Property

Beef land versus gold: Which is the better investment?

Ian McLean, Bush Agribusiness, June 19, 2020

It would appear to us that agricultural land has some key characteristics in common with gold. The main ones being;

  • It is a finite resource and is valuable, primarily, as a result of scarcity.
  • Typically, both have very low yields (zero or less in the case of gold).

The first of these characteristics, combined with an uncertain global economic outlook, has contributed to an increase in the prices paid for agricultural land in Australia.

This has been a double-edged sword; the upside is that it has increased the wealth of those who own land; the downside is that, with no corresponding increase in profits, it reduces the returns on capital.

Analysis of historical data indicates that agricultural land in Australia has been a better investment than gold over the last 40 years.

The below graph compares the market price of all beef land in Australia with that of gold. The comparison is in real terms (inflation removed) and both sets of data are indexed to 100 in 1982, the starting year of the analysis. The Beef Land Index is derived from data sourced from ABARES and the Gold Index from data from the World Gold Council.

Comparison of price of gold and rural land in Australian dollars (real)

These data show that over this period, beef land increased in price more than gold.

However, it also shows that both assets can go flat for a long time, as happened in the 90’s, and they can decrease in value.

If you look at the figure above, nearly all the gains for both effectively happened in one decade, the 2000s.

How to appropriately value rural land?

Rural land being a good store of wealth, and generally increasing in value over time, can cause confusion in how to appropriately value it.

Asking ‘what is the purpose of your investment’ is a key question in determining how to value rural land.

Is it:

  1. a store of wealth?
  2. a speculative investment in increasing land values?
  3. an investment that requires an adequate operating return from the capital invested, taking into account risk and opportunity cost?

The approach taken to determining value under each purpose is quite different.

For a) and b), the ‘value’ is determined by the market on the day, assuming it is an efficient market and everything is correctly priced.

Purpose c) requires an appraisal of the likely returns, the risks involved, and clarity on what return you require on your investment.

At the moment, it is very difficult for those requiring a reasonable return from their investment, to justify purchases at current land prices. There are exceptions, but exceptional yields are generally harder to find at current prices.

This can lead to the argument that, as it is an appreciating asset over time, the returns from capital gains could be factored in to help justify the purchase price.

This is what economists refer to as the ‘greater fool theory’, which is where a buyer pays more for an asset than it is intrinsically worth, in the belief that a ‘greater fool’ will come along and pay even more in the future. This approach is b) above, not c).

An advantage of our economy is that individuals and organisations are free to invest and risk their capital on pretty much whatever they want, for whatever reason they want. Investors also have differing risk profiles and investment timeframes. The disadvantage is that buyers from all three approaches above are competing in the same market, with those prepared to pay the most, consequently setting the ‘value’.

This creates a very real problem where a purchaser with purpose c), who does not do his or her due diligence well, and accepts the market price as ‘value’, which has been perhaps set by a purpose a) or b) buyer, is effectively locking in a very low return (see below example). If there is an expectation of good returns, significant debt to service, or both, then the pressure to generate returns can cause the land to be run too hard. This may go on for years and the purchaser may even find a greater fool, who pays even more for the property in spite of any overstocking.

Our opinion is that, for agricultural businesses, approach c) is the most appropriate because;

  • the investment provides a return without having to be sold to realise that return (i.e. independent of potential capital gains);
  • depending on leverage, the investment can service debt and is not a cash drain on the remaining business, or cash negative if standalone; and,
  • the investment has a ‘protective moat’ around it (if there is a decline in the land market or the economy, it is more likely to be able to withstand those variations if it is generating reasonable operating returns).

This is not to say that investment in agricultural land is not a good store of wealth, or that the increase in land value over time should be ignored. There is no question that agricultural land is a good store of wealth. We believe that the returns from capital gains should be secondary to the agricultural operating returns, and be treated as icing on the cake, rather than being necessary to make the investment stack up.

Our approach is not for everyone, and there have been many fortunes made, and lost, through taking the approaches a) and b). In fact, if you look at history, all the great Australian agricultural fortunes, from Macarthur, through Kidman, to the present day, have been made primarily through land dealing rather than profitable activity on the landscapes.

The Australian Beef Report 2020 Vision has been prepared for those producers who want to generate financial returns from their operating business, and rather than being dependent on capital gains.

  • The Australian Beef Report 2020 Vision will be launched on Wednesday June 24 at 10:30am AEST and live streamed on Bush AgriBusiness’ Facebook page. The book will be available from the Bush Agribusiness website

 

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Comments

  1. Michael VAIL, June 23, 2020

    To answer your question posed by the Title to the Article … Gold may continue to rise in Demand, and therefore Market-Price … and as JP Morgan said when asked what the market will do, “The market will continue to fluctuate!”

