Talking point: Are we valuing rural land correctly?

Beef Central, 11/01/2012

A commentary on rural land and the income & capital disconnect by Brisbane business advisor and accountant, Michael Vail, Tre Ponte Corporate





Coming from a pastoral family, I grew-up listening to the stories of the good and bad times, like almost famous saying about life on the land, “It never rains, then it pours”; meaning a land of feast or famine, or as Dorothea McKellar put it “I love a sunburnt country… a land of droughts and flooding rains.”

We are of course, living on the driest continent on earth.

Seasonal variations, combined with the production of staples of diet, which are a commodity, where farm-gate prices depend on supply and demand, tweaked by the reverse-engineering of the middle-men, leads to wild variations in both top-line revenue and bottom-line profits over time, and sometimes in consecutive seasons.

I was born and raised in the Blackall region of Western Queensland, where the family had owned the same property since 1908, and it was expected, based upon history, that we could average seven good years in every ten. Now that is quite good, considering some areas, however, very occasionally, we were given the three bad ones back-to-back. Conversely we had years like the early and mid-50s, through to the early 60s, when regions with an average rainfall of 600mm (24 inches), were receiving more than 1500mm (60 inches).

As an aside; through the generosity of our forefather politicians, and the forbearance of Treasury, the genuine rural producer has the benefit of being able to average their income (with conditions), in a rolling pattern over a five year period, due to the understanding that income in this industry is by its very nature, volatile.

This is only currently available to individual tax-payers, though strong consideration should be given to allow all rural-based entities to access this mechanism to smooth income, as it takes a long-term view of a cycle.

I hasten to add, that any beneficiary of this technique should be able to prove they are directly involved in the supply chain, as a genuine producer of edible food, and not investors looking for losses and a lifestyle.


Complimentary Income

It should also be a consideration of the Government to increase the amount of Complimentary Income allowed to be earned each year off-farm, before this averaging mechanism cuts-out, to a figure not exceeding $140,000 as any applicants will be genuine producers.

This then takes me back to the purpose of this article, to discuss the disconnect between the sustainable operating earnings of a risky rural enterprise, before the cost of funding and before taxation (EBIT), and the value attributed to the land, on apportionments of sale or purchase of a going concern.

If an enterprise is a going concern, this is a matter of fact; or is it?

A going concern enterprise may be defined as one where all things necessary, including in the case of a profitable rural enterprise, the land component, the plant and equipment and stock, are sold as one unit on a walk-in, walk-out basis; for it is only in this manner that the enterprise ‘life’ may continue.

Makeham & Malcolm in their book “The Farming Game Now” (1993) (with my comments for context, in brackets), state that:-

1. Land prices, (on a going concern basis), are not determined by present income, but by the expected future net income (from that particular farm enterprise, on a going concern basis).
2. The main point in any discussion about land values is this: whatever happens to profitability of production, be it a sustained rise in produce prices because of increased demand from a new market, or protection and assistance granted by Government, it will all end up in the land price. (The question is, should this happen, if it is truly the sale of a going concern? I’m sure governments will not want this to change because their rates and taxes will go down if the value of the land apportionments do.)
3. Land values (on a going concern basis), reflect mostly incomes and capital gains which are expected after the prospective purchaser has made an allowance for the uncertainty about future prices and yields (i.e. discounting).
4. (Theoretically,) when calculating the Present Value of an income stream over a known period of time, the formula is PV=Income divided by (1+Opportunity Cost of Capital per Annum), raised to the power of the term in years. If this changes to a period in perpetuity, the denominator (divisor) changes to the Opportunity Cost of Capital per Annum on its own. For example: If the sustainable net income is $100 per year, in perpetuity, and the opportunity cost of capital is 10.2%, then the asset would be valued at $980.39; or 9.8039-times earnings.
5. Now using the income capitalisation method the value of all the farm-land improvements, stock, plant and machinery (walk-in, walk-out) value can be derived by capitalising the operating profit which is expected to be produced by the whole bundle of assets (including all things necessary).
6. To value farm-land, the expected net returns to the land alone would have to be separated from the return to the land, and the associated investment in plant, stock and improvements (ie the apportionments). Thus in theory, to value farm-land alone, the return to use should be, after deducting from operating profit an interest return to the non-land capital such as improvements, machinery and stock. The formula might be: Value of land=Net Return to Land (after deducting a return to non-land capital) divided by the appropriate capitalisation rate.
7. Fixed improvements are unable to be separated from the land value, albeit they are able to be measured to arrive at an unimproved value.
8. To estimate operating profit and capitalise it, gives the value of all the land and improvements, plant and stock, WIWO. The realisable value (or Fair Market Value) of the non-land assets such as machinery and stock can then be estimated and deducted from the from the WIWO value. The remainder of the WIWO value is the implied worth of the land and fixed improvements.
9. NB: The value of the machinery and stock to use in the calculation, is the value of the machinery and stock services needed to earn such an operating profit; NOT necessarily the value of those particular assets presently located on the farm in question.

