Bonnefield Newsletter – Q3 2022

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Permanent Crops and Canada’s Evolving Agricultural Landscape

As a major agricultural producer and exporter, Canada is a leading supplier of traditional cold-weather crops such as wheat and canola across the globe. However, higher-value permanent crops such as apples, berries and stone fruits are increasingly being grown in Canada as growing conditions continue to become more accommodative as a result of climate and weather shifts.

Bonnefield has been working with blueberry farmers for many years and recently completed its first transaction with a leading British Columbia-based grower of raspberries, as we continue to ensure our farmland portfolios reflect the diversification of the Canadian agricultural landscape. Below we break down some of the key differences between row crops and permanent crops and how changing growing conditions may impact the future economics of agriculture in Canada.

Row Crops vs. Permanent Crops – What’s the Difference?

The terms “row crops” and “permanent crops” may be unfamiliar to some. An easy way to distinguish between the two is to think about a permanent crop as one that does not require annual replanting. Examples of permanent crops in Canada can include apples, blueberries and grapes. In each of these instances, fruit is produced for multiple years on the same plant (biological asset). Row crops, on the other hand, are seeded annually (i.e. wheat, canola, barley, corn, etc.).

The risk profile of permanent and row crops varies due to the fact that permanent crops rely on the biological asset’s survival through the winter months and potentially volatile weather conditions through the entire year, over the course of several years. Permanent crops also tend to be more labour-intensive than row crops, requiring greater inputs from a time and materials perspective.

The demand and end-market profile for row crops and permanent crops also tend to be different. Due to a shorter shelf life a larger percentage of permanent crops are sold into local markets. In addition, demand for permanent crops depends more on consumer preference than demand for row crops does. For example, certain varietals of berries and apples are more popular today than they were a decade ago as end consumers’ size and flavour preferences have changed. Conversely, demand for row crops is driven by a variety of macro-factors such as global production and supply levels for key crops such as wheat and soy, as well as continued global population growth. As row crops are more likely than permanent crops to be processed prior to human consumption – for example, the milling and refining of flour prior to its use in producing baked goods – consumer preferences generally have less of a direct impact on overall demand.

Permanent Crops in Canada

Canada has not historically been known as a major grower of permanent crops. While approximately 34% of all Canadian farms were reported as oilseed and grain farming operations, just 4% were fruit and tree nut farming operations per Statistics Canada’s 2021 Census of Agriculture(1).

However, we are seeing a wider range of cultivars now available as a result of favourable climate impacts on Canadian agriculture. Historically, harsh winters have limited permanent crop production in Canada as permanent crops, which are harvested from trees, shrubs or vines that do not need to be replanted each year, generally require milder conditions to protect the plant through the winter months.

Producers use the Canadian Plant Hardiness Zone Mapping system to predict winter survival rates for their crops and, in 2010, these maps were re-drawn to reflect changing climatic conditions. The  updated maps show a substantial northward migration of historical growing regions, and academic studies predict continued northward expansion of land suitable for growing warm weather permanent crops(2)(3). This change is exciting for Canadian farmers as permanent crops that have historically been grown in warmer, more southern parts of North America tend to command higher prices, which drive increased farm revenues and, ultimately, higher farmland values(4).

Bonnefield’s Experience

As previously mentioned, Bonnefield works with a number of leading permanent crop growers across Canada. We currently support apple, blueberry and raspberry producers through our alternative farmland financing solutions, and we continue to evaluate new varietals and growing regions in order to broaden our scope across the industry.

From our perspective, exposure to permanent crops offers valuable diversification that both de-risks our activities and provides us with exposure to farm operators with different and higher cash-flowing economic models than many traditional row croppers. While a single, standalone transaction in a permanent crop farm would likely demonstrate meaningful volatility and thus have a higher overall level of risk compared to a row crop operation, Bonnefield’s ability to complement exposure to permanent crops with a solid base of row crop investments creates an attractive risk/return profile for our holdings overall.

Additionally, our experience working with diversified permanent crop producers in Canada has further highlighted for us the benefit to being in Canada versus other parts of the globe. We all recognize that California has historically been a leading producer of high value permanent crops and a leading agricultural region. However, ongoing water shortages create significant strain on the industry and increasing heat units create risk for harsh growing conditions, and increased pest and disease prevalence. This increases the cost of operating in the region and enhances its volatility profile. Canada, on the other hand, has significant access to water resources and more moderate growing conditions. Our ability to grow varied permanent crop types is increasing which offers Canadian farm operators valuable optionality in their crop choices. Bonnefield is proud to be able to support these farmers throughout their business life cycle as we work towards the common goal of a strong and resilient Canadian agricultural industry.

