Back in the Spring, I posted a few comments on biofuels and grain prices, in which I predicted that grain prices (which drive land values) would likely start to track with the pump price of petroleum based fuels. The rationale being that we now have enough refining capacity to suck the entire domestic grain production out of the market and use it for biofuels (ethanol and biodiesel) if those products are competitive with pump prices of transportation fuels. At the time that piece was written, grain prices had soared to heights far greater than anything the livestock and export markets had been able to support.

Well the summer has passed, so lets take a look. What follows are two charts….November Heating Oil (another name for which is #1 diesel….a good barometer of #2 diesel) and November Soybeans. Again, my prediction was for grain prices. The real product being soybean oil, but all of those are part of the soybean complex, which tracks together. The Charts:

The red lines are moving averages. While it could be coincidence, the rise of both markets beginning in April, the tracking of the movements, the similar 1-2-3 tops and near simultaneous drop in mid July, and the little whipsaw bounce in the last few weeks seem to me to take the coincidence out of it. Looks to me like these markets are tracking very closely.

So going forward, until substitutes are found for biofuel feedstocks, keeping an eye on the direction of crude oil may be a good indication of where the grain markets are going (baring a disaster like an early frost). These charts do appear to support the notion that the pump price of transportation fuels sets an economic cap on biofuels and that this remains greater than what the alternative markets (like our livestock industries) can support.

As has been stated before, the role of an appraiser in mortgage loan transactions is that of a brake…..a safety valve. No bad deal can go through unless the scammers can find an appraiser to go along. Basically, appraisers have to be “untouchable”. Some are, some are not. Enough have not been that things got wild and out of control. The losses? Billions and Billions. Enough billions to put the entire US economy at stake. This is how Depressions get started.

In these deals, fraud took (and in some cases still takes) many forms. Lying on loan documents, misrepresenting income, etc. That was fraud against the lenders. But for others, lenders knew full well what was going on, and even encouraged it. As has been stated before, nobody gets paid unless these deals go through.  The role of the appraiser in this fraud took many forms, but in all of them, the goal was to “make value”. Plenty of my brethren did.

So what were the consequences? To an appraiser who refused to work these deals, no more business, or to some, loss of jobs (they were fired). So a wink here, a nod there and the deal slips by. Worse, some appraisers thought their role was to make deals work, so they groomed “dogs” to make them look like they were ready for an AKC show, or just flat out lied.

But now that it’s hit the fan and regulators who were asleep start to wake up, what are the consequences? We used to think the worst that could happen was you could lose your license. Not so. The worst is a 30 year jail sentence! Mortgage brokers, RE Agents, buyers, sellers and appraisers are facing felony convictions and are going to jail.

For now, the center of interest is on residential mortgages. Not having done any of that, I’m removed from that problem, but have seen enough of it in my farm appraisal work that I know the same things have been going on and for the same reasons. For now, the good times in the farm economy are masking it, so we have not heard about those…….yet.

Things are about as wild out in the country as I’ve ever seen them. In addition to being a professional observer of the market,  I monitor some ag news sites and the contradictions I’m seeing are huge. Farmers still buying and bidding up prices for land, with no real reason or basis, other than relative to the last sale. $7,000 per acre is too high today, until somebody pays that, then that becomes the benchmark of what land is “worth” (actually, it’s what somebody else just paid – a price). But opinions of value and worth flow from that, so at the next sale, buyers/investors look to that as a relative value of what to bid or pay for the next farm. You would think there would be targets, such as yield on investment, but if so, those never get mentioned. It’s always price per acre.  I don’t need to mention yield, but if land values in an area are increasing by double digits every year, relative to other options, it’s a good investment.

And to support these prices, we now have the unheard of price of $6 corn. As near as I can tell, this is an all time historic high. At this level, the price of corn is putting a huge strain on traditional users, not to mention the market mechanism through which the corn must flow for the farmer to get his money. Livestock producers are losing money and at these prices, will start liquidating herds. Ethanol isn’t competitive at these prices and plants will either shut down or lose money. The goose laying the golden egg is not feeling well.

Heard today that an elevator in NE has gone bankrupt. A domino of sorts, as the elevator was also an investor in an ethanol plant that went bust. But also caught up in margin calls they couldn’t meet.

