Jose Minaya, Managing Director, Head of Global Natural Resources and Infrastructure Investments
Justin Ourso, Director and Portfolio Manager, Global Agriculture Investments
August 14, 2012
Over the past several years, farmland has attracted significant investor interest because of the potential for good returns, diversification and a degree of inflation protection, as well as ongoing price appreciation. However, one of the worst droughts since the late 1980s continues to plague farming regions throughout much of the United States, putting corn and soybean crops in peril and damaging yield potential.
It’s hard to overstate the scope of this summer’s extreme dry weather. By mid-July, 55% of the continental U.S. was in moderate to extreme drought conditions, and the federal government had declared one-third of the nation’s counties—nearly 1,300 across 29 states—federal disaster areas. The impact on crops could be dire. Analysis by the U.S. Drought Monitor shows that 88% of corn and 87% of soybean crops are in drought-stricken regions.
These cyclical drought conditions have some investors wondering if the extreme weather could also have a negative impact on farmland investments. In the following interview, Jose Minaya, Managing Director and Head of Global Natural Resources and Infrastructure, and Justin Ourso, Director and Portfolio Manager of Global Agricultural Investments, answer some questions about one of the worst droughts on record and its impact on farmland investing.
Let’s start by getting a better understanding of farmland as an asset class. What are the benefits of farmland investing?
There are several benefits, including potentially attractive total returns in the form of current cash income and appreciation over time, inflation protection and portfolio diversification. Between 1970 and 2009, agricultural land values, as measured by the USDA’s Economic Research Service database, actually outperformed both domestic stocks and bonds on an annualized basis, returning 10.25% compared to 6.24% for the S&P 500 and 7.3% for 10-year Treasuries.
Those double-digit gains also beat inflation by a wide margin. During the same time period, 1970 to 2009, the U.S. Consumer Price Index rose an average of 4.36%, less than half the return on agricultural land. What’s more, farmland offers great potential for global diversification. By investing globally in farmland in regions with different climates, crops and economies, we can potentially increase portfolio diversification and reduce overall risk.
Do you believe the long-term outlook is equally attractive?
We do, for a number of powerful, long-term reasons, including a growing global population, changing dietary habits and a shrinking supply of arable land. Keep in mind that the world’s population grows by about 25 million people per year; to keep up agricultural producers will have to nearly double their output by 2050 when the world is expected to have 9 billion people. Meanwhile, as the world has more mouths to feed, people in the developing world are becoming more prosperous and consuming more meat, which requires that they buy even more corn and grain to feed their livestock. These are very powerful trends, but they aren’t the only ones driving farmland appreciation. Alternative fuel production is also boosting demand for arable land. Corn and sugarcane are used for ethanol production; soybeans and canola are used to manufacture biodiesel.
What is TIAA-CREF’s approach to farmland investing?
We started investing in farmland in 2007. Since then, TIAA-CREF has become one of the largest institutional owners and managers of farmland in the world, with about $2.8 billion of investments across the U.S., Australia, South America and Europe. We believe the best way to capitalize on this asset class is through direct ownership of farmland properties and through diversification across countries, crop types and operating strategies. Each time we consider a farmland investment, our agricultural investment team studies an array of regional and micro-climate factors. Sustainability and responsible management practices are also critical to our strategy as we are long-term investors in the space (For more information, please see Pioneering Sustainable Farming Practices).
Given that backdrop, what about today’s extreme drought? Is it possible that a single-season drought could have a long-term impact on investing in farmland?
A single season of drought should not have a long-term impact on farmland investing. One of the things we like about row crops such as corn and soybean is you get to start over every year. In fact, farmers are used to dealing with droughts, pests and floods over the long-term. It’s really a normal part of doing business. What’s important is that the fundamental demand dynamics—a growing world population and a growing middle class in emerging markets—haven’t changed. And from TIAA-CREF’s point of view, returns from farmland tend to be stable even in drought years because we buy land and lease it back to the farmer. So if the farmer has a low profitability year we still receive payment under our lease, and if the farmer has a hugely profitable year we still have that same lease. We typically receive rent before a U.S. farmer plants a seed.
Is there a silver lining to this story?
The silver lining is that the world’s inventory will need to be replenished next year and that will support higher commodity prices. Plus, this year, many farmers will be protected with their crop insurance. Insurance payments are based on the coverage level chosen and calculated by multiplying production yields based on prior experience by the price of the commodity. Insurance payments are expected to provide cash to farmers, enabling them to continue their farming operations the following season. With low global inventories, farmers should be well positioned to benefit from strong commodity prices and will plant significant acreage to meet global demand in the next planting season.
