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.

Bonnefield Newsletter – Q3 2021

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An Increasing Focus on AgTech

Those who follow the agricultural industry will be aware of the increasing attention that agriculture technology (AgTech) firms are receiving, and with it, significant investment dollars. In fact, one of Canada’s largest institutional investors, the Ontario Teachers’ Pension Plan (OTPP) recently made its first AgTech investment through its venture capital arm, Teachers’ Innovation Platform. With the spotlight on the AgTech industry, we wanted to review the role that technology has played in agriculture and explore how ongoing innovation can drive industry performance through the lens of a farmland owner / investor.

Technology in Agriculture: A Driver of Productivity & Farmland Values

Innovation and technological advancements in agriculture have been around for as long as farming itself. The search for increased efficiency to meet growing consumer demands is not going away and significant technological advancements have been made in the agriculture industry over the past several decades. Today, technologies such as GPS Guidance for farming equipment and Site-Specific Crop Management practices allow farmers to be more precise and efficient in crop production. As a farmland owner, this raises a key question: how do technological advancements affect producer income and subsequently, farmland values?

For a conventional crop producer, farm income is a function of underlying commodity prices, expected crop yields, and the cost of crop production. Commodity prices are determined by the global market and, while producers can use certain marketing strategies to help reduce risk, individual producers cannot ultimately influence commodity prices. As such, farm operators looking to improve productivity, and thus profitability, can be better served by finding ways to boost crop yields and lower production costs to increase income.

Since farm incomes are a key driver of farmland value, the result of sustainable increases in overall farm profitability can be seen through appreciation of farmland values, making new advancement in AgTech interesting for not only the farm operator but the farmland investor as well.

Examples of AgTech Areas of Focus
Plant Breeding

While longer growing seasons resulting from climate change certainly play a role in increasing crop yields in certain geographies, advances in agricultural technology are also widely acknowledged as being a major driver of improved yields. Notably, there have been significant advancements in plant science and breeding over the past 30 years. Varieties of certain key crops, such as corn, soybeans, and canola can be engineered to mature over a specific number of growing days to accommodate local growing conditions and allow farmers to plan for crop maturity at desired times, or to be more resilient against certain diseases. This allows farmers to select and seed optimal plant varieties that are best suited to their location and the characteristics of their land.

Precision Agriculture

Precision agriculture (also referred to as Site Specific Crop Management) uses aerial and satellite imagery, weather data, and crop health indicators to enable farmers to be more exact in the planting of seeds and the application of fertilizer. For example, variable-rate fertilizer application allows producers to apply the ideal amount of fertilizer to different regions of a single field to maximize crop health and avoid unnecessary overuse of fertilizer. Beyond increasing crop yields, this technology also has considerable benefits from an environmental perspective as it reduces the overall amount of fertilizer required thus preserving supply and limiting unnecessary run-off. Other technologies, such as GPS guidance, have allowed for more accurate planting of crops and fewer wasted acres.

Larger, More Efficient Machinery

Technological advancements have also created significant cost savings in agriculture, and farming operations are larger and more efficient than ever. This is made possible by new technologies such as the large machines that allow producers to plant, fertilize, and harvest greater acreage in less time. Today, large tractors with planting implements spanning over 60 feet in width can cover over 300 acres in a single day, whereas the smaller 15-foot no-till drills of the past would have taken more than four days to cover the same amount of land.

What This Means for Farmland Values

Technological advancements have helped producers to increase yields, reduce costs and have ultimately had a positive impact on farm income and farmland values. As noted in our Q1 newsletter, there has been much excitement in the Canadian farmland market in the first half of 2021, attributable to commodity prices rising to multi-year highs, low transactional activity in 2020, and the prolonged low interest rate environment. However, these factors are cyclical and can shift in a relatively short period of time. In contrast, activities by farm operators and the agriculture sector as a whole, to develop and implement new technologies, increase yields, manage costs, and reduce their environmental footprints are something we believe will support the ongoing capital appreciation of Canadian farmland.

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:

Mitchell King
Associate, Investment Management

Lauren Michell
Director, Capital Markets

The Benefits of Geographic Diversification in Farmland Investing

We are often asked what sets Bonnefield apart as a leading Canadian farmland manager. While there are many qualities that come to mind (our strong 10+ year track record, institutional quality reporting and administration, and our sale-leaseback model that attracts leading farm partners, just to name a few), diversification is one of the most obvious.