Next problem: it’s now mid April and in recent years, Midwest farmers would be well along with planting the corn crop. Not this year. It’s been a cold wet spring and not much if anything is planted and won’t be for at least another week if it stopped raining today, but it is raining today with more rain forecast for later this week. So for those farmers that have forward contracted corn, there is probably some concern about now, or soon will be if it keeps raining.  The first criteria for raising a corn crop is to get it planted. The earlier the better so it beats the summer heat. But to a farmer who contracted his crop, they have to come up with actual corn to deliver to the elevator, who has contracted it, etc. Imagine the consequences of a short crop that goes to $7 or $8 per bushel (this would have been total fantasy a year or so ago, but not today).  If ethanol producers and livestock farmers are in a bind now, wait until this hits.
Then there are the farmers who didn’t contract anything; who will get their crops planted, harvested and sold at these prices. To those folks, it’s going to feel like they won the lottery.

Yep, this is going to be an interesting summer!

To landowners and farmers still holding grain, it has been an interesting guessing game. When do you sell? How much is enough and how high is this going to go? You hate to leave money on the table but you don’t be left holding the bag.

Then there is next year’s crop to worry about. With prices this high, grain producers realise they had best be selling some…..and they have been, and it’s causing problems. When a producer forward contracts grain, the elevator that contracts for it has to hedge the grain on the futures markets. Corn sold on the board at $3.00 triggers margin calls as it goes up. For an elevator contracting hundreds of thousands or even millions of bushels, these margin calls can be huge. In some cases, millions of dollars per elevator! If the elevator doesn’t have that kind of cash, and can’t borrow it, that turns serious fast. Then there is the problem of what to pay for grain on days when the futures market is locked limit down and a trade can’t be made. What do you pay for grain you can’t hedge? In some cases, they are refusing to buy it. Not having an orderly market is not good and again, unprecedented.

As this relates to biofuels, I recently had an occasion to work on a biodiesel appraisal project. What I found was a biofuels market that is somewhat inelastic to price, and the price that sets the tone for biodiesel is the pump price of #2 diesel. At the current price of soybeans, and pump price of #2 diesel, a biodiesel producer is going to lose money on every gallon he produces from soy oil. Consequently, as grain prices took off, most plants simply shut down or converted to lower cost sources of oil that can also be used for biodiesel, namely animal fats. But as for soy oil, even with generous subsidies and tax credits, at current grain prices, it won’t work. So all that anticipated demand for soybean use for biofuels is on hold at these prices. There is demand for traditional uses and there is still an export market for the grains due to the value of the dollar in relation to foreign currencies, but that was not what was said to be driving the grain markets. It was biofuels.

Another large concern is that at current grain prices, the traditional domestic users of grains are being priced out of the market. One I’m aware of is the livestock producers which is the largest domestic user of feed grains. Hogs and poultry are not doing well, and if they shut down, there goes the market for corn, DDG’s from ethanol, soy meal from the soy crush and on and on. Bottom line is it’s not likely that grain prices can be sustained at the high levels they were bid up to in February and March. At these levels, they have priced all their users out of the market.

Long term, the biofuels market is going to be driven by the pump price of petroleum based fuels. Fuel prices are high enough now to bid up grain prices to levels above what has been seen in the previous 15 years or so, but not to the levels they are now. The retail fuels market will buy biofuels when they are competitively priced. So any drop in grain prices below a certain point and the biofuels industry now has the capacity to suck all the surplus grain out of the market. In times of high profit, there isn’t enough grain to produce much more than 20% of our transportation fuel requirements.

So long term, it looks like the grain markets are destined to track the pump price of transportation fuels. Not above, not below, but tracking in an equilibrium pattern. Mandates may come and go, as will tax credits and subsidies, but after periods of correction to account for these, the equilibrium will again be established.

So if I was looking at buying land and intended to pay for it from selling grain, I would not be using $5 corn and $15 soybeans as my long term price, at least for now. The economics of the biofuels industry won’t support it, nor will any other domestic use.

It will be interesting to see if the market agrees with me.

http://archive.columbiatribune.com/2007/dec/20071219news022.asp

http://www.fcs-mo.com/index.cfm?show=4&id=0702BF4F

A person reading these two articles is likely to come away with the impression that investment in corn producing farmland is a good idea. What the energy bill appears to have put into place is an expansion of the existing ethanol production from corn (and perhaps now other non-cellulose sources such as sugar beets) from 6 billion gallons now to 15 billion gallons in the next 15 years. It will be interesting to see if new capital flows to all the existing ethanol plants that are in trouble.

