You may already be familiar with how to invest in traditional real estate - what to consider when comparing properties, how to think about risk, what options you have to invest more actively (or passively), etc. - but most people dont have the same fluency outside of commercial real estate.Below I outline for you the differences and similarities of farmland investing and real estate investing.Youll see how you can apply the same knowledge and frameworks from traditional real estate to evaluate farmland.

Over 11% of all the land on Earth is used for farming today. This number is even higher in America - over half (55%) of the landmass of the United States is used for agriculture. That number may surprise you, but it shouldnt: the United States is the worlds #3 producer of food and the leading global food exporter. The only two countries that produce more agriculture are China and India, both of which have over 1 billion people compared to just 330 million in America. This is because no country produces food as efficiently as the U.S., mainly because agriculture production in America is more productive than anywhere else in the world and productivity has been increasing for decades (for example, the U.S. now produces more than 2x the food today than it did during the post-WWII period, despite the fact that total active farmland has decreased).

The farmland market in the U.S. is worth nearly $2.5 trillion today. For comparison, multifamily (the biggest sub-segment of real estate outside of single family) is worth $2.9 trillion. I point this out to express the magnitude of the market opportunity, since we know many of you are familiar with multifamily. We always talk about multifamily being a huge, virtually unlimited TAM, and the reality is that farmland is almost the same size.

1 - Investment Structure

You can make either debt or equity investments in both farmland and real estate. With debt, youll receive periodic payments plus interest on the principal.For equity investments, youre getting rental income as well as a lump sum from the appreciation when the property sells.More than 30% of Americans rent rather than own; and the same is true looking at the percentage of farmers who rent the property they farm, making rental properties a viable long-term option for CRE and farmland.

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In about a fifth of cases, farmland owners use variable rent, which provides additional exposure to the underlying commodity itself.Its a higher risk/return arrangement, with a flat, smaller portion of rent up-front and the balance at the end of the season based on a percentage of the farmers revenue.

2 - Variables Impacting Cap Rates: Demand & Market Trends

Cap rates aim to estimate risk. Less elastic demand is perceived as less risky, hence lower cap rates.For example in CRE, this translates to lower cap rates for multifamily buildings, considering that no matter whats going on in the economy people always need a place to live.For farmland, youll see the same concept with primary cropland (wheat, soybeans, corn, cotton, rice) as theyre all essential to everyday products used for human consumption (raw or as inputs to other food); livestock feed; biofuels; and clothing.

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More exposure to market trends - like a preference for one food over another or a predilection for open office space - and broader economic conditions affect cap rates. Lower demand means longer or more frequent vacancies or lower rent. The inverse is also true, just look at industrial real estate over the last decade with the rise of online shopping. Cropland ideal for annual speciality crops, like most veggies, means farmers should consider trends before planting, though they still have flexibility between seasons to alter what theyre growing.Accordingly, this type of farmland will have lower cap rates than vineyards or orchards (permanent cropland) that take multiple years to mature. With permanent crops, either a mismatch to demand or an extreme weather event can mean years to re-establish a profitable business, so more risk and thus higher cap rates.

3 - More Cap Rate Variables: Location & Quality

Location and asset quality also impact risk perception for CRE and farmland.Real estate closer to a metro area (segment), with more up-to-date features (class), and in a higher tiered metro area will have a lower cap rate.Different crops have different optimal conditions. E.g. citrus, like many people, prefer the climates in certain parts of California and Florida, but a viral disease in Florida means less production and falling land values over the last decade.Even within any particular region, property quality (soil, sun, water, etc.) varies, impacting yields.Higher quality land means more rent and production. While not as straightforward as CRE classes, there are tools like American Farmland Trusts PVR (Productivity, Versatility, and Resiliency) to measure quality.

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4 - Value Add Investments

If you want higher returns, you can also try to convert your real estate investment to its highest and best use.Value add in CRE ranges from less risky, light capex projects (think renovating apartments between tenants) or converting the land entirely from apartments to office space.Major changes are costlier, take longer, and are more at risk to delays, especially if you have to go through a rezoning process, but it often means more in rent and potentially higher profits at resale.

For farmland, your marginal improvements are things like increasing tillable acres or capex for improvements like replacing a well or optimizing irrigation.The bigger, costlier and thereby riskier capex investments for farmland are in permanent crops where you can either convert existing orchards to more desirable crops or through clearing acreage to establish trees or vines from scratch.

5 - Operating Agreements and Leases

Lease terms and market norms vary across real estate types and impact the magnitude of an investors opex.Farms, like industrial properties, usually use net leases in which tenants are responsible for taxes, most insurance, and most maintenance.Practically, this means relatively low opex for farmland owners as your tenant does and pays for most of the upkeep.

Over 50% of operating leases for farmland are renewed annually, like with multifamily housing.That said, the majority of landlords have much longer relationships (7+ years) with their tenants. Accordingly, the fact that the leases are renegotiated annually does not necessarily mean that theres high tenant turnover.

With historically near zero-vacancy rates for farmland and continued demand for agricultural products driven by population growth, it is becoming less likely that farm properties will sit idle without a tenant.

Conclusion

In many ways, farmland functions similar to traditional real estate and can be a great alternative. This increasingly scarce resource includes similar return drivers - rental income and appreciation - as traditional real estate as well as the ability to adjust risk. Over the last decade, tech platforms, like Fundrise for conventional real estate, have eliminated the historically high cost-to-entry, and now companies like FarmTogether are creating the same options for farmland investing.

Link:
5 Ways Farmland Investing Compares To Traditional Real Estate - Forbes