Geographic diversification has been a central theme in Bonnefield’s investment thesis since the firm’s inception over a decade ago. As Canada’s leading farmland investment manager, we invest in more Canadian provinces than any other Canadian agriculture-focused asset manager. We apply a granular approach to diversification, investing in over 30 unique growing regions across the country, and ensuring portfolio diversification across multiple climatic regions, crop types and tenant relationships.

 

Assessing Risk & Return: Sharpe Ratio Analysis

To illustrate the value of diversification in an investment portfolio, we conducted a Sharpe ratio analysis(1) using historical Canadian farmland values between 1985-2019. This type of analysis is a staple of portfolio management theory and a relative measure of the trade-off between risk and return. A higher Sharpe ratio typically suggests a higher potential return per unit of risk taken on and therefore, many investors focus on improving / maximizing the Sharpe ratio of their portfolios.

 

Risk-Return Profile: Diversified Canadian Farmland in a Portfolio (Sharpe Ratio Analysis)(2)

The first takeaway from this analysis is the positive impact on the Sharpe Ratio as a result of increasing the allocation to Canadian farmland (regardless of its diversification) as opposed to holding only publicly traded equity. With its historically stable return profile, Canadian farmland reduces the volatility of returns and, therefore, improves the Sharpe ratio.

The second takeaway is the relative benefit of holding a portfolio with greater diversification amongst its farmland holdings. As seen in the chart above, portfolios consisting of farmland diversified across most provinces in Canada (Bonnefield currently invests in BC, AB, SK, MB, ON, NB, and NS) demonstrate higher Sharpe ratios, indicative of a favourable risk‐return trade-off, compared to those with farmland limited to only the prairie provinces. This illustrates the relative benefits of maximizing potential diversification within the farmland portfolio.

As noted in our Q1 2020 Newsletter, the Canadian agricultural community has been optimistic since the beginning of 2021 given:

  • The backdrop of increased feed demand from China;
  • The reduced crop supply from Brazil and Argentina; and
  • The Russian export tax on wheat.

Combined with a prolonged period of low interest rates, relatively low transactional activity for Canadian farmland in 2020, and the current multi-year high commodity prices for key crops, we continue to believe that Canadian farmland values are poised for an exciting period of strong growth.

As investors explore the benefits of Canadian farmland within their investment portfolios, we encourage them to consider the relative value of exposure to a well-diversified farmland portfolio to minimize volatility and maximize your potential risk-adjusted returns.

 

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

 

 

Source: Farm Credit Canada, Statistics Canada, Yahoo Finance

(1) Sharpe ratios represent a relative measure potential returns compared to potential risk of an investment, and are calculated by dividing i) the excess return above a selected risk-free rate (i.e., average historical rate of return for an asset/investment less a risk-free rate such as the prevailing rate for a Government or Treasury-issued instrument) by ii) the standard deviation of those historical returns.

(2) Analysis contemplates hypothetical portfolios balanced between i) Canadian equities (S&P TSX index) and ii) Statistics Canada farmland values (weighted equally between selected provinces; Bonnefield’s investment provinces include BC, AB, SK, MB, ON, NS, and NB), between 1985 and 2019.

(3) Noted Sharpe ratios assume 100% allocation of a hypothetical portfolio to each of i) Canadian farmland in Bonnefield’s investment provinces, ii) Canadian farmland in AB/SK/MB only, and iii) Canadian equities (S&P TSX index).

ESG, Climate Change, and the Lure of Farmland Investing

Over the past decade, we have seen increased interest among the investment community in agriculture and farmland as an asset class. Not only are large, sophisticated, institutional investors across the globe evaluating (or already invest in) farmland and agricultural investments, so too, are increasing numbers of non-institutional investors.

Click here to read an article by Bonnefield’s Andrea Gruza that explores how farmland investments provide investors with a diversifying asset with strong ESG characteristics, climate change hedging capabilities and potential to support a move towards a net zero investment portfolio.

(Original article published in the spring 2021 edition of Radius European Investment Journal.)