On the land value front, it does indeed appear to be the case where land values continue to rise. Readers should always keep in mind the dated nature of these studies. They are usually based on data collected over the previous year, so they may not be reflective of what is happening today. But they are popular. Folks owning land in these markets who read these studies are prone to do a little math with an evaluation of personal net worth as the end game. Studies like this generate a lot of smiles.

And what is happening today is that method of sale has switched to auction sales, which in times of high demand allow for an open ended determination of the price the market is willing to pay. Several recent auction sales do support the trending increase, at least for production cropland in the Midwest. Is there an end in sight. There was until the news of this energy bill. This keeps it open ended as the market sorts it out.

As appraisers, we always look at the why. Markets are forward looking, which means “anticipation”. In this case, anticipation of even greater prices for corn and soybeans, but also anticipation this will lead to increases in land. Right now, it’s the best game in town and money is flowing in. Wildfires tend to create their own wind until the run out of fuel and the new energy bill is throwing more alcohol on the fire. From today’s perspective, money continues to flow in, so you have to expect more of everything.

Now for the paradox. Those pesky subprime markets again. As recent as just one or two years ago, the same setup we are seeing in agriculture was in place for residential markets in all sectors of the US. That same land value survey mentions “collar counties” around Chicago, where land values have dropped from $60,000 to $30,000 per acre, as residential development demand has come to a halt. Who thought that could happen?

If you have read my previous blogs, I have outlined a few things that went wrong in the subprime and general residential markets that lead to the problems. Well, it now appears to some folks in Congress that appraisers didn’t “resist enough” and are again a big part of the problem. My hope was that government would stay out of this, but that isn’t going to happen. Legislation is washing up on the shore in waves.  The of the more interesting ones is Senate Bill S2452, introduced by Senator Dodd. Among other things, it’s going to REQUIRE appraisers post a bond of 1% of appraised value so borrowers who get tricked into the risky deals have a recourse for damages?

Is there a point? Yup. Land values increasing again, busting through the roof they say. Lenders want to make those loans….loan volume, fees, etc. Try to NOT appraise an ag property for what it is selling in these markets and see if you get more business! (disclaimer: I don’t do many loan appraisals, so I’m more or less an observer in this deal).

So while on one hand we are witnessing a retraction in two segments of the real estate market (residential and to some extent, commercial), we are watching an explosion in the ag segment. Rules are being written to address problems in one segment that don’t exist in the other, yet we will be held accountable to those same rules.

Yup, interesting times.

One last thing…….none of this is new. As evidence, I offer this passage from a famous, but seldom read piece of literature (circa 1840) which is essentially saying capitalists never get it right. They rush in, overcook it, the endeavor fails, they pick up the pieces and do it again, inflicting a lot of pain and suffering along the way.

“A similar movement is going on before our own eyes. Modern bourgeois society, with its relations of production, of exchange and of property, a society that has conjured up such gigantic means of production and of exchange, is like the sorcerer who is no longer able to control the powers of the nether world whom he has called up by his spells. For many a decade past, the history of industry and commerce is but the history of the revolt of modern productive forces against modern conditions of production, against the property relations that are the conditions for the existence of the bourgeois and of its rule. It is enough to mention the commercial crises that, by their periodical return, put the existence of the entire bourgeois society on its trial, each time more threateningly. In these crises, a great part not only of the existing products, but also of the previously created productive forces, are periodically destroyed. In these crises, there breaks out an epidemic that, in all earlier epochs, would have seemed an absurdity — the epidemic of over-production. Society suddenly finds itself put back into a state of momentary barbarism; it appears as if a famine, a universal war of devastation, had cut off the supply of every means of subsistence; industry and commerce seem to be destroyed. And why? Because there is too much civilization, too much means of subsistence, too much industry, too much commerce. The productive forces at the disposal of society no longer tend to further the development of the conditions of bourgeois property; on the contrary, they have become too powerful for these conditions, by which they are fettered, and so soon as they overcome these fetters, they bring disorder into the whole of bourgeois society, endanger the existence of bourgeois property. The conditions of bourgeois society are too narrow to comprise the wealth created by them. And how does the bourgeoisie get over these crises? On the one hand, by enforced destruction of a mass of productive forces; on the other, by the conquest of new markets, and by the more thorough exploitation of the old ones. That is to say, by paving the way for more extensive and more destructive crises, and by diminishing the means whereby crises are prevented.” *

*  – From the Communist Manifesto

The other aspect of this is the governmental response. Looks like congressional action is shaping up on two fronts: one faction is crafting legislation to help borrowers, the other looks like lender bailouts to me. Underlying it all is the concern of the Federal Reserve Board that an implosion of the residential market and will somehow lead to a failure of the economy in general. It may take the latter to inflict enough pain on the system to avoid this again in the future.