About Bonnefield Financial

Bonnefield is the foremost provider of land-lease financing for farmers in Canada. Bonnefield is dedicated to preserving farmland for farming, and the firm partners with growth-oriented farmers to provide farmland leasing solutions to help them grow, reduce debt, and finance retirement and succession. The firm’s investors are individuals and institutional investors who are committed to the long term future of Canadian agriculture. www.bonnefield.com

 

Contributing Authors:

Christian Eisenhauer
Associate

Jaime Gentles, CFA
Senior Principal

Lauren Michell
Senior Principal

Sources:

(1) Statistics Canada. Table 32-10-0166-01 Farms classified by farm type, Census of Agriculture historical data
(2) Rochette, P. (2004) Climate Change and Winter Damage to Fruit Trees in Eastern Canada, Canadian Journal of Plant Science
(3) McKenney, D. (2014). Change and Evolution in the Plant Hardiness Zones of Canada, Oxford BioScience
(4) Mailvaganam, S. (2017) Area, Production and Farm Value of Specified Commercial Fruit Crops, Ontario 2015-2016, Ontario Ministry of Agriculture, Food and Rural Affairs
(5) (2021) Plant Hardiness Zones, Natural Resources Canada
(6) (2022) Canadian Plant Hardiness Zones, Upper Canada Growers

 

This document is for information purposes only and does not constitute an offer or solicitation to buy or sell any securities in any jurisdiction in which an offer or solicitation is not authorized. Any such offer is made only pursuant to relevant offering documents and subscription agreements. Bonnefield funds (the “Funds”) are currently only open to investors who meet certain eligibility requirements. The Funds will not be approved or disapproved by any securities regulatory authority. Prospective investors should rely solely on the Funds’ offering documents which outline the risk factors in making a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax consequences from an investment in the Funds. The Funds are intended for sophisticated investors who can accept the risks associated with such an investment including a substantial or complete loss of their investment.

Bonnefield Newsletter – Q2 2022

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Fertilizer Costs on the Rise

Surging agriculture input costs, especially the prices of fertilizer and fuel, have been top of mind for many Canadian farmers as they kick off the 2022 seeding season. Fertilizer prices reached multi-year highs in Q4 2021, and the emergent conflict in Ukraine in early 2022 has only exacerbated the already-strong upward pressure on market prices.

According to Bloomberg’s Green Markets Fertilizer Price Index – which tracks North American fertilizer prices over time – fertilizer prices have more than tripled since early 2020.(1)

Green Markets Fertilizer Price Index (Nov. 2019-May 2022)

Source: Green Markets, a Bloomberg LP Company

The global supply chain has been massively disrupted since the onset of the global COVID-19 pandemic, as logistical bottlenecks built up at the world’s largest shipping ports while nations experienced labour shortages due to lockdowns, and dislocations affected shipping routes, air cargo, ground transport lines, and railways(2).

As countries around the world began to loosen pandemic-related restrictions through late 2021 and 2022, commodity prices have soared as result of pent-up demand and supply constraints, with fuel prices rising significantly. In addition, several recent events have further restricted the supply of fertilizer chemicals, such as ammonium phosphates, nitrogen, potash, and urea, resulting in continued upward pressure on prices:

  • Extreme Weather in the U.S.: Hurricane Ida hit the U.S. Gulf Coast in September 2021, effectively shutting down production and causing serious shipping delays and logistical challenges in New Orleans – the U.S.’s main trading hub for fertilizers(3);
  • Chinese Export Policy: China, one of the world’s key suppliers of urea, sulphate, and phosphate, imposed new customs regulations in October 2021 that included enhanced inspection requirements and new export certificates on a wide variety of export products, including urea and ammonium nitrate, that effectively curbed the export of fertilizers from the country. This move followed a September 2021 circular from China’s National Development and Reform Commission, the country’s economic planning body, calling for stability in fertilizer prices in the domestic market(4);
  • Russian Trade Restrictions: Russia temporarily halted the export of fertilizers from the country in March 2022, citing a lack of logistical connectivity and lack of transport ship arrivals in Russian ports after commencing an attack on Ukraine that continues to occur as at time of writing. Notably, Russia is also a major producer of potash, phosphate, and nitrogen-based fertilizers, and many countries have implemented sanctions against Russia as well as tariffs on Russian goods(5).