Bonnefield Newsletter – Q1 2021

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Canadian Farmland Poised For Growth

The mood in much of the Canadian agricultural community has been positive lately. Following several years of depressed agricultural commodity prices, there is a significant rebound in prices across multiple commodities. The last time we saw similar commodity price growth, combined with low interest rates was in 2011 which marked the beginning of several years of double digit increases in farmland values. While there is no guarantee that we will have the same outcome, the signs are very encouraging.

 

1. Increased Demand from China

The catalyst for this rebound has been a massive increase from China for feed, as it rebuilds its hog herds following the devastating impacts of the 2018 swine flu that resulted in a ~60% reduction of the country’s breeding sows by the second half of 2019 (1). We expect that the increase in demand from China should be longer lasting as it will likely take two to three years to rebuild the pig herds back to pre swine flu levels.

 

2. Severe Drought in South America

A severe drought in South America since last October drastically reduced supply from Brazil and Argentina – two major corn and soybean producers. While this offers short-term support to pricing, recent rains in the region should provide positive conditions for the current harvest.

 

3. Russian Export Tax on Wheat

Finally, prices are also seeing an impact from a recently announced export tax that Russia placed on its wheat producers in an attempt to reign in recent domestic food price inflation resulting from COVID-19. In 2015, this had a major impact on global wheat supply. We expect a similar impact this year with wheat prices increasing materially.

 

 

                                                                                                             Sources: OMAFRA, Grain Farmers of Ontario

 

Commodity Price Impact on Farmland Values

Given the magnitude of recent commodity price increases we took a look back to see what effect commodity prices have had on farmland values historically. Two notable characteristics emerge from this analysis.

 

1. Significant upside potential for farmland values resulting from a combination of high commodity prices and low borrowing costs.

This creates a favourable environment whereby farm profitability increases, leaving farm operators with more cash in their pockets. The combination of greater cash on hand and low borrowing costs facilitates an increase in farmland acquisitions. Having this combination of factors is important because, as we saw in 2007, an increase in commodity prices against the backdrop of high borrowing costs, did not see meaningful farmland value increases.

 

2. Farmland values have had historical downside protection through several years of significant commodity price decreases.

Not only have farmland values failed to track the declines in commodity pricing, they have actually continued to increase in value (albeit at a slower rate in years of significant commodity price declines.) This trend can be attributed to the favourable supply and demand dynamics that exist due to a limited supply of global arable farmland with an increasing demand for food. From 1961 to 2016 there was a 48% decline in hectares of arable land per person (2). This is attributable both to a growing population as well as a decline in total arable land from desertification and urbanization.

It is evident, based on historical analysis, that commodity prices can influence farmland values through enhanced farm profitability. Based on our experience of the last two decades, that influence is far more significant on the upside than it is on the downside.

 

What This Means For Farmland Values

While there is always potential for unforeseen events to arise, a review of current market conditions provides support for a positive outlook on farm prices. The combination of increasing commodity prices and low borrowing costs shows the potential for a return to farmland valuations reminiscent of the early 2010’s.

 

 

A Note on the Analysis

We focused our analysis on Ontario using the three main cash crops grown in the province: wheat, soybeans, and corn. According to data from the Ontario Ministry of Agriculture, Food and Rural Affairs (“OMAFRA”), these three crops represent roughly 71% of the total cropland in Ontario based on seeded acres which makes this a meaningful, albeit simplifying, analysis for evaluating general trends in the province. In addition to commodity prices, we have also included the prime rate as a proxy for farmers’ borrowing costs, as this also has a significant influence on land values. The graph above illustrates the annual percentage change in commodity prices and Ontario farmland values against the prime rate. To capture historical commodity prices, we used a hypothetical commodity price index comprised of 40% soybeans, 40% corn and 20% wheat. This is representative of a typical five-year rotation for an Ontario farmer of two years planted to corn, two years planted to soybeans and one year to wheat.

 

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:

Jaime Gentles
Director, Investment Management

Jeff McAllister
Vice President Investments

Andrea Gruza
Vice President Capital Markets
(1)www.reuters.com/article/china-swinefever-pigs-idUSL4N2FC2RL
(2) – World bank. https://data.worldbank.org/indicator/AG.LND.ARBL.HA.PC

Bonnefield’s Andrea Gruza on “Between the Rows” Podcast

Bonnefield’s Andrea Gruza on “Between the Rows” Podcast

Bonnefield’s Vice President of Capital Markets Andrea Gruza joined host Robert Arnason on the Between the Rows podcast recently to discuss ESG Investing and its relevance for Canada’s agricultural sector.