    So I suppose, like in times past, the price of Gold will go Up, and then down again, and so on … As to the price of Farm and Grazing land … price depends upon Demand for the ‘Factory’ and what’s produced In volume and revenue from its constraints … but ‘value’ of anything as an investment, always relies on the fundamentals … what it may produce (Q) across time, and what price across time you may receive (P). This is Revenue …

    … but for land (as the Factory in the Farm setting … the ‘thing’ that adds the value) to rise from around 45% of total Enterprise Value to over 60%, when the long-term growths are around 3.5% for meat and around 2.2% for land is extraordinary at best … this reeks of cheap-money trying to find a home and bankers shovelling money out the door … it may all end in tears …

    CVP-Analysis is paramount …

    Just imagine what happens down the track … when the great-seasons return and the cow-herd is re-built (around 5 to 7 years) … suddenly, there’s cattle everywhere … a higher Australian Dollar … and maybe unbalanced trade-terms.

    I’d suggest it’d be like a return to 1971 (does anyone remember … Cows and Calves-at-Foot for $1.00 per Cow and Calf given-in) … the revenue virtually disappears and the fixed-costs remain … and you go buy 1,000-rounds to just shoot them so you can look after your land.

    Where’s the ‘value’ at that point … grass and water everywhere, but no income …

    And this is why (in the planning process) when investment decisions are made, that its important to look through the cycle to find those Median numbers and put some scenario analysis around them to arrive at a ‘Fair Investment Value’ (FIV).

    Also, Agistment Rates (per Head, per Week) lead to an Annual Rent per Beast. These rates should match with land-value. They currently do not … therefore, a complete disconnect …

    The ‘market’ may disconnect with economics for a while; and then there’s the ‘reckoning’ … and those ‘jaws’ snap shut ferociously, if history is any guide. It’s even got a name … it’s called ‘mean-reversion’.

    … and it’s the Debt-levels (on diminished cash-flow) that will be the factor that causes the problem … as you may impair Assets … but Debt may only be repaid, or forgiven.

    Caveat Emptor

    Look to history … looking back to learn … and forward to grow ! IMO

  2. Michael Vail, June 22, 2020

    Excellent points you are making, and I’d say, “Spot-On!”

    The EBIT measure (or Operating Profit) always tells the story … looking through a rolling 10-year cycle of median measures. For EBIT is the ‘residual amount left-over’ to pay Taxes, Debt, Capex, and Dividends … and I’d suggest, in that order.

    From an Investment viewpoint, the Return on Invested Capital (ROIC), must be greater-than the Weighted Average Cost of Capital (WACC) for combined levels of both Equity and Debt in the proportions they exist on that farm; and for the total period that these investments are ‘held’.

    The ‘exit’, or Sale cannot be the main or end-game …

    Be prudent … I’ve seen a few high quality properties of scale change hands recently, where the cash-flows may never provide a recovery of capital invested … where the implied Net Farm Gate Price is greater than the roughly $4,500 being received over the retail Butcher-shop counter at around $17.00 per Kg. I know two of these properties intimately … they are not a ‘feed-lot’, and getting 4-turns if livestock per Annum (every 90-days).

    Hope is not a Prudent strategy: yet I agree with your idea of the emotional FOMO-factors at play … and I’ve been saying for years that like Gold, pastoral and farming land should be valued like a Zero-Coupon Bond … with a very deep discount to Face Value … Gold is valued (when monetised as a security) at around 70% discount.

    To me, it’s like looking at an Orchard. There’s the ‘tree’, or the land-as-factory; and then there’s the ‘fruit-if-the-tree’, or the annual expected Harvest. Each has a value … very ‘bond-like’ … and each can be valued appropriately; and prudently as a fundamental value … one which is at an Aristotlean ‘fair-price’ … to both Vendor and Investor. The premium (or discount) to pay above (or below) the fundamental Value, and which might be ‘fair’, depends upon the quality of the soils and the improvements on and to the ‘factory’.

    It’s pretty simple stuff … are you buying an investment … or are you buying a job … with the former you’re in charge, and relatively stress-free … with the latter, you are forever chasing money and the bank is chasing you …

    The banks need to go away from lending based upon market-price expectations, and return to fundamental value … and lend up to around 64% of fundamental value … with the intending purchaser finding the balance of the risk-capital … from the usual suspects … own savings, or Family, Friends, and the Fools.

    The ‘Bigger-Fool’ theory is a real phenomenon … be aware 😊

  3. Peter Vincent, June 20, 2020

    Blind Freddy can tell us that option C is the proper means by which to value any land purchase, however option C is almost irrelevant in the economic climate of the last decade where superannuation and multi-national entities are making substantial investments in a land bank which far exceeds returns from bonds or cash deposits and is free from political and other irrational influences associated with an equities market.
    Such a scenario lays a minefield for any investment in agriculture which requires significant debt facility.

  4. Rod Barrett, June 19, 2020

    A more realistic comparison would be land and the ASX. My guess is that shares are more commonly held than gold. As well, shares offer an annual return as does land.
    Just saying!

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