Fertilizer exports from the U.S., China, and Russia have historically reached differing end markets, with the main destinations for U.S. fertilizers being Canada, Brazil, and Mexico, whereas some of the key markets for Chinese and Russian fertilizers include Brazil, India, Australia, and Estonia(6).  That said, the developments highlighted above collectively have led to an unprecedented strain on the global supply of fertilizer chemicals, thus impacting farmers and food prices across the world.

Global Fertilizer Trade

Fertilizers represent one of the world’s most heavily traded product types and, as shown below, the largest exporters in 2020 were Russia, China, and Canada

Largest Global Exporters of Fertilizers – Share of Global Export Trade Value by Country (2020)

Source: Observatory of Economic Complexity.

As noted, Russia and China have recently implemented increasingly isolationist-style export policies and, in 2020, the two countries accounted for ~23% of fertilizer exports globally(6). With these two major exporters limiting outbound trade of fertilizers, as well as the war in Ukraine and its trade implications (e.g., sanctions affecting the ability import of Russian goods), countries around the globe have directly felt the impact of supply limitations. Brazil and India stand to bear the brunt of the immediate supply shock, with Brazil and India having sourced ~26% and ~31% of their fertilizer imports from Russia and China collectively(6).

In Brazil’s case, there are concerns that the uncertainty and extremely elevated costs associated with sourcing fertilizer could hinder crop yields, resulting in a smaller harvest and even higher global food prices higher given the country’s importance in global crop markets. This is in addition to existing concerns around Brazil’s 2022 yields due to the possibility of extreme weather, like the severe drought experienced during the 2021 growing season(7). Brazilian farmers are considering various strategies of dealing with the shortage; SLC Agricola SA, one of the country’s largest producers of soybeans, corn, and cotton, is planning to reduce fertilizer usage by up to 25% in the coming year(8). On the supply side, major fertilizer producers are exploring ways to ramp up production, but doing so will take time and is thus not an immediate possibility. Canada’s largest potash producer, Nutrien, has committed to increasing its potash production by almost 1 million tonnes this year – the ramped-up production is expected in the second half of 2022(9), which is after the Northern Hemisphere’s seeding season. In summary, while major food and chemical producers alike are employing their best efforts to stabilize prices and ensure continuity of supply for both fertilizers and food, it could take months (or longer) before the impact of those efforts is seen.

A Canadian Perspective

Canada is the world’s third-largest exporter of fertilizers and has historically imported significantly less fertilizer in aggregate than it has exported(6). In 2020, the total trade value of fertilizers exported from Canada totalled approximately US$5.5 billion (C$7 billion(10)), whereas the total trade value of imported fertilizers was approximately US$1.4 billion (C$1.8 billion(10))(6). Notably, Canada is the largest global producer and exporter of potash, which refers to a group of chemicals and minerals that contain potassium (such as potassium chloride) that are most commonly used in fertilizers(11). Canada exported 22 million tonnes (“MT”) of potash in 2020, accounting for approximately 39% of the world’s total exports(11).

From this perspective, it may seem that Canadian farmers would be well-positioned to rely extensively on domestically produced fertilizer in operating their farms. However, it is important to note that successful crop growth requires a variety of different soil nutrients, some of which are not naturally occurring in soil and must be added through fertilizer application; as such, farmers cannot rely solely on Canadian-produced potash to grow their crops.

Canadian fertilizer production is very heavily concentrated toward potash, with 23 million MT having been produced between July 2020 and June 2021. In contrast, during the same period Canada produced approximately 4.8 million MT of ammonia, 4.5 million MT of urea (a form of nitrogen fertilizer), 1.5 million MT of urea ammonium nitrate (“UAN”), 1.3 million MT of ammonium sulphate, and less than 1 million MT each of ammonium nitrate and other fertilizer products(12).

We can also look to the Fertilizer Shipments Survey conducted by Statistics Canada on behalf of Agriculture and Agri-Food Canada for data on what types of fertilizer are shipped by manufacturers, wholesale distributors, and retailers to destinations within Canada to provide context on what types of fertilizers are used in Canadian farming(13). Between July 2020 and June 2021, the most-shipped fertilizer chemicals were urea (3.5 million MT of shipments within Canada reported), urea ammonium nitrate (1.4 million MT); and monoammonium phosphate (“MAP”; 1.5 million MT)(14). In addition to being a widely used fertilizer in Canada, MAP is water-soluble, contains the highest concentration of phosphorus of any common solid fertilizer, and has good storage and handling properties(15).