“ESG investing isn’t necessarily a widely agreed-upon term and the definitions and parameters around ESG in the investing community really are evolving. It stands for environmental, social and governance factors. The term certainly has become pretty widely recognized and adopted across multiple industries over the last few years, not just within finance, and you’re hearing [it] from the majority of large sophisticated investors across the globe.

“I think everybody’s situation is unique and I can’t speak [for] all farmers across the country, but I don’t think ESG is [just] a trend. I can imagine the terminology around ESG evolving and the set of considerations for each industry changing over time as it better reflects what’s happening in the world around us. I think that as we learn more, we’re more aware of what things we should be thinking about when we evaluate how a business is performing.

Listen to the podcast and full interview below, or by clicking here.

PART VIII: Population and Food Demand: Growing Appetites and Shrinking Fields

Note: This is the final article in an eight-part series published by GAI News that examines eight existing trends set to alter the structure of our global food system. Be sure to read the first seven articles here: Part I , Part II, Part III , Part IV  , Part V , Part VI  and Part VII.

“Economic growth won’t feed a growing population living on this finite planet.”– Phil Harding

Concerns about population growth have circulated through discourse since ancient times. Philosophers, such as Plato and Aristotle, questioned the sizes of their respective communities and their capacity to nourish additional people when the world had a population of about 162 million [i]. Writers from ancient Carthage had dwelled on population growth when global numbers had reached 200 million people, who were noted as “burdensome to the world which can hardly support us”. As we approach a global population that is fifty times larger than in Plato’s time, the same concerns come to light, albeit with different information.

Productivity improvements have typically remained one step ahead of food demand, allowing the world’s population to grow geometrically over the past two hundred years. Although the population continues to grow, crop yield productivity improvements have slowed considerably in the past several decades[ii].

While the preceding seven articles of our ‘Agriculture in a Changing Climate and Society’ series focus on secular trends affecting the supply side of the global agri-food system, this final piece delves into the demand side. A multitude of evidence points to a singular fact: nutritional demand is increasing rapidly on a global basis[iii]. Some experts question the world’s collective ability to nourish this demand in the long term[iv], while others speculate that new technologies will need to be developed and implemented in order to address the supply/demand imbalance. The World Resource Institute (WRI) indicates that while fulfilling nutrient requirements for an additional 2.4 billion people in the next thirty years is achievable, the global agri-food system will have to undergo significant changes in order to adapt[v].

As external factors, such as urbanization, water scarcity and pollinator loss, are set to reduce global food supply[vi], the earth’s population is projected to continue increasing for the next century[vii]. Sub-Saharan Africa is set to foster most of the world’s population growth, an area that is likely to become less suitable for crop production over the next century. In addition to increasing populations, a growing middle class will naturally continue to increase the global appetite for meat, dairy, and high-value fruit crops. These products are characterized by high production and overhead costs compared to other commodities of similar nutrient profiles. While this consumption shift is positive from the perspective of social mobility and will likely foster a period of robust demand growth for farmers in the short-medium term, the increased demand will come at cost to the environment.

Some estimate that we will have to increase arable land by 593 million hectares (more than twenty-four times the size of the United Kingdom) between 2010 and 2050 in order to bridge the gap needed to meet increasing food demands[viii]. The greatest concern lies in our collective food security in conjunction with global environmental sustainability. The socio-ecological trade-offs that arise from developing forested land lends itself to notions that our arable capacity is reaching its peak.

 

Food Spending and Disposable Income

Spending on food in the United States, as a percentage of disposable personal income, has been sitting near its historic low since 2004. This does not come as a surprise, but as a paradox, as calories consumed per capita in the U.S. reached the all-time high of 3,828 per day in 2005[ix].

Figure 1: Normalized food expenditures by final purchasers and users[x].

Source: USDA, 2019

 Food cost compared to relative wealth is historically low throughout the world, largely due to commercialization of value-chains, historical productivity growth, and national subsidies. While consumers in developed countries are currently offered nourishment at relatively affordable prices compared to their historical income levels, these prices generally do not address the ecological externalities involved in producing the food[xi]. As such, a trend reversal is forecasted to begin in the next twenty years for net food expenditure, predicated on a declining basis of scarce resources, transitioning food demand patterns and a need to account for the environmental effects of food production.

