To this day, most individual investors remain primarily invested in stocks and bonds. While this may have worked well in the past, the future has become very uncertain.
Stocks are priced at historically high valuations even as we face a raging pandemic, geopolitical uncertainty, high inflation, and rising rates.
Bonds are arguably even worse since they are priced at a guaranteed negative real return. Even after its recent surge, the yield of the 10-year treasury is just 2%, which is far below the 7.5% inflation rate:
As a result, the future return prospects of stocks and bonds don’t look very promising. The biggest hedge fund manager in the world, Ray Dalio, fears that we could face a lost decade with ~0% annual returns. Jeremy Grantham’s famous 7-year-forecast predicts even worse with negative returns across the board:
This may sound like fear-mongering, but the reality is that lost decades tend to happen every 5-10 years, and we are long overdue for one to occur:
The combination of high valuations, elevated inflation, rising rates, a raging pandemic, and growing geopolitical uncertainty is a scary one for stocks and bonds.
That explains why alternative investments have gained so much steam in the past few years. Alternative investments can be anything other than stocks and bonds.
Today, some of the most popular alternative asset classes include commercial real estate, infrastructure, and cryptocurrencies, but there are also many lesser-known alternatives that aren’t gaining enough attention in my opinion.
Farmland is the most obvious example that comes to my mind.
Many legendary investors invest substantial amounts in farmland and yet, most individual investors have never considered investing in it.
Today, Bill Gates is the biggest individual farmland owner in the nation.
Warren Buffett often uses farmland as an example to highlight a strong investment.
Finally, ‘The Big Short’ Michael Burry has said in previous interviews that the little investing that he does these days focuses mainly on farmland and water. When asked how much he is investing in farmland, he responds: “Oh I don’t want to disclose that, but it is a significant amount at this point.”
So what’s so special about farmland?
I invest about 10% of my net worth in farmland and in what follows, I highlight the 5 main reasons why you may want to consider it as well.
Reason #1: Strong Historical Performance & Attractive Prospects
Farmland generates returns from two main components:
- The rent or the profit split with the tenant/operator.
- The appreciation of the underlying land.
Historically, when combined together, these have resulted in double-digit annual total returns, outperforming even the S&P 500 (SPY) and REITs (VNQ). Farmland also generated these superior returns with much lower volatility:
In Berkshire’s (NYSE:BRK.A) (BRK.B) 2013 letter to shareholders, Warren Buffett talks about the returns of a 400-acre tract of farmland that he bought in the 80s:
“I needed no unusual knowledge or intelligence to conclude that the investment had no downside and potentially had substantial upside. There would, of course, be the occasional bad crop, and prices would sometimes disappoint. But so what? There would be some unusually good years as well, and I would never be under any pressure to sell the property. Now, 28 years later, the farm has tripled its earnings and is worth five times or more what I paid. I still know nothing about farming and recently made just my second visit to the farm.”
In other words, farmland is simple to understand, it is fairly safe, but it still enjoys good return potential. This is in large part because the supply of farmland is limited, but its demand is ever-rising.
We are not making any more land. On the contrary, the availability of good-quality farmland is ever decreasing due to better-use developments. Meanwhile, the global population keeps on growing and the middle-class is getting bigger, which leads to more consumption. As a result, the amount of farmland per capita is declining rapidly:
Will farmland be more valuable a year from now? I don’t know. But will it be more valuable 10 years from now? I think that it is very likely.
Reason #2: High Yield Potential
We live in an ultra-low yield environment with stocks paying a ~1.5% yield and Treasuries barely paying any more than that.
In comparison, farmland can generate far higher yields depending on what you are buying.
High-quality row-crops with triple net leases may get you 3-4%, but some permanent crops, especially if you accept some development/operational risk, can result in yields reaching 6-9%:
As Buffett noted earlier, the yield will go up one year, down the next, but on average, you will earn a high yield compared to what you could get elsewhere.
Reason #3: The Ultimate Inflation Hedge
Farmland is arguably the best inflation hedge in the world.
It is absolutely necessary for the survival and prosperity of the human race.
It cannot be replaced. And it is limited in supply but growing in demand.
That explains why the price of food has consistently risen faster than the rate of inflation:
Historically, farmland values have shown high correlation with the CPI, while rising even faster than it and generating particularly high returns during times of elevated inflation.
Given how much cash has been printed over the past two years, this is a protection that I want to have in my portfolio.
