After four decades of benefiting from the decline in interest rates and the tailwind it provided the standard 60/40 portfolio, investors now face a new macro environment. The highest inflation in four decades and the resulting interest rate increases made 2022 the worst year for the 60/40 portfolio in a century.
Since the 1950s, farming as an industry has benefited from improvements in mechanization, the implementation of new technologies, and productivity gains from modern biotechnology. These innovations have transformed farming into a scale business requiring farmers to increase the size of their operations to remain viable. While farming operations need to grow, farmland ownership remains fragmented. The result is that more than half of the farms are rented to larger farmers, even as families continue to live on their family farm. The ownership of farmland is largely in the hands of older farm families with the average age approaching 60. In Ontario, it is forecast that as much as half of the approximately $170 billion of farmland could see a change in ownership over the next decade. The fragmented ownership and the aging demographic of farmers make it an asset class ripe for consolidation and in need of capital.
Farmland may be the last trillion-dollar asset class that has not been ‘financialized’ or taken over by investors. Given the significant capital needs, ownership of farmland could very well transition to investors much like large real estate assets transitioned from individual and family ownership to pension funds, insurance companies, REITs, and other investors. In the meantime, the fragmented ownership has made the market less efficient, while the lack of financial players has meant no boom-bust cycles like those seen in financial assets.
Farms produce the food we need regardless of business cycles. Farmland has long been a safe haven investment with financial yields tied to food prices. Farmland has provided income during economic downturns and periods of uncertainty. The farmland in Canada and in Ontario in particular, is some of the best in the world. Glaciers bulldozed their way over the vast Canadian Shield and left deep lacustrine (rich) soil behind in the most southern regions of the province. Those same glaciers also carved out the five great lakes leaving behind one of the best farming regions on the planet. While farming regions such as California deal with a decreasing water supply, Ontario receives consistent rainfall throughout the year and is surrounded by vast amounts of freshwater. Water is crucial to farmland productivity and ensuring a stable food supply. This consistent and reliable source of water means the crop insurance in Ontario is among the lowest in the world. Those tasked with assessing risk have determined little can go wrong in Ontario. The combination of rich fertile soil, consistency of water, and an increasingly longer growing season means Ontario farmers can grow many different insurable crops. The region is a one-day truck drive from up to 200 million consumers and access to nearby ports along the St. Lawrence Seaway means millions more in addressable markets. The region is a critical source of the food supply for millions of North Americans and consumers around the world.
While precise numbers are difficult to establish, recent estimates put farmland ownership in Canada by financial players at less than two per cent. This means valuations are determined by farmers and based on fundamentals, not liquidity in financial markets. Farmers look to buy the neighbours’ farm if the economics are viable, not in the hopes of flipping it. Farmland prices in Ontario have appreciated at a compound annual growth rate of 8.2 per cent over the past 71 years, with only eight years of price declines, the worst being an eight per cent drop. Farmland values have a history of preserving capital during the worst of economic downturns. Prices of Ontario farmland remained positive during the implosion of the tech bubble, the great financial crisis, and the sell-off following the COVID shutdowns. The asset has shown it can play an important role in a diversified portfolio.
While farmland values have compounded during almost all periods, returns during periods of inflation have been particularly strong. During the last extended period of inflation, farmland proved to be a particularly effective store of value (see Figure 1). From the period beginning in 1970 through to the end of 1981, the S&P 500 realized a 12-year CAGR of only 2.2 per cent (before dividends) resulting in a material loss of purchasing power. Over that same period, Ontario farmland generated a 15.5 per cent CAGR (before financial yields from farming). While owners of financial assets saw a sharp reduction in purchasing power, owners of farmland saw an increase in their purchasing power, as farmland prices more than kept pace with inflation.
Anthony Faiella is a partner at AGinvest Farmland Properties Canada.