While Canada’s domestic production of both urea and UAN exceeded the total amount shipped to destinations within the country over that period, the same is not true for MAP(12)(13). In 2020, Brazil, Canada and Australia were the world’s largest importers of MAP, accounting for approximately 32%, 12%, and 7% of global trade value respectively, whereas the top exporters of MAP were Morocco (25% of global trade value), the U.S., (20%), China (19%), and Russia (16%)(6). The specific example of global MAP trade highlights that Canadian farmers do have to rely to some extent on importing certain fertilizer chemicals to generate strong crop yields while ensuring that the soil on their farmland remains in good health. Historically, the majority of Canada’s fertilizer imports have been sourced from the United States, with only a small fraction having been imported from Russia and China(6). With that said, Eastern Canada relies more heavily on Russian imported chemicals than does the rest of the country as there is essentially no local production of nitrogen, phosphorus, or potash in the region(16).

Fertilizer supply contracts are typically put in place by larger, more sophisticated Canadian farmers well in advance to ensure access to supply and allow for long lead times associated with production and shipping, with many of the contracts for 2022 having been established in 2021. That said, the 35% tariff on virtually all Russian imports implemented by the Canadian government in March 2022 went into effect as shipments were already en route to Canada from overseas destinations including Russia(10), which has resulted wholesalers and importers passing the tariff-related costs along to the end purchasers, including farmers(17).

As a result, Canadian farmers are currently in a position where they are reassessing whether they can apply smaller amounts of fertilizer and still achieve strong crop yields, or if alternatives (such as manure) present a viable option to minimize costs. Another unique aspect of Canadian farming is that many producers have some degree of optionality as to what crops they plant. For example, if the fertilizer specifically required to grow corn is not readily available, growers are able to switch to a crop that may need less fertilizer, or to a crop requiring fertilizer that their dealer can reliably source.

While input costs are on the rise, so too are the food commodity prices that drive farm incomes. Canadian farm cash receipts came in at an all-time high in 2021, marking a 9% increase over 2020, due primarily to record commodity prices(18). The strong growth in 2021 farm cash receipts was on the back of an already strong year in 2020, which had seen a 15% increase over the previous year(12). Higher revenue as result of food prices largely keeping pace with increasing input costs has provided some comfort for Canadian farmers with respect to their abilities to tolerate those cost increases over at least the near- to mid-term.

How Does This Affect Bonnefield’s Farmers?

Bonnefield’s farmers, who are progressive, well-established operators and have strong community ties, continue to be agile in their handling of the uncertainty around supply availability and costs. Many of our farmer tenants were very proactive ahead of the 2022 growing season, purchasing fertilizer well ahead of time. In addition, many of our farmers purchase seeds that already contain fertilizer which provides some flexibility as to the timing of fertilizer application should shipping delays occur. This are just some of the many examples of the resilience and business savvy that our farmers have demonstrated over the years.

Our team has heard in recent weeks that farmers’ main concerns aside from input costs remain primarily local for the time being and include domestic supply chain issues such as rail strikes, rising interest rates, and the possibility of unfavourable weather. The continued strength in food commodity prices has led to optimism that 2022 will be another year of strong farm incomes, which are a key driver of Canadian farmland values. Bonnefield offers our farmers long-term leases that are not immediately impacted by rising interest rates, and we act as a supportive partner to our farmers by investing in property improvements that might otherwise be delayed or forgone as result of other unforeseen expenses that strain farmers’ cash positions. As we have since our inception over a decade ago, Bonnefield remains committed to supporting our farmers through all conditions as a true partner in Canadian agriculture.

About Bonnefield Financial

Bonnefield is the foremost provider of land-lease financing for farmers in Canada. Bonnefield is dedicated to preserving farmland for farming, and the firm partners with growth-oriented farmers to provide farmland leasing solutions to help them grow, reduce debt, and finance retirement and succession. The firm’s investors are individuals and institutional investors who are committed to the long term future of Canadian agriculture. www.bonnefield.com

 

Contributing Authors:

Bhushan Chiniah
Senior Principal

Cameron deGooyer
Prinicpal

Lauren Michell
Senior Principal

Sources:

(1) Green Markets, A Bloomberg Company – Green Markets Weekly North America Fertilizer Price Index (May 2022)
(2) Forbes Magazine – No End In Sight For The COVID-Led Global Supply Chain Disruption (September 3, 2021)
(3) Bloomberg News – U.S. Fertilizer Prices Soar as Storms Roil Industry Hub (September 15, 2021)
(4) Bloomberg News – China’s Curbs on Fertilizer Exports to Worsen Global Price Shock (October 19, 2021); Government of China – Notice of the National Development and Reform Commission and other departments on ensuring the supply and price of domestic chemical fertilizers for a period of time in the future (September 22, 2021)
(5) Reuters News – Russian Ministry Recommends Fertiliser Producers Halt Exports (March 4, 2022)
(6) Observatory of Economic Complexity Data Visualization Tool – Fertilizers (retrieved May 2022; data reported as of 2020, latest available at time of writing)
(7) NASA Earth Observatory – Brazil Battered by Drought (June 17, 2021)
(8) BNN Bloomberg – Major Brazil Soybean Grower to Cut Fertilizer Use Amid Shortage (April 28, 2022)
(9) Financial Post – Nutrien to Boost Potash Production by 1 million Tonnes Amid Worries about Food Security (March 17, 2022)
(10) Canadian dollar equivalent calculated based on the prevailing CAD/USD spot foreign exchange rate of 1.2808 as at December 31, 2020 per the Bank of Canada
(11) Government of Canada; Natural Resources Canada – Potash Facts (February 3, 2022)
(12) Statistics Canada – Table 32-10-0037-01, Canadian Fertilizer Production by Product Type and Fertilizer Year, Cumulative Data (x 1,000); data for the period between July 2020 and June 2021.
(13) Statistics Canada – Surveys and Statistical Programs, Fertilizer Shipments Survey; Detailed Information for the Second Quarter of the Fertilizer Year 2021/2022
(14) Statistics Canada – Table 32-10-0038-01, Fertilizer Shipments to Canadian Agriculture and Export Markets by Product Type and Fertilizer Year, Cumulative Data (x 1,000); data for the period between July 2020 and June 2021.
(15) The Mosaic Company – Monoammonium Phosphate (retrieved May 2022)
(16) Toronto Star – Island Farmers Told Ukraine War Threatens Canada’s Food Supply Chain (April 6, 2022)
(17) Global News – Critics Say Federal Support for Canadian Farmers puts “Water on a Grease Fire” (May 6, 2022)
(18) Statistics Canada – Table 32-10-0045-01, Farm Cash Receipts, annual (x 1,000). Data noted reflects the year-over-year increase in Total Crop Receipts.

 

This document is for information purposes only and does not constitute an offer or solicitation to buy or sell any securities in any jurisdiction in which an offer or solicitation is not authorized. Any such offer is made only pursuant to relevant offering documents and subscription agreements. Bonnefield funds (the “Funds”) are currently only open to investors who meet certain eligibility requirements. The Funds will not be approved or disapproved by any securities regulatory authority. Prospective investors should rely solely on the Funds’ offering documents which outline the risk factors in making a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax consequences from an investment in the Funds. The Funds are intended for sophisticated investors who can accept the risks associated with such an investment including a substantial or complete loss of their investment.

Bonnefield Newsletter – Q1 2022

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Interest Rate Increases on the Horizon

We are seeing it at the grocery store and the gas pump – prices are rising. The topic of inflation is receiving a lot of attention as observers wait to see how governments will act to address those rising prices. With central banks around the world either considering or already increasing interest rates in 2022 to combat inflation, we are reminded that the prolonged low interest rate environment that has prevailed in Canada for more than a decade is atypical in the context of long-term monetary policy and is unlikely to persist  indefinitely. In January 2022, Bank of Canada Governor Tiff Macklem noted in an interview during the same week that, “the message is pretty clear. We’re on a rising path.” (1).

More recently, on March 2nd 2022, Bank of Canada’s target for the overnight lending rate (a key benchmark for lending rates in Canada) was raised to 0.50% from 0.25% (2), marking the first time rates have changed since the COVID-19 pandemic in early 2020. In an accompanying statement, the Bank of Canada noted the emergence of conflict in Ukraine has led to increased uncertainty in global markets and has also caused prices for oil and other commodities to rise sharply in recent weeks, which will increase inflationary pressure above what was initially anticipated in January 2022 (2).

As a source of alternative financing for Canadian farmers, and a manager of a diversified portfolio of Canadian farmland, Bonnefield is often asked what impact rising rates may have on farm operators and farmland values in Canada. We’ve provided some thoughts on this complex relationship in the following sections.