These above statements, made nearly twenty years ago in this erstwhile text-book, are as valid today as they were then. I note with interest that Ian Clarkson FAPI, Lecturer in Property at CQUniversity, Rockhampton, has commented on this matter, and I refer readers to his 2009 article, “Rural Valuation Education: Taking City to the Country” ( which distinctly points to the issue of using a Return-on-Investment approach to value farming enterprises.

Furthermore, the issue of failure to train rural valuers is possibly due to rural valuation courses falling out of favour in universities and institutes of higher learning. Well done Ian.


Are we valuing rural land correctly? 

I strongly believe that rural land, sold as a part of a going concern, is being valued incorrectly. That’s because as an interested observer, commentator, business advisor and accountant, I have closely watched what has happened over the past thirty-odd years, with the divergence in prices paid for farms compared to the net income earned. Many have paid too much for too little and without scale, ending up in bankruptcy, liquidation and penury. Caveat emptor – Buyer beware!

A main assumption in the valuation process of a going concern business, is that the Enterprise Value (EV) is the operating business, including all things necessary. If  the total equity of a company then needs to be valued to understand its value per share, then the level of debt and other liabilities on the Balance Sheet will have to be measured at a point in time, and this figure taken away from the EV to arrive at a value for equity. The accounting equation being Assets minus Liabilities equals Equity.

Registered Rural Land Valuers may use a Comparative Method to value farming land; and the value derived may depend on who asked for the valuation; vendor, prospective purchaser or bank.

They usually choose a method associated with a Market, Cost or Income approach to valuation. Now, as a valuer of business for many years, I would have assumed that rural land is akin to an operating factory being sold as a going concern; the enterprise value includes all things necessary, including the factory. The grass is attached to the land, so without the land included, you do not have all things necessary.

Why then, is most rural land sold/marketed on a Net Asset Value basis, as if it is not a going concern; on a ‘break-up’ value, if you will? Either the business enterprise is a going concern or it is not!


‘Rule of thumb’ method

A further commonly used method of valuing rural land on a comparative basis, is a ‘Rule-of-Thumb’ method, called the Beast Area Valuation (BAV). The only constant in this formula is the quantum of land within the boundary fence, with all other inputs being variables; much like all the other things in the bush, with the only constant being the variation.

This formula, simply stated, assumes that the carrying capacity per unit of area (the stocking rate), when multiplied by a comparable price of the same unit of area, will equal the BAV. Then, when this number is multiplied by the total carrying capacity of the property, will equal the price that might be paid for the enterprise, on a Walk-In-Walk-Out (WIWO) basis, with all things necessary.

This is a round-about way of directly applying a dollar rate per unit of area directly to the land area, to come up with a price; instant self justification! This derived BAV can then be used to work backwards to calculate the ‘comparable’ price per unit of area for a block with a lower stocking rate. WOW! It even has a BAVI acronym for Beast Area Valuation (Improved Basis). This is lazy valuation, in my opinion.