In answer to the question, “Is real estate a good investment”, first, it’s important to define the criteria of “good”. I don’t know what the criteria of “good” is for everyone, but to me, it’s an investment that offers a reliable return on and more importantly, a return of the investment. Return of simply means if I put a dollar in, I want my dollar back. Return on represents growth of the money, like interest or capital gains. Beyond that, “good” might mean how one investment stacks up against another. For example, markets that compete with real estate for an investment dollar are the stock market and similar financial investments (CDs, bonds, etc.). All these investments have different characteristics…..some produce annual income, some long term capital appreciation, and there are differences in safety, liquidity, etc. What is “good” for some investors would be a disaster for others. So “good” is a relative term.

Long term, real estate has proven to be a growth market. With the exception of two periods (late 1920’s and early 1980’s), real estate values have been stable to increasing. Farm income fluctuates considerably, but tends to also run positive.

The combined formula considering both income and property value changes indicates the combined yield to the investment, and is written as follows:

Yield = Annual Rate of Return + Property Value Change

Example: Property value = $3,000 per acre. Net income is $90 per acre from renting the property (3% Annual Rate of Return) and property value increasing 10% per year.

Yield = Rate + Change = 3% + 10% = 13% Annual Yield

So in the context of an annual cash on cash return (3%), the investment is not so hot. But throw in the change in value and 13% looks pretty good (compared to the stock market, bonds, etc.), but keep in mind that 70% of that yield is coming from an increase in property values.

So what happens if RE values go down? Trouble. Really BIG trouble!

The formula for yield is the same, but using the same examples as above, if property values were to decline 10% in one year (if you don’t think this can happen, look to the residential market and the subprime problems), then Yield is:

Yield = 3% + (10)% = (7)% – A negative annual yield of 7%

In this scenario, the only way to achieve the 13% yield (assuming income stays the same), would be to lower property values. How much?

Rate = Yield – Change = 13% – (10)% = 23%

Value = Income / Rate = $90/.23= $391

Ouch! The formula overcooks it beyond reality, but the market does work in that direction. In the 1980’s, when land values started down, they kept going down until farm income alone supported values that were competitive with other investments. In that case, the drop was about 50 to 60% in many markets and cash on cash returns of about 8% to 10% from farm income alone. At that point, investors cashed in CD’s and started buying land.

So here is the scary truth: for real estate to remain a good investment today (double digit yields) land values must continue to rise. The safety factor is that in the last hundred years or so, they have only failed to do that twice. Maybe not double digit, but at positive gains at least.

On the income side, popular opinion is that the current land value boom is income driven, most say it’s directly tied to ethanol. If that is true, then land capable of producing a product that can be converted to ethanol should be the one in demand. In the Midwest, right now, the ethanol producing commodity is corn. And corn prices have risen:

This is a 15 year summary of corn prices on the Chicago Board of Trade and clearly shows a spike in prices in 2007. While much speculation exists that corn prices are going to stay at $3 or $4 per bushel, historically, this has not been so. In the past 10 years, corn prices have been below $2 more than they have been above $3. Almost every spike in prices above $3 were the result of weather driven crop failures. But that was before ethanol. BUT, ethanol is also sensitive to corn prices. For ethanol to be competitive as a fuel, there is a price point for corn. I don’t know what that is, but judging from reports of ethanol plants closing or halting construction, I’m guessing it’s not much more than $3. There are also the other corn based industries to consider…..the ones that existing before ethanol. All the livestock operations….cattle feedlots, dairy farms, hog farms, poultry (layers, broilers and turkeys) and a host of other industrial uses not often considered. At $3 and $4, many are suffering and running the risk of shutting down. So is $3 the new standard for corn prices? I don’t know, but it will be interesting to watch it play out. And what of the other land types that don’t produce ethanol commodities? All the pasture and wooded tracts. They have risen too….not as much as corn producing cropland, but a lot. Is that ethanol based or investment driven? My guess is the latter.

So with land prices at all time highs and many farm commodity prices at all time highs is farm real estate a good investment? As long commodity prices stay where they are and land values keep going up as they have been, and the criteria of “good” is an investment yield of 10 to 15%, yes!

Will corn prices stay high and land values keep doing up? That’s what we are watching and will report on as we find it. Stay tuned!

http://en.wikipedia.org/wiki/Subprime_lending

Why would lenders or borrowers do this? Short answer is money.

