How to get exposure to rural property via ASX.
An Australian Real Estate Investment Trust (A-REIT) is a way for investors to own a share of a property portfolio. A-REITs purchase and lease properties, distributing any rental income net of operating expenses.
This article provides a background on the agricultural property sector and considerations when investing in this asset class via an A-REIT structure.
A-REITs are commonly categorised by the kind of property they hold, such as industrial warehouses, retail shopping centres, childcare facilities or commercial offices. However, the A-REIT structure can also be applied to agricultural property.
In 2017-18 the Australian Bureau of Statistics (ABS) reported there were 378 million hectares of agricultural land across Australia, or 49 per cent of total landmass. Of the total farmland in use, 328 million hectares were used for grazing and a further 31 million for crops.
Although the ABS publishes data on the number and type of agricultural enterprises, there is little data available on the actual capital value of the industry. Rural Funds Management (RFM) has previously estimated this value through a range of techniques applied to Australia’s major agricultural industries, including cattle, sheep and cropping sectors.
Based on this analysis, RFM has estimated the total value of agricultural property exceeds $200 billion, which makes the agricultural property sector of comparable size to the office, retail or industrial property sectors.
Agricultural property leasing
A farmland leasing structure can benefit both the investor (lessor) and the operator (lessee).
The lessor is free of the operational risks of running a farm, such as weather, fluctuating commodity prices and international market forces. The lessor simply receives a return comprising rental income and any appreciation in underlying asset values.
The agricultural property sector can also provide a diversification benefit to other property types, because asset values can be influenced by variables that are unique to farmland.
A risk to the lessor is if the operator’s business conditions deteriorate to the extent they cannot pay the rent. This risk can be mitigated by selecting financially robust lessees, careful asset selection and diversification.
A benefit to the lessee is that they have more capital to invest in risk mitigation for their business, to reduce debt and to conserve cash.
Furthermore, leasing, rather than ownership, allows an operator to more efficiently use scarce capital. Rather than tying up equity in property that could be rented for, say, 5 to 10 per cent, many operators choose to invest the money in expanding their business operations, where they may hope to make a return of 20 per cent.
Growth of the sector
Despite the size of the Australian farmland sector, RFM estimates only a small portion of agricultural property is leased, perhaps around 10 per cent. Although the level of property leasing has increased in recent years, it is still low compared to more mature agricultural markets. For example, in the United States and many European countries, agricultural property leasing represents closer to 40 per cent of the sector.
The growth of agricultural leasing is likely to continue as the Australian sector becomes more consolidated. Figure 1 below shows data from the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) depicting the number of broadacre farms by size and value contrasted with the increasing age of Australian farmers.
Figure 1: Farms by size and average age of farmers
Source: ABARES
The data shows that from 1997 to 2017 the total number of farms decreased by approximately 28 per cent while the number of larger farms, those with more than $1 million of turnover, grew approximately fivefold.
Over the same period the average age of farmers increased from 53 to 60. Suggesting a catalyst for consolidation is farmers selling assets as they approach an age where they start to plan for retirement.
RFM distinguishes between two kinds of agricultural enterprises: infrastructure predominant and natural resource predominant. Figure 2 below presents the range and characteristics of agricultural assets that are common in Australia regarding their levels of infrastructure or natural resource predominance.
The rates of income and growth set out in this diagram are notional rates based on historical returns and are presented here to highlight the contrasting characteristics of various assets.
Figure 2: Agricultural sectors and return characteristics
Source: Rural Funds Management
Farms on the left-hand side of the diagram rely on significant infrastructure to operate. Poultry farms, which rely on temperature-controlled sheds for birds, fall into this category.
These assets generally provide a higher rental return than natural resource predominant properties. However, the higher lease rentals are, in part, due to the eventual depreciation of infrastructure. A purpose-built shed will eventually deteriorate, necessitating either an expensive upgrade or the demolition of the asset. These costs must be factored into the lifecycle of the building.
On the other side of the continuum, natural resource predominant farms rely on very little infrastructure. As an example, modern cropping farms typically have no fences, no buildings and only a few access roads. Grazing properties that support cattle will also use relatively low levels of infrastructure, such as fencing or cattle yards. Instead, these assets have considerable value embedded in the natural resources that are used or made available to them.
Natural resource predominant assets will trade based on the amount and reliability of rainfall, their access to water entitlements, the water holding capacity of the soil, and other issues such as proximity to markets. It is these attributes that drive higher rates of capital growth in this class of agricultural property.
Since 1978, when systematic measurement began in Australia, farm values have achieved compound growth of approximately 4.4 per cent per annum. A longer data set is available from the United States, where farm values have increased by 4.5 per cent per annum.
These potential growth rates, coupled with the income possible from leasing agricultural property, can provide an attractive investment proposition. Moreover, it is possible to construct a mix of investments across the spectrum presented in figure 2 to balance a suitable level of income and growth within the portfolio.
Conclusion
Agricultural land leasing is an emerging asset class driven by consolidation within an ageing farm industry and the flow of investment funds into this specific property class. A-REITs that specialise in agricultural property are one way for individuals and institutional investors to access this asset class.
About the author
David Bryant established Rural Funds Management in 1997 and since then has led a team responsible for the acquisition of large-scale agricultural property assets and associated water entitlements.
RFM manages more than $1.2 billion of agricultural assets, including the Rural Funds Group (ASX:RFF). RFF is a real estate investment trust that owns a diversified portfolio of high-quality Australian agricultural assets leased to experienced agricultural operators.
By David Bryant, Rural Funds Management
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