Well, that was how it used to be before someone from South, very cleverly imported the idea into Queensland in the late 60s-early 70s, that this contrived value was only for the land portion, and that the stock and plant were extra. It may have been a self-interested party such as a manager of a Stock and Station Agency, because they would receive commissions on sale.

Now even the Northern Territory and Kimberly regions have adopted the Queensland lead. When did economics and finance theory change? Where is the robust argument? Why should the application/the practice, depart from theory?

This BAV technique and other Net Asset Value approaches to valuing a going concern are incorrectly applied, in my opinion, and in the case of BAV, I have never seen such an incestuous logical loop prior, as it seems to validate the ‘dollar per unit of area’ figure, as a type of ‘constant’, without consideration to valuation theory; though it is neat isn’t it?

The premise of this ‘theory’ is supposed to be, that a beast will return this ‘amount’ net, over its productive life, and this is the BAV, as if it is an economic measure. Therefore, it would be reasonable to assume that the BAV would not only go up, but also fall, in lock-step with the markets; but not so.

I have looked for the empirical research, and the published articles defining the concept (such as a robust mathematical method should have), for many years, and so far, I have been unable to find it; though articles where the practice is used in Land Court decisions and Government Department marketing brochures, a principal of a top-line valuation firm and a university academic, start to appear from 2008. We need to be very mindful of a ‘Rule-of-Thumb’ method, which is not heeding valuation theory, yet has fallen into generally accepted use by ‘leaders’ in their field.

The BAV, by definition, also implies that there will be a different BAV for cows, and also for bullocks etc, because the stocking rates are different depending on purpose. A kilogram of meat is the same wherever you go, surely? What if we are back-grounding cattle – is the BAV different?

Surely the BAV will be different compared to a property breeding calves to sell as butcher’s calves to the local trade? Does it depend on when the beast will be sent to market? Does it allow for the vagaries of the weather and the percentage of loss in any one year? Does it matter if I have forestry country, gidyea/melon-hole country, Mitchell grass downs, or brigalow/belah country covered in buffel grass?

I have seen individual properties, situated right next door to each other, where one was used for breeding and fattening (involving ring-barked yellow-box creek-flats and large patches of developed brigalow/belah soil types, sown to silk sorghum, Rhodes and buffel grass), and the other used for breeding (predominantly ridgy and plateau, forestry country, with some improved pasture where possible, but mostly spinifex and spear grass, which might fatten cattle one year in ten).

They were once a part of a larger pastoral holding; the bullock and heifer paddocks, and the breeding run, respectively. These properties were being marketed on a comparable ‘price for the region’ basis, yet there is no comparison. Maybe they should be re-united?

I believe the selection of this technique to value a going concern, raises more questions than it answers, yet it has fallen into common usage, because it is a simple model to understand and apply; like all ‘Rules-of-Thumb’.

There is an increasing disconnect between the sustainable income of a rural holding and the capital value of the enterprise, and most of the change is in the land content. If a business is being sold/purchased, with all things necessary, then this is by definition a going concern enterprise, and the place should be sold on this basis, WIWO.

However properties are being sold/valued, not on a sustainable long-term earnings basis, but at inflated prices over value; without, it seems, much consideration for the concept of Margin-of-Safety. Remember the old adage, “Price is what you pay, but Value is what you get!”

The new Consumer Credit Act should stop this behaviour when implemented, however it also needs to address issues of the suitability of the applicant.

Sustainability is a long-term concept, and about stewardship. What that piece of land will produce on a tonnage basis, on the average over a few cycles, using appropriate farming and animal husbandry techniques, and applying a long-term moving average of prices achieved, for that production; and leaving the land in a better state than how it was found, relatively speaking.

Two-edged sword for Corporates

Where the future for rural land prices is headed, I do not know. However I pull out my crystal-ball and see the current prices risen to such an extent that corporate entities, are very interested; witness Macquarie Bank’s Paraway Pastoral Co, for example.