Who benefits from these deals? Lenders (when the loans are good), but more importantly, lenders reward loan officers with bonuses for loaning money. Often times, loan officers have quotas or goals for volume of money lent. Lenders make money on the origination fees, points, etc, so they push their loan officers hard to push money out the door, and reward them when they do. Realty agents work off commission and often times 5% or more of the purchase price is divided up among realty agents in the transaction. Let’s see…..commission or no commission? To be fair, there are a lot of RE agents who saw the problems and did none of these deals. But there are a lot of RE agents, and some made a lot of money doing it. Hope they sleep well.

Then there is the rest of the RE industry (title companies and escrow agents, surveyors, inspectors…… and appraisers!) who benefited from these transactions. A lot of folks were getting a piece of the action.

And lastly, the borrowers themselves. Why not take on a house with nothing down? Keep in mind, when these loans were being setup, home prices were soaring…maybe a $100,000 house today would be worth $120,000 next year? The only way to screw up the deal was to not be a part of it. So these borrowers took a chance and rolled the dice. Why not? If you have nothing to lose, you have nothing to lose. But with the perfect vision afforded by 20:20 hindsight, we can now see it was as if it were setup to fail.

So aside from all the money that was dispersed, what went wrong? The lending industry is based on a system of checks and balances……the Five C’s of credit:

http://www.loanuniverse.com/credit.html

In the subprime mess, just about every one of these were ignored. Collateral (as reflected by an accurate appraisal) is one of them. Appraisals are to be relied upon in the loan process as offering a realistic level of market value. Lending only a portion of that creates a built in cushion of equity from the borrower. When all the standards are ignored, such as when appraisers are instructed by lenders to make deals work or lose the business, and there is no equity, trouble is bound to happen. So why ignore the Five C’s? Money.

The best thing for government to do is to stay out of it. Let the lenders work it out on their own or fail, after all, it was something they themselves created. To those caught in the middle, this is a painful process, but this correction is a good dose of medicine the industry was in desperate need of. A government bailout would only encourage more of the same type of reckless behavior.

Why MODIRT and why a blog? First on the MODIRT name. Short, easy to remember and very descriptive of what it is we do. In farm and ranch appraisal, often times most of the value is in the land or dirt component (as opposed to building improvements) and most of what we do is in the State of Missouri. Since we are experts on Missouri dirt why not go with that as the name?

I must admit from the outset that the concept of the Internet “Blog” has been a difficult one for me to grasp. About the time I finally had the basic blog concept down, the whole thing struck me as humorous that someone would presume to think that anyone would care what they thought about anything (reminds me a little bit of those street corner preachers), or that anyone would even find a blog to read it. Akin to a “shout” in the forest…..if nobody is around to hear you, does it matter? To some, it does. And what I find surprising is that more hear that shout than you might think.

So what I’ve decided to do with this “Blog” (if we insist on calling it that), is to provide thoughts and information on three broad topical issues:

 1. Opinion pieces on appraisal, economic and political issues relating to real estate.

 2. Humorous observations during my travels

 3. Updates on land values.

On the first topic, while I have some thoughts on political issues, for the most part, I tend to keep those to myself. But politics is so ingrained into our lives that in many ways some discussion of it is unavoidable. For now, I’ll only say about politics is that in my opinion what we need in the way of elected officials are more statesman and fewer politicians and if you don’t know the difference, I’d encourage you to look it up. On the opinion pieces, I’m viewing these as being similar to Letters to the Editor that you might read in your local paper. As such, they are my opinions, and we all know opinions are like hind ends…..everyone has one. If you have a different opinion, feel free to share it as a response. You have that opportunity. As long as you remain civil, I can take it. Heck, I might even learn something.

 On the humor side, one of the joys or benefits of doing this type of job is being outside a great deal. I normally have a camera at my side and find myself taking some interesting photos. Shame to keep those to myself, so I’ll be posting those along with some humorous observations…on what I find and see and anything else that interests me.

 Lastly, one question I get more than any other is what are land values doing? It’s a real and valid concern. Fun and exciting when it’s going up, but serious as a heart attack (with the very real possibility of causing a heart attack!) when values are going down. So when possible and when appropriate, I intend to post information on land value trends. As there are often privacy concerns, most of these reports will be based on public auction sales and those where the public has free access to sale prices. Don’t expect real specific information and as a liability disclaimer, don’t hold me responsible if you act on information you find here. It’s free information and worth every cent!

And so the journey begins. Stay tuned!