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IS THERE ROOM FOR FARMLAND PRICES TO KEEP RISING? As discussed in the last edition of Seasons, land values are primarily driven by two things: the net value of the agricultural products the land can produce over time and the cost of funding its purchase. The cost of funding agricultural land is ultimately driven by the rate of return for alternative uses of capital adjusted for the relative risk of the investment. In other words, the opportunity cost.
The earnings capacity of the land is influenced by several factors. One of the most important is the rate of productivity growth, which is the ratio of outputs produced to inputs used. At present, the cost of funding agricultural land is historically low (see Chart 1). As interest rates have been low for some time, and with limited capacity to reduce further, it is likely that these rates are now fully priced into land values. This means they will support land prices while they remain low but are unlikely to contribute to further rises. Alternative investment returns are also low, with future returns uncertain as economies adjust to the impact of
COVID 19, and the COVID 19 “normal”, whatever that will be, among other things. Of interest is the more recent low rates of productivity growth, largely attributed to dry conditions in most areas of Australia, at a time of rapid increases in land values (see Chart 2). The recent rises in farm values have come from a convergence of low funding costs and improved commodity prices relative to the cost of inputs. The rate of productivity growth over time compared to farmers’ terms of trade (output prices relative to input prices) is shown in Chart 3. That is, the prices received by farms have increased faster that the prices paid for inputs. This has been a key driver of increased farm returns.
Chart 1 Reserve Bank of Australia Interest Rates, Source: RBA, ABARES AgSurf Data Base
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