I see them, and others of the same ilk, owning the very best of available country, and/or managing them for Industry Super Funds, and becoming landlords. Macquarie Bank has paid around 11.5 to 17-Times earnings to acquire its northern stations.

This is a two-edged sword for the corporates, and based on their investment policies of ‘hurdle-rate-of-return’ and their Weighted Average Cost of Capital (WACC), they will be caught in a pincer move of their own making, between their Board and the poor serfs whose capacity to pay is at the mercy of the Gods, and diminished by the season and/or market prices.

On the other hand, they have the size to vertically integrate, add value, and negotiate strongly with the buyers from the large stores like Coles or Woolworths, because they have the scale.

For example, I shall proceed to ‘value’ a typical property, located in Queensland’s central west, using the BAV technique, and also a commonly used Corporate Applied Finance methodology, being the Present Value of the Sustainable EBIT, in perpetuity, to show the disconnect:-

A) BAV Technique:- Comparable sales sees a per unit rate of $432/ha. The land area is 14,570ha. The current stocking rate is 1:5.667 ha; so # 2,571 head is the carrying capacity of the land, with a margin-of-safety. The implied BAV therefore is $2,448.14 ($432 x 5.667). The calculated value of the farm is therefore $6.294m. (# 2,571 x $2,448.14).
Not one mention anywhere of the efficient use of, or production from, the parcel of land. Thereafter, because of common usage, we shall have to add the value of the Stock-on-Hand and the Written-Down-Value of the Plant and Equipment, making a total of around $9.214m. (NB: This property went to auction in 1987/88 and realised $2.112m. or roughly $150/ha, WIWO, and included all things necessary for the continuing profitable business.)

B) Present Value (DCF) approach:- EBIT = $350K. (On a five-year moving average basis.) PE Ratio = 13.5-times the Enterprise Value (EV) = $4.725m. (This includes all things necessary, on a WIWO basis.) This method is purely about the enterprise value and the units of production. Someone might pay more, if the land is not being used to its best economic alternate use, however this is the value for a cattle breeding operation.

The difference in the values derived by the application of the two methods above, on exactly the same set of data, is extraordinary.

If we valued the EV at the same value as the BAV technique (not including the machinery and stock added on top), the implied PE Ratio becomes nearly 18-times prospective earnings. For the level of risk taken by the farmer, considering the variations in seasons and commodity prices etc, an industry risk premium of 25pc to 33.3pc should be added to discount rate, used to price a less-risky and safer investment.

For a company listed on the boards of the ASX, a PER of 18-times would imply an expectation of higher returns, when the reality is just higher risk.

Public companies may pay these rates and justify them on purchase (using other people’s money, and smoke and mirrors), however you make your money when you buy, not when you sell; and if you pay too much, compared to the property’s ability to earn an income above a reasonable hurdle rate of return, then the liquidators may come knocking.

If a Corporate owned this farm, and rented it on a bare basis to a tenant farmer, the rent would be based on the land apportionment only, of around $712K. If the enterprise had a top-line revenue of $1.62m., and a benchmark rent was 7pc, then a rent of $113K would be levied.

This would equate to a yield to the landlord of around 15.9pc, and this would be more than acceptable. However, what happens in those times, like the past twelve years, where the drought holds the land in an iron-grip and will not let go? What happens to the landlord’s income then?

Contrast this with the ‘value’ of the land apportionments touted in recent going concern enterprise sales; this $113K of prospective ‘rent’, as a percentage of the BAV amount, is only 1.8pc, which is not a very attractive yield. This is a disconnect of a very large proportion.

A social and economic cost is that the young farmers who have trained at their father’s knee and/or attended University to lift skill levels, to enable them to operate the farm as a business, are either unable, or unwilling to buy their father out, or buy a farm of their own. The reason is because the risk/return trade-off is too high at present prices, and the new Consumer Protection Lending legislation may well stop banks lending to the very people who will do the best job to maximise production and have stewardship of the farm.