A Recent History of Inflation and Interest Rates in Canada

As of February 2022, the Canadian Consumer Price Index (“CPI”; index of all goods including gasoline) rose again to 5.7%, remaining above the Bank of Canada’s target normalized range of 1-3% reaching its highest level since August 1991 (3). Generally, prices begin to increase when the demand for goods and services outpaces the supply of those goods and services in the economy. Price inflation in turn reduces the purchasing power of individuals, which can have a significant impact on the overall standard of living.

When faced with increasing levels of price inflation, central banks have few policy options to cool price increases and to alleviate the financial strain caused by elevated prices for goods and services. A gradual increase in key lending rates, such as the Bank of Canada’s target overnight rate, can help to reduce spending, thus tempering the demand side of the equation and slowly reducing inflationary pressures. Despite a now-lengthy cycle of low rates and the continued effects of the COVID-19 pandemic, it is very apparent that increased interest rates are on the horizon. When asked about the timing of target rate hikes, Tiff Macklem responded to reporters in January 2022, “How far and how fast? Those are decisions we’ll take at each meeting, depending on economic developments, depending on our outlook for inflation, and what we judge is needed to bring inflation back to target.” (1)

Canadian Consumer Price Index (CPI) Monthly 12-Month Percentage Change Data (2016-2022)

Source: Bank of Canada, Statistics Canada.

Interest Rates on Farm Balance Sheets

From a balance sheet perspective, while the principal amount of a loan is not directly affected by a change in borrowing costs, the total amount of capital that must be repaid to lenders over time increases when rates rise. In turn, this increases the overall financial riskiness of farmers’ balance sheets and leads operators to carefully consider whether certain expenditures and investments are necessary.

From a profitability standpoint, the rates charged by financial institutions on traditional loans can represent a substantial expense for farm operators that primarily use debt to fund their operations, much like many other businesses. Interest rate increases are typically used by central banks as a tool to help temper rising inflation, and inflation also causes the cost of key inputs for farming operations (such as fertilizer, seeds, fuel, and equipment) to rise. Combined, an increase in borrowing rates coupled with elevated input costs can put significant pressure on farm profitability. However, as inflationary pressure also affects the market prices for key food commodities, some of that input cost pressure can be offset by increases in farm revenues and incomes.

Interest Rates and Farmland Values

Given the relationship between inflation and interest rates, and farmland’s demonstrated inflation-hedging  characteristics, Bonnefield’s investment thesis is that in times of high inflation, Canadian farmland values perform strongly. Historically, farm incomes have increased during inflationary periods and strong farm incomes lead to rising farmland prices.

When valuing farmland, one of the most widely accepted approaches to establishing property values is to divide the rental income that can be generated by a property by a discount rate, which is based on an adjusted “risk-free” interest rate (often a Government of Canada bond yield or, more recently, the Canadian Overnight Repo Rate Average, “CORRA”). This equation, referred to as the capitalization method of valuation, effectively assesses the present value of potential future income generated by a property. Interest rates are a central part of the valuation equation and a higher discount rate (denominator) with no change to the rental income component would decrease the resulting value.

With that said, farm incomes are the single strongest direct drivers of farmland values, and the momentum in market prices for key commodities observed in 2021, and so far in 2022, suggests that incomes will remain healthy in the near-term. Further, while interest rate increases are coming more clearly into view, the overall cost of borrowing is still low compared to historic levels.

Over the years, Bonnefield has observed that when lending is relatively inexpensive and farm incomes are strong, farm operators have been eager to borrow funds to acquire additional land. In 2021, we also saw a high level of transaction activity in the market for Canadian farmland driven by both farmers having ample cash on-hand, as well as pent-up demand after relatively depressed activity in 2020 from the COVID-19 pandemic.

How Could Rising Interest Rates Impact Bonnefield’s Farmland Holdings?

Bonnefield’s core strategy is to invest in a diversified portfolio of prime Canadian farmland on a long-term, fully unlevered basis. We expect that rising interest rates will have a minimal impact on the value of farmland held by our investment partnerships or on the funds’ profitability. Further, as the leading provider of sale leaseback financing to Canadian farmers, Bonnefield’s partnership-based approach to providing an alternative source of capital to the agricultural community has helped many of our farm partners to strengthen their balance sheets by reducing debt. As such, we anticipate that our farmers will weather rising interest rates well. As always, we remain prepared to assist strong Canadian farmers who may have become over-levered by entering into long-term sale leaseback arrangements that allow operators to free up capital, clean up and stabilize their balance sheets, and invest in their businesses.