 

The Malthusian Theory: Cropland Per Capita

Most significant, agricultural producers are losing cropland per capita[xii]. A typical Western diet requires about 1.2 acres of cropland per year to supply the types of calories to which we are accustomed. Emerging economies are now consuming similar diets to those of the West with more meat and dairy. This is creating a critical point of increased demand for energy intensive food products. Many areas of the world, namely Asia and Africa, will not have the arable land to produce nearly enough food to nourish its population. Figure 2 depicts each region’s cropland per capita.

Figure 2: Acres of Cropland Per Person, 2016

Source: History Database of the Global Environment (HYDE)

If every person had the appetite of an average individual in the United States at the current level of production, we would need to convert every acre of forest into farmland and would still be short of calories by about 38 percent[xiii]. With current Western food consumption, a diet that is becoming normalized by the world’s middle class, only a select few countries have the capacity to domestically produce more calories than they consume. The burden of production will be left to a handful of agricultural exporters with enough productive cropland to contribute to the global food stores, such as Canada and Australia. Admittedly, the Malthusian model of food supply versus cultivated land does not offer full explanatory power for the planet’s carrying capacity. It does, however, paint a general picture of the planet’s capacity to nourish different appetites at current technological levels.

 

Calories versus Nutrients

In assessing the issues surrounding global food demand, a distinction should be made between calories and nutrient-requirements. While about 800 million people globally are suffering from a means-based caloric deficit[xiv], over 2 billion do not have regular access to safe, nutritious, sufficient food[xv].  The developing world will continue to struggle with food accessibility as its population grows. Further, crop nutrient capacity in equatorial regions especially, is incredibly sensitive to rainfall variability and spells of extreme heat.

The developed-world’s farming system, which will likely provide the nourishment for most of the world’s growing population, is largely based on maximizing caloric production rather than nutrient density and diversity. This model has perpetuated throughout agricultural economies, as farmers are incentivized to maximize their yields in response to historic consumer and government interests in driving down food costs. Farmers act as rational participants, naturally responding to the markets they supply.

The developed world’s agricultural system is still incentivized with the same family of subsidies that were legislated at the dawn of the third agricultural revolution. In North America and Europe these subsidies typically offer support for a handful of crops with high caloric density such as feed-grains and oilseeds.

While global needs, production methods, and resource constraints continue to change, the policies surrounding the food system have remained largely unchanged since their inception. National subsidy programs are frequently reciprocated by similar or equivalent programs in neighbouring countries, leading to antiquated and sticky legislative movement across international value chains. Re-orienting farmer incentives from caloric density to nutrient diversity could be a fundamental step towards solving this issue by producing foods which meet the needs of a growing consumer base.

 

Solutions, Steps, and Goals

While the difficulties in feeding a growing population are considerable, there remains optimism that it can be achieved. There are 10 steps that would help us to address the challenges related to nourishing the food demands of a growing population. Each topic is complex, worthy of its own article, and many have been listed by the World Resource Institute as keys to “feeding the 10 billion”.

