels of growth since the country joined the EU in 2004 and land markets have effectively capitalised the additional growth in farm incomes that have occurred since then. Improvements in management, fertiliser and crop protection plus joining the EU’s Common Agricultural Policy added significant income to the sector – and together with improved access to capital – has led to consistent growth in the land market. In the 12 month period to the end of 2019, good quality farmland rose by an annualised 7% across all regions. Brown & Co’s view is that this may be a little over optimistic and the view is that values in recent months have levelled off. However, with good quality land currently leasing for c. 3-3.5% this still makes for a compelling long term strategic investment, particularly when looking at the long run potential for further, steady increases in land values, as further efficiencies are realised.
Uruguay has perhaps been overshadowed by its larger South American neighbours, Brazil and Argentina, both of which are facing very significant political and economic challenges. However, Uruguay is witnessing political change which has not been seen in close to 15 years. The former left-wing coalition known as the Broad Front lost the election in November last year, making way for a more conservative centre right movement led by Luis Lacalle Pou. Uruguay, typically described as the “Switzerland of South America” is well known for valuing private freehold property, has seen a decreasing GDP growth over the 10-year period highlighted in Fig 1.5. It is noteworthy however to recognise that despite a decreasing trend, Uruguay’s GDP growth has never dropped below 0% within this time period, unlike its neighbours – indicating a certain resilience and stability that is conducive to long term investment strategies.
Agricultural land values, until 2018 were increasing and 2019 saw a 21% increase vs 2018 values. The land market decreased in 2018 and has recovered to a large extent but there are now large variances opening up in the land market and certainly some distress in the market. Values are ranging $1,500-2,500 for productive grassland all the way up to $10,000/hectare for the best quality land with irrigation. However, with double cropping possible in some parts the returns, for well managed blocks can be c. 6-8% cash yield.
As with many developing countries, the recent turmoil created by COVID-19 has affected the strength of local currencies. The particular opportunity relating to certain countries is connected to this. The Peso is currently trading at a 15% discount to the dollar, compared to the start of the year. At the height of the crisis there was a 20% devaluation. Given much of the portfolio performance is ultimately connected to currency movements, the currency “gap” in certain parts of the world should not be considered underweight in the overall risk management strategy.
Despite the media headlines portrayal of doom and gloom from an economic and political perspective agriculture seems to be one of few shining lights as a sector in Brazil. Worries that the Phase One trade deal between China and the U.S. would lead to a decline in Brazilian agricultural exports to China have not played out and in fact the opposite has happened. Exports have reached new highs, cushioning the impact of the ongoing Covid-19 crisis on the economy. Despite the Covid-19 crisis, overall exports to China rose by 13.1% in the first five months of the year compared with the same period in 2019. Across all the markets outlined in this article Brazil is certainly at the high-risk end mainly due to the political situation; however, the industry provides a perfect example of how resilient agriculture is as an asset class in light of a global pandemic. There is a strong argument to suggest that Brazil is too reliant on Chinese exports and may need to look at diversifying its export policy and destinations going forwards. On Tuesday 9th June, the Brazilian Institute of Geography and Statistics (IBGE) indicated the harvest estimate of 245.9 million tons of cereals, legumes and oilseeds by the end of the year, up 1.8% on 2019 production. As with Uruguay, Brazil’s weaker currency acts as an obvious attraction for investments at the present time and has certainly fuelled the additional exports. The Real has lost a very significant 24% of its value since January ensuring agricultural exports such as Soybeans are extremely competitive alongside the U.S crop. The Agriculture and Livestock Federation of Brazil states agricultural gross domestic product is up 8.6% for 2020, showing positive signs that the country is continuing it’s strong stance as a global agricultural powerhouse. Indeed many producers are reporting that in local currency terms – 2020 will be their most profitable year ever.
One of the challenges relating to Brazil however, remains its legislative framework for foreign ownership. In 2010, at the end of the government of former President Lula, there was a change in the position adopted by the Office of the General Counsel to the Federal Government (AGU), consisting of the new Opinion which re-established restrictions on the acquisition and lease of farmland by foreigners and similar entities (ie, Brazilian subsidiaries of foreign companies, controlled by foreign entities). Currently, a foreign investor may only hold a minority stake in a Brazilian company holding farmland. However, Bolsonaro and the Ministry of Finance have indicated they are keen to facilitate foreign investments in order to leverage the Brazilian economy. Thus, it may be opportune to reconsider whether the political and economic reasons for the restrictions are still justifiable, or whether the time has come to find a better way to deal with investment in Brazilian farmland by foreign companies.
In recent years Romania has attracted significant interest following its accession to the EU in 2007. With one of Europe’s largest agrarian profiles and representing the lowest valued farmland in the EU (together with Bulgaria) – it makes for a compelling investment case. With reasonable political stability plus strong economic growth, the land market has strengthened from a very low base, but is still considerably undervalued compared to markets such as Poland. However, the challenge in Romania relates to the land fragmentation. The market varies significantly depending on parcel size and Brown & Co’s research shows a clear relationship between parcel size and land value. Indeed, in recent years the very smallest parcel sizes have actually decreased in value whilst the larger parcel sizes have increased significantly.
From a long term growth perspective, Romania represents the most interesting farmland market in the EU at the present time. Whilst the fragmentation represents a challenge, for well managed strategies this also represents an opportunity when coupled with a productivity drive to deliver higher yields and improved performance. Brown & Co’s experience, with a permanent office in Teccuci is that there are key strategies that deliver value in this rising market. Research indicates an annual average land appreciation at the present time of c. 16% across all land types and sizes. It is perhaps interesting to note that Romania’s average land price (Euro 5,331/ha) is where Poland’s land market was in 2008. Poland’s current land price (subject to quality) is Euro 10,913-13,476/ha. Whilst clearly there are a number of differences between the markets – subject to political stability and economic development – Romania presents an interesting opportunity for properly researched and managed investments.
With the government introducing legislation that will end the moratorium on agricultural land sales, there is some excitement around the market in Ukraine at the present time. The legislation allows for local ownership beginning in 2021, with a number of significant restrictions and a referendum with a positive outcome will be required before foreign land ownership will be permitted. However, this is a long term market and for certain investors, there will be merit in taking active leasehold interests that may, subject to future legislative changes – facilitate conversion to full land ownership in the future
However, perhaps the most interesting and exicting opportunity for certain investors is around higher value cropping opportunities. The availability of large amount of relatively inexpensive labour plus high quality land and in certain parts, access to water – means this “low cost platform” is ideally suited to labour intensive, high value crops, then being shipped to high value markets such as the middle east and/ or Western Europe.
Whilst many economies adapt to new working environments and lockdown measures restrict and dramatically impact business activities in retail, hospitality and residential property, the wheels of agricultural machines continue turning and it is largely business as usual. With planting and harvesting operations continuing to meet global food demands agriculture finds itself meeting an ever-increasing demand for food production. Covid-19 has highlighted not only the resilience of the sector but also its importance as consumers flocked to supermarkets across the months of March, April and May like never before. We have seen export quotas put in place across many corners of the globe, including Russia, Ukraine and Kazakhstan as governments initially took a nationalistic approach to food security. Low commodity prices globally continues to put pressure on primary producers, whilst those marginal/poorer producers may fall by the wayside opening up opportunities for progressive farming businesses looking to expand operating areas and drive production based efficiencies. These productivity improvements (including Ag Tech) in key largescale ag markets provide the platform for agricultural investments going forwards.
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