Food prices are expected to rise because of the drought. What does this mean for farmers’ incomes? What impact would that have on demand for farmland?
Lower farmer income and profitability may reduce demand for farmland in the short term because most farmland in the U.S. is bought by other farmers. However, we would see lower demand for land as a buying opportunity. All those long-term drivers we mentioned—tight global inventories, growing populations, increasing protein consumption—still exist to propel farmer and farmland profitability over the long term.
Do you see the crop shortage and the decrease in farming activity hurting the industry of companies that support the farmers with machinery, fertilizer, seed and other farming necessities?
The drought may impact certain pieces of the value chain more than others. When you look at companies that rely on production volume and economies of scale for their business—grain handlers, processers, transportation—these companies may be impacted as crop production needs to be handled, processed and transported. And there may be an impact on the local communities too. There could be less taxable revenue from lower agricultural production.
Are today’s farmers positioned for ongoing profitability even in the face of atypical changes in weather patterns and economic cycles?
It’s important to keep in mind that agriculture is a very fundamentally driven market. There is demand on one hand, which is growing from the fundamental forces we discussed, and on the other, supply, which is having a hard time keeping up. We believe that these fundamentals bode well for profitability. Inventories for many agricultural commodities are so constrained today that any threat to supply can be a problem; it’s what’s driving the value of commodities and farmer profitability.
Is the government offering any support?
We invest globally, and in places like Brazil and Australia where the government is not materially involved in the sector. But in the U.S. the government plays an important role by subsidizing crop insurance. Given the strategic and national importance of food production the idea is to make sure that farmers aren’t driven out of business after one bad year, thus taking their land out of production. From an investor point of view, there are very few asset classes that have this kind of structural support.
The U.S. is the world’s top exporter of corn and soybeans, among other crops. Will the drop in farmland yields have a negative impact on the U.S. economy and spur a fresh round of world food price inflation?
The U.S. may see agricultural exports and tax revenue decline in the sector in the short term. And food inflation will be an issue globally since less production does mean higher prices, but it will ultimately depend on to what degree the higher prices get passed along to consumers. Sometimes it’s the companies in the middle that get squeezed by the higher commodity prices because they can’t raise the price of products, for example cereal, commensurate with their own cost increases. In the end, companies and agribusinesses follow long-term driven business models and are accustomed to managing through cycles.
Has the emphasis on global diversification and risk management been helpful to TIAA-CREF's portfolio during the current drought situation?
From an investment perspective, the drought has had little to no effect on our portfolio to date since, as we mentioned before, we lease the land to farmers who then take the crop production and price risk. This allows us to capture long-term land price appreciation while smoothing out short-term volatility from production and commodity price movements. In addition, our portfolio benefits from global geographic diversification, for example in Australia and Brazil, as these countries are experiencing better cropping seasons.
Earlier you mentioned the sustainable and responsible management practices of farmland investing. How important are these factors in TIAA-CREF’s approach to farmland investing?
We, as an institution, care deeply about sustainability, so TIAA-CREF puts a strong emphasis on environmental stewardship. For instance, in 2011 TIAA-CREF joined several other international organizations to launch the Principles for Responsible Investment in Farmland. (For more information, please see Investors Launch Principles for Responsible Investment in Farmland)
These principles include: promoting environmental sustainability, respecting labor and human rights, respecting existing land and resource rights, upholding high business and ethical standards, and reporting on activities and progress toward implementing and promoting these principles.
We’re very proud of the role we can play in promoting a sustainable approach to farming, and we believe the current drought shows how vitally important these efforts are. After all, we own the land and plan to own it a long time. It only makes sense to take care of it properly because not only is it good for our investments, it’s the right thing to do.
TIAA’s Agriculture investments are just one of many investments of TIAA’s General Account, an account solely owned by TIAA that is not available to individual investors and whose performance is not directly allocated to any specific contract or obligation. TIAA’s General Account invests in a broad range of diversified investments to support TIAA’s contractual guarantees and business operations.
Past performance is not indicative of future results. The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons.
TIAA-CREF Asset Management provides investment advice and portfolio management services to the TIAA-CREF group of companies through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC and Teachers Insurance and Annuity Association® (TIAA®). Teachers Advisors, Inc. is a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association of America (TIAA).
Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income.
Performance of farmland may be based on appraised values or comparable market transactions, whereas stock and bond investments are typically marked to market and reflect actual market prices. Past performance does not guarantee future results.