  1. Food Waste Mitigation: Evidence indicates that the most effective mechanisms for supplying accessible and nutritious foods exists in reducing food waste rather than growing greater volumes of crops per acre. In the developing world, most food waste occurs at the production and storage levels, while in the developed world a staggering amount of food is lost at the consumption and market levels.
  2. Investment in Aquaculture & Developing Sustainable Fisheries: Improved fish farming technologies including new genetics, infrastructure, and algae-based feeds have increased the competitiveness and investment merits of the aquaculture industry. Preservation of current fishery stock, alongside sustainable farming methods, will be the foundation from which we can offer omega-3 fatty acids in the future.
  3. Climate-Controlled Agriculture: With so much emphasis placed in farmland per capita and the notion of declining scarce land assets, climate-controlled agriculture is consistently climbing towards profitability, and therefore viability, on a large, commercial scale. Investing in low-cost options such as warehouse conversion may prove to be the next frontier of effectively nourishing urban populations. With this being said, 95 percent of our food, even in the developed world, comes from farmland.
  4. Improved Technology & Genetics: While crop-yield productivity growth has been slow compared to green revolution levels, new advances in crop genetics and molecular biology are remarkably promising. Further public and private investment in crop breeding, biologicals, and AI technology could make all the difference in feeding the next 2 billion people.
  5. Enhanced Water Management: Water depletion in groundwater systems continues to be one of the most alarming aspects of modern agriculture. We will eventually have to shift to a process where crops are irrigated only through sustainable water sources, such as rain-fed reservoirs, rivers, and/or snowmelts. That shift should begin before aquifers are fully depleted.
  6. Soil Health Preservation: Some scientists estimate that we are losing up to 1 percent of topsoil each year, with nutrient availability degrading as well. Nearly two-thirds of this degradation is derived from deforestation and overgrazing. Incorporating techniques such as no-till agriculture, rotational grazing, drill seeding, and certain organic production methods could significantly reduce the rate of soil loss.
  7. Sequester Carbon in Soils: What benefits soil health may also create the opportunity to sequester additional carbon. Maximizing soil organic matter levels offers a multitude of effects, such as enhancing yields, sequestering more carbon, diminishing the required nutrients amendments, and enhancing ecosystem diversity. This can be achieved through the use of cover crops and healthier rotations, as well as no-till and conservational tillage methods.
  8. Shift Diets Globally: While a sensitive argument in agricultural circles, the fact remains that reducing ruminant (beef and lamb) consumption would reduce the number of calories and land needed to produce that food-type by over ten times. If global diets slowly shifted towards plant-based proteins and nutrient-dense fruit/vegetable products, total stress on the environment would reduce. In addition, many farmers have the opportunity to improve pasture productivity with enhanced fertilizers and regenerative grazing techniques, which could increase the output of meat and reduce emissions.
  9. Reforest Inefficient Lands: The second greatest contributor to carbon emissions is land deforestation, particularly in equatorial regions. Investing in direct efforts to bring these fallowed lands back to productive capacity or re-foresting the lands would promote carbon sequestration and a multitude of ecosystem services. Large food companies may also commit to plant trees and sourcing products from tropical deforestation-free value chains.
  10. Re-orient Legislation: It may be time for consumers to take the burden of paying the ‘total price’ for food and water resources, which includes the cost of depletion and the externalities involved in using the resource. Further, subsidies and farm support should slowly start to shift towards food types that dovetail with the nutritional needs of our growing population.

 

Ultimately, addressing challenges pertaining to population growth and its nourishment will require active collaboration between businesses, policy makers, and consumers. Resources must be used more efficiently, and innovation will need to be spurred by public and private support. The above 10 points are topics that will exist throughout this century and likely beyond it. Many solutions to the nourishment issue are also investable opportunities, underpinned by global demographic trends. Those who have the opportunity to allocate capital also bear the responsibility to deploy their resources towards environmentally resilient strategies and regions. With investors in all asset classes assessing how they can limit their exposure to the effects of global warming, there are few industries more intertwined with climate change than agriculture. The effects of climate change are relevant to every aspect of the global food system. The long-term issues that affect the world’s agricultural output become opportunities to invest, thereby creating value for investors and society.

[i] US Census, 2019. Global Population Estimates.

[ii] Ray et al., 2013. Yield Trends Insufficient to Double Global Crop Production by 2050.

[iii] Henchion et al., 2017. Future Protein Supply and Demand: Strategies and Factors Influencing a Sustainable Equilibrium.

[iv] Ray et al., 2013. Yield Trends Insufficient to Double Global Crop Production by 2050.

[v] World Resource Institute, 2018. How to Sustainably Feed 10 Billion People by 2050.

[vi] Challinor et al., 2014. A meta-analysis of crop yield under climate change and adaptation.

[vii] United Nations, 2019. World Population Prospects 2019.

[viii] World Resource Institute, 2018. How to Sustainably Feed 10 Billion People by 2050.

[ix] FAO, 2017. New Food Balances – FAOSTAT.

[x] US Department of Agriculture, 2019. Food Expenditure Series Dataset.

[xi] Lusk, 2016. Externalities and the “Hidden” Cost of Food.

[xii] Goldewijk et al., 2017. Per-capita estimations of long-term historical land use and the consequences for global change research.

[xiii] Grantham, 2018. The Race of Our Lives: Revisited.

[xiv] World Health Organization, 2018. Global Hunger Continues to Rise.