Having been a trusted partner of farm operators for over 12 years, Bonnefield has seen a number of economic conditions. One thing we know is that farmers are creative and resilient, able to adjust to a wide variety of market conditions in order to maximize the value of their operations. We are confident that this period of inflation and increased interest rates will prove to be no different and Bonnefield is available to support these operators through economic cycles.

About Bonnefield Financial

Bonnefield is the foremost provider of land-lease financing for farmers in Canada. Bonnefield is dedicated to preserving farmland for farming, and the firm partners with growth-oriented farmers to provide farmland leasing solutions to help them grow, reduce debt, and finance retirement and succession. The firm’s investors are individuals and institutional investors who are committed to the long term future of Canadian agriculture. www.bonnefield.com

 

Contributing Authors:

Andrea Gruza
Managing Partner

Lauren Michell
Senior Principal

Sources:

(1) Reuters News, January 26th, 2022
(2) Bank of Canada, March 2nd, 2022
(3) Statistics Canada, March 16th, 2022

 

This document is for information purposes only and does not constitute an offer or solicitation to buy or sell any securities in any jurisdiction in which an offer or solicitation is not authorized. Any such offer is made only pursuant to relevant offering documents and subscription agreements. Bonnefield funds (the “Funds”) are currently only open to investors who meet certain eligibility requirements. The Funds will not be approved or disapproved by any securities regulatory authority. Prospective investors should rely solely on the Funds’ offering documents which outline the risk factors in making a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax consequences from an investment in the Funds. The Funds are intended for sophisticated investors who can accept the risks associated with such an investment including a substantial or complete loss of their investment.

Bonnefield Newsletter – Q4 2021

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Canadian Farmland & Inflation

It is impossible to read the news these days without seeing inflation-related headlines. Canadian inflation rates have generally been low and stable in recent years. However, recent data puts inflation at the forefront of investors’ minds. As countries around the world begin to emerge from the wide-scale restrictions and shutdowns implemented in early 2020 as a result of the COVID-19 pandemic, inflation numbers have steadily crept up with the latest year-over-year Canadian Consumer Price Index (CPI, all items including gasoline; a key inflation measure) coming in at 4.7% for October 2021 – the highest rate since 2003(1).

This is certainly notable, as the Bank of Canada typically targets inflation of 2% over the medium term with its target range being 1-3%(2). In recent years, inflation has hovered at the low end of that range.

Canadian Consumer Price Index (CPI), Monthly 12-Month Percentage Change Data (2016-2021)


Source: Statistics Canada, October 2021

As inflation creeps up, many investors ask what can be done to preserve the long-term value of their assets. Gold is often cited as an asset which provides inflation-hedging characteristics but farmland is increasingly being recognized as having similar characteristics while experiencing less volatility and historical downside protection(3).

Canadian Farmland as an Inflation Hedge

Canadian farmland values have historically demonstrated a strong positive correlation to inflation, as measured by the Canadian Consumer Price Index (CPI), with the relationship being particularly notable in years of high inflation. Between 1952 and 2020, when Canadian CPI rose between 1% and 3% year-over-year, the average year-over-year change in Canadian farmland values was approximately 7%. However, when Canadian CPI increased 5% or more, the average change in Canadian farmland values year-over-year was significantly higher at approximately 16%(4).

This relationship between inflation and farmland values can largely be explained by increasing commodity prices and the dynamic created by increasing global demand for food, driven by continued global population growth and an inherently limited supply of arable land. Simply put, commodity inflation generally increases farm incomes, and as farm incomes increase, so too do farmland values.

We note that in the late 1980s, farmland prices did not increase in line with inflation due to some unique features of the time period. Total absolute debt levels in the Canadian agricultural sector increased at a compound annual growth rate of approximately 15% between 1973 and 1981(5) as farmers took on debt to fund real estate purchases as land values continued to rise. Then, between the late 1970s and early 1980s, we saw rapidly increasing, high interest rates to control inflation, with the Bank Rate reaching as high as 21% in August 1981 (compared to approximately 10% in August 1980)(6). The high interest rates of the early 1980s affected farmland values by decreasing the affordability of traditional loans, including agricultural financing which resulted in a wave of farmers (particularly in Western Canada) entering into insolvency.

The unique confluence of factors that led to a compression of farmland values in the mid- to late 1980s has not recurred since. While there has been some fluctuation, total Canadian farm sector debt levels have generally grown at much more modest levels from the early 1990s onward(7), and interest rates have remained at historic low levels for over a decade.