If the numbers do not stack-up for the farmer who owns the land right next door, how can the Corporates justify the price paid? Do they just sell the parcels of land back-and-forth to each other in a non-arms-length fashion, to hold the values up? I am surely too young to be that cynical.


No different to commercial property

As an Asset Class for consideration in an investment portfolio, rural land must have a value, but like rented land in the suburbs, there must be a strong correlation between the price you pay and what it will yield (both in tonnage and ROI), if it is a going concern.

Take commercial property, for example. If the Net Lettable Area of a building is 400sq m and the going market rate for office space is $280/sq m, plus out-goings, then as a landlord you will expect to receive $112,000/annum in rent.

If commercial property is currently being sold on yields of 7pc, then the ‘value’ of the property at auction should be $1.6m. It should be no different for a rural farm, if it is to be sold as a going concern.

To sum up:-

1. You make your money when you buy, not when you sell; so do not pay more than its economic value. If this happens enough then the price of rural land will fall to an appropriate level, with the focus returning to the Profit and Loss Statement and away from the Balance Sheet.
2. In a low inflation environment in which we now find ourselves, the focus should be mainly on the P&L and the cash that can be generated, and not on asset value growth, as in a high inflation environment.
3. Productive rural land should be re-assessed, as to what is a ‘living area’.
4. Rural land, as a part of an enterprise, if it is a living area, and going concern, able to withstand the vagaries of the cycle and the markets over time, should be valued accordingly; on an Income Basis.
5. A widely accepted method, under the Income Approach, is the Capitalisation of Future Sustainable Net Earnings.
6. The applied finance theory has not changed; why has the practice?
7. If rural enterprise is valued appropriately, any disconnect between income and capital will cease, because of the argument of opportunity cost, and what a landlord could reasonable expect to charge on a sustainable basis.
8. If you are a short-term investor with a purely financial focus, it is all about the cycle and how long you hold. This type of investor will only drive-up values in the short-term. As a part of a going concern enterprise, is a long-term patient capital investment, and if this does not describe your investment style, then do not apply yourself here, as you will usually get hurt financially.
9. Business Planning and Implemented Goals equals Growth.
10. Understanding, Measuring, Mitigating and Managing Risk equals Sustainability.
11. Always price-in all identifiable Risk, and include a Margin-of-Safety.
12. Rent if applied, could be in a band-width; no less than this lower number, and no more than this higher one, and tied to an agreed percentage of turnover in the middle. Everybody wins.
13. There should always be a separation between the ownership of the asset (land) and the operation of the enterprise; whether you own the land, or someone else does. This is good risk management.
14. I espouse the establishment of a healthy market in leased rural land, where the stewardship is centred in long-term leases to appropriately experienced entities and individuals, who may earn a more than reasonable income from the venture to reward them for the level of risk they are taking, and still pay a suitable level of rental yield to the landlord.
15. Finally, if a rural farm enterprise is operating as a going concern, and therefore profitable, then it should always be sold on a Walk-In, Walk-Out basis, with all things necessary, including the land.
16. A Net Asset Value approach to valuing an enterprise is a Liquidator’s or Banker’s approach, on a ‘break-up’ basis. By definition, if a rural enterprise is valued this way, it is not a going concern. Why would anyone ever invest in such a business, as there must be a reasonable expectation of a future profit and a reasonable Return on Investment?

I am open to debate on the above commentary, and am happy to be proved wrong.



Publisher's note:  Macquarie Pastoral Fund, owner of Paraway Pastoral Co, has taken issue with Michael Vail's description of the company in his contrubuted article, above. In response, it has offered the following comment:

"Paraway Pastoral Company Limited (Paraway) is the operating entity of the Macquarie Pastoral Fund. Paraway is not a landlord, rather it directly owns and operates sheep and cattle properties across Australia, alongside other Australian farmers. Paraway is an active member of the local communities in which it operates and is a significant rural employer."  


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