[xv] World Health Organization, 2019. World hunger is still not going down after three years and obesity is still growing.

 

 

PART VII: BEE FATALITIES AND THE STATE OF POLLINATION

Note: this article first appeared in Global AgInvesting on November 15, 2019 globalaginvesting.com. This is the seventh article of an eight-part series published by GAI News that will examine how the global food system is set to be altered by eight existing trends. Each month a new installment will be released. Click the following links to read the first  six installments: Part I , Part II, Part III , Part IV  , Part V and Part VI.

Written by: Jeremy Stroud, Bonnefield, Agricultural Investment Analyst

Institutional investors are allocating capital with greater longevity in mind than ever.(1) With US$84 trillion of institutional assets under management in the 34 Organization for Economic Co-operation and Development (OECD) countries and a lengthening timescale of liabilities, investors are increasingly considering factors that were previously overlooked.(2) As the Canada Pension Plan Investment Board (CPPIB) stated in its last annual report, its current strategy involves “investing in quarter centuries, not quarters” by addressing factors that are projected to pose a threat to return generation and capital preservation several decades in the future.(3) While crop pollination and insect extinction may not be issues that rise to the top of an investor’s mind, they are fundamental to many economic activities in the long term.(4) One-third of the world’s food supply is reliant on external pollinators such as ants, honeybees, and bumble bees. The quality and frequency of their activity is intrinsically tied to the success of the agri-food sector and all adjacent industries. The matter is therefore worthy of rigorous consideration when investing in agriculture.

Commercial fruit and vegetable producers – a group with the most economic dependence on the ecosystem services offered by pollinators – are seeing consistently declining pollinator populations.(5) Ecosystem biodiversity is at a lower level than needed to sustain healthy colony numbers, and investors may have a part to play in solving the issue.(6) Investors with access to local expertise, an understanding of biological sciences, and flexibility in capital deployment may benefit from investing in the preservation of native pollinators as part of their asset management activities. This may also be a key factor in underwriting new investments in fruit and vegetable land, as crop yield and quality fluctuates in proportion to the amount of pollination it receives.(7) Native wild pollinators have been shown to increase the shelf life and commercial value of fruit crops versus their domestically managed counterparts.(8) From the farmer’s standpoint, permanent crops such as orchards, vineyards and bushland as well as row crops like canola, beets, and strawberries are all dependent on external pollination.

Neonicotinoids

There exists a contentious issue in modern agricultural communities where pesticides such as neonicotinoids, which account for about 25 percent of global agro-chemical sales, are perceived to cause destructive effects to bee colonies. As there exists a correlation between higher pesticide use and regional colony collapse disorder frequency, countries who use the most pesticides are projected to have more rapidly declining bee populations. With this being said, a statistically significant study of causation has yet to be found, and the issue continues to be debated in agricultural circles. Exhibit 1 shows the extent of pesticide use by country.

Exhibit 1: Pesticide Use per Hectare of Cropland (kg/ha), 2014

Source: United Nations Food and Agriculture Organization, 2014

As seen in the above chart, farmers in countries such as China and the Netherlands use three times more pesticides on their crops than farmers in the U.S., UK and Canada. The latter countries may attribute part of their moderation in chemical use to the cold winters which naturally regulate pest and disease risk. Countries with year-round growing seasons and extended periods of wetness are more susceptible to the growth of undesirable organisms. In contrast, pollinators such as bees are more likely to thrive in Canada due to its lower population density, greater extent of forested regions and reduced use of pesticides compared to other agricultural producers.

Honeybees

A recent comprehensive study indicates that the U.S. agricultural landscape is 48 times more toxic for bees than just 25 years ago.(9) Honeybees, which are used by the US Environmental Protection Agency (EPA) as a proxy for other insect populations, are consistently declining in numbers throughout North America. As insect populations drop, bird populations that rely on insect nutrition also decline.

Despite the abundance of rhetoric surrounding honeybee colonies in the United States, the insect is not native to North America. Their genetic predecessors were first seen in Asia over 300,000 years ago and the species we see today was brought to the Americas by early colonists.(10) Honeybees may be thought of as a domesticated species, similar to livestock, that are bred, managed, and shipped from farm to farm for their pollination capacity of crops such as blueberries. While they do provide additional economic value through their productive capacity for honey, honeybees are generally less efficient than native pollinators and are prone to spreading diseases to other insects.(11)  Global pollinated crops are valued at over US$212 billion per year, a value that is expected to accelerate at a pace faster than typical grain crops due to a growing global appetite for fruits, nuts and vegetables.(12) Exhibit 2 demonstrates where pollinator services provide the greatest benefits on a per hectare basis.