Historical Canadian CPI and Canadian Farmland Values (1952-2020)


Source: Statistics Canada.
Note: Data represents annual changes from December 1952 – December 2020 in Canadian farmland values and annual change in Canadian CPI. Farmland year over year return data represents land values only.

The current environment seems to be playing out differently compared to the 1980s, with guidance from most central banks remaining accommodative. In its most recent Monetary Policy Report, the Bank of Canada indicated that it expects CPI inflation to ease in 2022 as pandemic-related disruptions to supply gradually begin to fade[7], and appears to be committed to maintaining the policy rate at the lower end to continue stimulating the economy(8).

Finally, we anticipate continued strength in market prices for Canada’s key agricultural commodities (wheat, soy, canola, and corn).

Key Agricultural Commodity Prices (2015-2021)

Source: Bank of Canada, Bloomberg News, Grain Farmers of Ontario, ICE Data, OMAFRA.

Strong market prices for these commodities, like the multi-year highs observed in 2021, can translate directly into increased farm incomes that leave farm operators with more cash on-hand and contribute to strong activity in the Canadian farmland market.

Recent Trends in Farmland Values

Farmland is a long-term asset class with limited transaction windows as farmers typically do not buy or sell farmland between seeding in the spring and harvest in late fall. As such, we typically expect values to lag broad market conditions and do not look to quarterly updates as fully reflective of future performance. With that said, as an active farmland owner across Canada, Bonnefield is seeing high and increasing demand for land in some premium farmland regions, supporting strong farmland values.

Farm Credit Canada (FCC) reported in late September 2021 that, despite drought conditions that affected Western Canada during the summer months and a relatively slow overall economic recovery from the COVID-19 pandemic, strength in key commodity prices and the prolonged low interest rate environment continued to support both strong demand and increased prices for Canadian farmland. FCC reported an average year-over-year increase in Canadian farmland values across all provinces of 6.1% as of July 2021, with a notable 15.4% year-over-year increase in farmland values in Ontario, which is home to many of the country’s prime farming regions(9).

Bonnefield’s internal analysis based on third-party appraisals of our properties as well as interactions with industry stakeholders support the themes highlighted in the FCC report. In Western Canada, appraisers noted property value increases of 3-10% in Manitoba, 5-10% in Saskatchewan, and 3-6% for irrigated farmland in Alberta, year-to-date in 2021. In Eastern Canada, we have seen increases in appraised values of between 2-5% in the Maritimes and Northern, Central, and Eastern Ontario. Like data from FCC, our own experience supports the view that high demand among farm operators for land in Southwestern Ontario is resulting in increases to farmland values of upwards of 10%. We note that the overwhelming majority of transactions that we see in the Canadian market occur farmer-to-farmer with prices reflecting farm operator sentiments for future farm incomes and land value appreciation.

Unlike gold, Canadian farmland values appear to be driven by real returns that drive farm profitability. This supports farmland’s role as an attractive asset class for investors looking to benefit from positive long-term value appreciation that outpaces inflation.

About Bonnefield Financial

Bonnefield is the foremost provider of land-lease financing for farmers in Canada. Bonnefield is dedicated to preserving farmland for farming, and the firm partners with growth-oriented farmers to provide farmland leasing solutions to help them grow, reduce debt, and finance retirement and succession. The firm’s investors are individuals and institutional investors who are committed to the long term future of Canadian agriculture. www.bonnefield.com

 

Contributing Authors:

Bhushan Chiniah
Director, Portfolio Management

Lauren Michell
Director, Capital Markets

Sources:

(1) Statistics Canada, November 2021
(2) Bank of Canada
(3) The Conversation, March 2021
(4) Statistics Canada, May 2021 & October 2021
(5) Statistics Canada, October 2021
(6) Statistics Canada, October 2021
(7) Bank of Canada, October 2021
(8) Bank of Canada, September 2021
(9) Farm Credit Canada, July 2021

 

This document is for information purposes only and does not constitute an offer or solicitation to buy or sell any securities in any jurisdiction in which an offer or solicitation is not authorized. Any such offer is made only pursuant to relevant offering documents and subscription agreements. Bonnefield funds (the “Funds”) are currently only open to investors who meet certain eligibility requirements. The Funds will not be approved or disapproved by any securities regulatory authority. Prospective investors should rely solely on the Funds’ offering documents which outline the risk factors in making a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax consequences from an investment in the Funds. The Funds are intended for sophisticated investors who can accept the risks associated with such an investment including a substantial or complete loss of their investment.