I was planning a different topic today but the release of the Kansas City Federal Reserve’s Main Street Economist Report “Financing Young and Beginning Farmers” caused me to reverse course.
Of interest to me in the report is that more beginning and young farmers are turning to lease agreements to enter farming or ranching. This is not surprising given the economic conditions discussed in the report: higher fixed costs, higher land costs, and higher debt-to-income ratios for beginning and young farmers. But entering farming or ranching via leasing may not be the worst idea.
First, leases allow a beginning farmer to cultivate a relationship with a landowner. This relationship, especially if it is with an established farmer or rancher, can lead to mentoring and education for the beginning farmer. You have the opportunity to learn from someone, ask for advice, and develop a mentor/mentee relationship.
Second, leases allow for flexibility with changing market conditions. Leases can be drafted so the beginning farmer shares the risk with the landlord. Thus, if the drought continues or commodity prices dip, the beginning farmer will not be locked into a debt repayment; instead, there is flexibility in the lease price if the lease is drafted to share risk.
However, even if the lease is not drafted to share risk with the landlord, a lease provides more flexibility than debt repayments. Instead of being obligated to repay the purchase price for a parcel of land, you may be able to stagger your leases so they are renewable on different dates, allowing you to determine which parcels of land provide the most bang for your buck and let go of parcels that are not producing to your standards when the lease ends.
Third, at least in Nebraska and Iowa, there are tax programs available for landlords who rent to beginning farmers. These tax programs can be a strong incentive for landlords to rent to a beginning farmer and beginners should consider approaching possible landlords with a lease proposal with these tax programs incorporated into the proposal.
There are risks with leases, namely that the landlord will not renew the lease. As a result, a beginning farmer has to weigh the risks and rewards of a lease with the risks and rewards of ownership. Keep in mind your debt-to-income ratio, especially when considering purchasing land. Your debt-to-income ratio affects everything from whether you can obtain a loan to what interest rate will be used to whether you will qualify for future loans you may need/want, such as for machinery. In short, beginning your operation with a lease may allow you to build up a nest egg to purchase land at more attractive terms than would be possible without the lease.
To know whether it is better for you to lease or own depends upon financial knowledge of your operation. As discussed earlier this week, that requires good financial recordkeeping. And to know whether you are obtaining good lease terms also requires knowledge of the income your operation generates, meaning you need good financial recordkeeping.
Need some help deciphering the above information or perhaps need some help drafting a lease or purchase agreement? Then contact us — it is what we are here for!