Exhibit 2: Pollination service contribution to the crop market output ($USD/ha)

Source: Potts et al., 2016(13)

The map above shows areas such as southern Europe and Asia as key regions where investment in pollination service could make the greatest improvement to crop market outputs. The total value of pollinator services may be attributed to thousands of species; however, and as some academics have stated, honeybees have a tendency to “hog the limelight”(14).

Alternative Pollinators

While honeybees are in vogue as a topic of discussion, non-bee pollinators such as flies, beetles, ants, wasps, butterflies, bats, and birds are all important contributors to global crop production.(15) Some studies estimate that these alternatives offer up to 50 percent of total pollinating services for all fruit, nut and vegetable crops.(16) With this being said, secondary pollinators are less efficient per visit, and cannot be relied upon to replace bee populations for specific crop types and climatic zones.

Considering that ecosystem fragility is a national or even continental issue, opportunities to work with governments in the form of Public-Private Partnerships may offer interregional solutions. Initiatives such as the Integrated Crop Pollination Project may be pointed to as a progressive example of the intersection between profitable farm management and environmental enhancement. An analysis from the Journal of Economic Entomology estimates that profit per acre can increase by over US $2,000 per acre of tree fruit land by incorporating alternative pollinators such as the native blue orchard bee on farms in North America.(17) This requires maintenance, expertise, and the deliberate allocation of patient capital, forgoing short-term profits for long-term gains.

Pesticides are necessary for generating the long-term crop yields that are needed to nourish the growing global appetite, but the management with which they are applied is crucial to preserving a diverse ecosystem – both above and beneath the soil. Strong evidence suggests that large-scale fruit and vegetable farmers could benefit from investing in the establishment and stewardship of wild pollinator colonies. Governments and enterprises are adopting a broader recognition for the roles that biodiversity and ecosystem services play throughout the value chain.(18) This is underpinned by a consumer base with preferences for supporting transparency and sustainability – a trend that is unlikely to disappear. Companies and investors who act early on this issue may benefit from an early mover’s advantage, industry recognition, and the development of proprietary processes.

 

Sources:

  1. Ameli et al., 2019. Climate finance and disclosure for institutional investors.
  2. Rottgers et al., 2018. Approaches to Mobilising Institutional Investment for Sustainable Infrastructure.
  3. Canada Pension Plan Investment Board, 2019. Annual Report 2019: Investing for Generations.
  4. Schroders, 2014. The bee and the stock market.
  5. Cameron et al., 2011. Patterns of widespread decline in North American bumble beesProceedings of the National Academy of Sciences.
  6. Winfree et al., 2011. Valuing Pollination Services to Agriculture.
  7. Rader et al., 2016. Non-bee insects are important contributors to global crop pollination.
  8. Winfree et al., 2011. Valuing Pollination Services to Agriculture.
  9. DiBartolomeis et al., 2019. An assessment of acute insecticide toxicity loading (AITL) of chemical pesticides used on agricultural land in the United States.
  10. Wallberg et al., 2014. A worldwide survey of genome sequence variation provides insight into the evolutionary history of the honeybee.
  11. Graham, 2018. Beyond honey bees: Wild bees are also key pollinators, and some species are disappearing.
  12. vanEngelsdorp and Meixner. 2010. A historical review of managed honey bee populations in Europe and the United States and the factors that may affect them
  13. Potts et al., 2016. Safeguarding pollinators and their values to human well-being.
  14. Donkersley. 2018. Honeybees hog the limelight, yet wild insects are the most important and vulnerable pollinators
  15. Rader et al., 2016. Non-bee insects are important contributors to global crop pollination. Proceedings of the National Academy of Sciences
  16. Rader et al., 2016. Non-bee insects are important contributors to global crop pollination. Proceedings of the National Academy of Sciences
  17. Koh et al., 2017. Ecology and Economics of Using Native Managed Bees for Almond Pollination
  18. Schroders, 2014. An overview of pollinator decline and its economic and corporate significance.