Issue 21: 2012

GLOBAL PERSPECTIVE

Supermarket America

As population growth forces other countries to import food, U.S. farmland is still
a go-to resource — and still a worthwhile investment to consider.

Bunsen Bookworm/Corbis

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Many investors with farmland in their portfolios are asking two pressing questions. Is the world approaching a tipping point in terms of its food supply? And will farm investments continue to return average annual yields of roughly 10%? As it happens, Dennis Moon, head of the U.S. Trust Specialty Asset Management (SAM) group and a longtime observer of agricultural trends, believes the answer in both cases is yes.

?Arable land worldwide is basically fixed, at about 3.4 billion acres, and most of the grain it produces is consumed,? Moon says. ?At the same time, the global population count continues to grow; we hit 7 billion last year and could reach 9 billion by 2050. With more people but the same grain volume, countries could soon be struggling to buy what they need in the global supermarket.? (See Exhibits 1 and 2.)

EXHIBIT 1: POPULATION AND ARABLE LAND Click to expand

We may in fact already be seeing signs of an international food fight. ?After years as an overall exporter of grain, China recently became an importer, in order to feed its growing populace,?1 says John L. Taylor Jr., national manager of the U.S. Trust Farm & Ranch group. But more mouths to feed are, it seems, only one piece of the puzzle. ?As the country slowly industrializes and some Chinese become wealthier, they are demanding bigger portions at mealtimes, as well as higher-protein foods like pork and beef that require more grain and feed to produce. A similar dynamic is occurring in countries like India, Indonesia, Malaysia, Vietnam and Thailand,? he adds. Notably, per capita gross domestic product, a major indicator of wealth, has been rising in these areas; in China, for instance, it grew fourfold, from about $1,000 to more than $4,000, between 2000 and 2010.2

No Food For You?

Some factors affecting the global food supply actually have very little to do with the dinner table. One is biofuels. ?The grain-to-ethanol industry may have used very little corn in 2000, but a decade later it was processing about 4 billion bushels a year, and estimates suggest ethanol manufacturers could use similar volumes until at least 2019,? Moon says.3 ?What?s more, the planet loses some 75 million acres of productive land every year to industrialization, urban sprawl and desertification.?4

The planet loses 75 million acres of productive land
every year.

What about efforts to boost grain output or supply? ?There are several ways to do that,? Taylor says. ?One is to develop new farmland. But unfortunately you can?t grow crops just anywhere. They need the right temperatures, sufficient topsoil of good quality, and ample rainfall or a water source for irrigation. That obviously sets a limit on how much new cropland can be developed.?

Another route to larger harvests is to plant seeds that have been genetically modified (GM) to be more disease-resistant and potentially more productive. ?Some 30 nations are now growing GM crops. But political and environmental opposition to modified foods has been growing for years and seems unlikely to diminish anytime soon,? Taylor says. ?So it remains to be seen how much GM can add to overall grain yield over time.?5

Tote up all these pluses and minuses, and we are still looking at a planet with more people but essentially the same food supply. Which brings us to America?s green acres ? sometimes called the breadbasket of the world.

Stocking Up

?The United States has almost 12% of the world?s arable acreage and not quite 5% of the population,?6 Taylor says. ?By comparison, China has just 8% of the land and close to 20% of the people.7 These ratios, along with farming efficiencies, helped American farmers in 2010?2011 produce 39% of the world?s total output of corn, not to mention 55% of all corn exported worldwide,?8 including some reportedly scooped up by the newly importing China.

EXHIBIT 2: SUPPLY AND DEMAND 2011 Click to expand

?This remarkable abundance is a significant part of why investments in U.S. farmland over the past 20 years have produced an average annual return of about 10%, as a combination of land values and crop values. And with the expectation of an increase in global competition for agricultural commodities, we believe U.S. farm investments could see similar returns in the decades ahead,? Taylor says. (See Exhibit 3.)

In 1980, land cost $750 per acre. As of 2010, it had risen to $2,250 per acre ? but income from major crops had also increased.

But what about media reports that the cost of a U.S. acre has risen too far and is about to tumble ? much as the housing bubble popped a few years ago? Both Moon and Taylor take issue with this analysis. ?We think the chance of a sudden price drop is low,? Moon says. ?The average cost of an acre has certainly increased over the past 30 years, from roughly $750 in 1980 to $2,250 in 2010.9 But income from major crops has also risen. The average price of a bushel of corn, for example, more than doubled in less than a decade, rising from $2.34 in February 2002 to $6.16 in February 2012.?10

As Taylor explains, the link between the price of an acre and the cost of grain is an important one. ?Many farmers lease from property owners,? he says. ?What they can afford to pay for an acre is a function of the gross income they expect from the land. And that amount is in turn related to the market price of the commodity they produce.?

EXHIBIT 3: FARMLAND RETURNS ? APPRECIATION AND INCOME 1991?2011 Click to expand

For land prices to plunge, then, would require a corresponding crash in commodity prices. ?But ongoing demands on the global food supply make that unlikely, certainly for the time being,? Taylor says. ?In fact, we could see U.S. farmland returning average yields of roughly 10% for quite some time, although that estimate could be affected by a catastrophic event such as widespread crop disease, floods or drought. Notably the current drought in the Midwest could well push crop prices up further.?

Investing in Supermarket America

Both Moon and Taylor have heard from clients who say they are attracted by U.S. farmland?s historically consistent overall yield and its low correlation with the securities markets. Yet these clients also say they are hesitant to purchase the investment because they have little or no knowledge of crop rotation, cattle feed or the like.

?We tell them not to worry,? Moon says. ?You can invest in farmland without knowing a thing about farming. Our experienced farm managers can do essentially all of the work for you, from inspecting a farm before a purchase to reviewing potential farm tenants to making sure things run smoothly after the purchase. As we like to say, the SAM group can help make investing in farmland almost as easy as buying securities.?

?Clients who would like to learn more about buying a farm property should contact their portfolio managers,? Taylor adds. ?Or they can email us and we?ll try to answer their queries as best we can.? You can contact Dennis Moon at dennis.moon@ustrust.com and John L. Taylor Jr. at john.l.taylor@ustrust.com , or visit ustrust.com/sam.

1 China Growth: USDA Bank of America Merrill Lynch Global Research, February 2011.
2 World Bank, February 2012.
3 Biofuels: USDA Agricultural Projections to 2019, February 2010.
4 ?Access to Land and the Right to Food,? United Nations, October 2010.
5International Service for the Acquisition of Agri-biotech Applications report, February 2011.
6 World Bank, February 2012.
7 United Nations, February 2012.
8 U.S. Production: USDA, World Aggregate Supply and Demand Estimates, February 2012.
9USDA, Trends in U.S. Farmland Values and Ownership, February 2012.
10USDA, Feed Grains Data, February 2012.

IMPORTANT INFORMATION

Projections made may not come to pass due to market conditions and fluctuations.

Past performance is no guarantee of future results. Asset allocation, diversification and rebalancing do not assure a profit or protect against loss in declining markets.

Always consult with your independent attorney, tax advisor, investment manager, and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

International Investing
International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Other
Nonfinancial assets, such as closely held businesses, real estate, oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and involve risks, including total loss of value. Special risk considerations include natural events (for example, earthquakes or fires), complex tax considerations and lack of liquidity. Nonfinancial assets are not suitable for all investors.

Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties, such as rental defaults.