Reason #4: Valuable Diversification to a Stock-Heavy Portfolio
In a way, I also see my farmland allocation as insurance against black swan events.
Historically, farmland has performed well during most crises. It is recession-proof by nature, and as long as you don’t use too much leverage and diversify properly, it is really hard to lose money in the long run.
Of course, this does not mean that farmland is immune to bear markets, but it can add valuable stability to a portfolio during times of high uncertainty like today.
Many invest in gold (GLD) instead, but farmland serves this purpose in my portfolio. Essentially, farmland is similar to gold in that it can serve as a hedge against crises, but it has far superior other properties:
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It has historically generated far higher returns
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It has paid a lot of income while you wait
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It has been a lot less volatile
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And it has even been a better inflation hedge
Reason #5: Upside From Growing Democratization of Farmland
Last but not least, today, the farmland market is still unpenetrated, but as more and more investors decide to add a farmland allocation to their portfolio, I expect prices to get bid up, resulting in substantial upside to investors who invest today.
20 years ago, allocations to alternative asset classes like farmland were only 5%. Today, it is already 25%, and by 2030, Brookfield (BAM) predicts that it could reach up to 60%:
That’s trillions worth of capital that could shift to alternatives like farmland. If the demand from investors grows, but the supply of deals is limited, prices will need to adjust higher. It is as simple as that. Today, we are still early.
How Can You Invest in Farmland?
Investors have three main options and each has unique pros and cons.
Option 1: Direct Investments
The most obvious is to buy a tract of land in the private market, just like how you would buy a rental property. That’s what most wealthy investors are doing because it gives them full control over the asset.
However, this option is probably the least suitable for individual investors because it would require 10s of millions to build a well-diversified portfolio by geography and crop type. Moreover, it would require a lot of time, effort, and skills to acquire and manage the portfolio.
Option 2: Crowdfunding
Crowdfunding can solve many of the issues mentioned above. Platforms like FarmTogether allow you to invest in farmland with as little as $15,000 and professionals handle everything for you. They find the deal, negotiate it, finance it, rent it out, and then distribute the returns to you.
Since you are buying a fraction of the deal and not the entire thing, it becomes much easier to build a well-diversified portfolio, even with a much smaller amount. It is a great solution for most investors who probably don’t have 10s of millions to invest and aren’t experts in the field.
But crowdfunding has its downsides too. You won’t have the same level of control as if you owned the property outright, and the terms of these deals are typically ~10 years. If you are long-term oriented, this is not necessarily an issue, but it is something to keep in mind. Also, platforms like FarmTogether only work with accredited investors so far. If you are not accredited, you are left with Option 3:
Option 3: Publicly listed REITs
Today, there are two publicly listed REITs that specialize in farmland.
Those are Gladstone Land (LAND) and Farmland Partners (FPI).
They allow anyone, including non-accredited investors, to gain indirect exposure to farmland by buying the stock of these companies. You get instant diversification, professional management, and liquidity – all in one package.
However, the downside here is that the liquidity also negates some of the diversification benefits of farmland. LAND and FPI typically behave like other stocks, resulting in significant volatility and their performance is often completely detached from the underlying performance of farmland. As an example, FPI’s share price has actually declined since its IPO in 2014, despite significant farmland value appreciation.
Moreover, you may also pay a hefty premium compared to what you would pay for farmland in the private market. LAND is currently priced at an estimated 50% premium to its net asset value, which essentially means that you are paying 50% above the fair value of its farmland.
Finally, these REITs may also participate in other farmland-related businesses like asset management, which may boost returns, but also increase risks.
So as you can see here, there are pros and cons to everything.
Personally, I use a combination of options 2 and 3 because I think that this will provide the best risk-to-reward over time. I invest in private farmland to enjoy its diversification benefits but also opportunistically buy farmland REITs when they become undervalued.
Bottom Line
Farmland has been one of the best asset classes to own over the past half a century. Today, with inflation at a 40-year high and elevated uncertainty, I think adding farmland to a diversified portfolio is a no-brainer.
Legendary investors like Warren Buffett have done it, but most individual investors haven’t. That’s probably because until recently it was nearly impossible for them to invest in farmland, but this is now changing with publicly listed REITs and crowdfunding platforms. At High Yield Landlord, we recommend holding a farmland allocation as part of a well-diversified portfolio.