My apologies for the cheeky “FAKE NEWS!” reference, but it does seem appropriate under the circumstances.
The Standing Senate Committee on Agriculture and Forestry just released a report entitled “How to Keep Farmland in the Hands of Canadian Farmers” and the few news outlets that noticed the report, seem to have widely mis-quoted its conclusions. The National Observer, for example quoted a Committee member as saying “…financial institutions, investment funds and foreign multinational companies [are] buying up Canadian farmland, which drives the prices up more and turns farmers into employees rather than owners of their land.” And Agri Investor carried the headline: “Canadian lawmakers warn against investment funds targeting farmland”.
For the record, the Committee’s report carries no such warnings and makes no recommendations against foreign ownership or investment funds.
While the report does acknowledge that some of the witnesses that appeared before the Committee in its 18 months of hearings expressed such concerns, the Committee’s report refrained from recommending measures that would limit either foreign ownership or institutional investment. The report also mentions other witnesses (such as Bonnefield’s Tom Eisenhauer, Farm Credit Canada, several academics and others) who found no evidence that foreign ownership or institutional investment in farmland are problematic in Canada. Indeed, the report sites examples of Bonnefield and other investors playing a positive role in providing financing alternatives to Canadian farmers and helping them reduce debt, grow their operations and transition their farms to the next generation.
While the Senate Committee’s report was not the anti-business manifesto that some news articles might lead you to believe, it was also not the call to action it could and should have been. In fact, it represents a missed opportunity to provide clear direction to lawmakers with firm recommendations for ways to ensure that Canadian farmland is protected and maintained for farmers and farming.
The report’s five recommendations range from soft (gather more data, better cooperation between levels of government, more funding for research) to downright bizarre. The report’s number one recommendation for keeping farmland in the hands of farmers? Increase the lifetime capital gains exemption for farm property. In the Committee’s view, increased capital gains exemptions will somehow help new farmers acquire farmland. Just how is unclear, as the report does not explain the connection between an increased tax exemption on the sale of a property, and easier acquisition of property by new farmers. Increased capital gains exemptions would certainly be good for retiring farmers. But new farmers? I don’t get it. New farmers need new forms of financing to build their businesses, not tax exemptions upon retirement.
Sadly, I don’t think Canadian farmland is any more protected from development or urban expansion, nor young farmers any better able to grow their farms, as a result of this Senate Committee’s report.
Note: the text of Tom Eisenhauer’s presentation to the Senate Committee, and Bonnefield’s recommendations for protecting Canadian farmland can be found here.
Note: this article first appeared in PEI Agri Investor February 13, 2018 www.agriinvestor.com
US farmers have had a tough time since 2013 when net farm incomes reached a record $135.6 billion after a stunning increase of 82% in just 4 years. Since those heady days, US net farm incomes have been in decline, and the USDA recently predicted further declines in 2018 – to levels not seen since 2006.
North of the boarder, the story has been very different. Canadian net farm cash receipts have enjoyed an 8-year run of continuous increases. Since 2013, net cash receipts have increased 27% in Canada, even as they have declined by 28% in the US.
DIFFERING FORTUNES – Canadian vs US Farm Profits (2000 = 100)
Sources: USDA – Net Farm Income; and Statistics Canada – Net Cash Receipts
It is a testament to the attractiveness of farmland as an investment asset, that US farmland values have not declined significantly since 2013, despite big declines in farm incomes. Farmers, after all, don’t react to short-term commodity price swings by selling land that is the cornerstone of their long-term business. According to USDA figures, average cropland values across the US are largely unchanged since 2014. In Canada, however, steadily increasing farm incomes have led to steadily increasing farmland values since 2014, in line with long-term historic averages of 6% to 8% per year.
Several years of belt tightening have deteriorated the balance sheets of many US farms, whereas most Canadian farms have maintained low debt levels and good liquidity. Farm Credit Canada (“FCC”) recently concluded that the “overall liquidity position of Canadian agriculture is strong”. The average current ratio (current assets divided by current liabilities) of all Canadian farmers was 3.0 in 2015 (the latest year for which figures are available), with the grain and oilseed sector especially strong at 3.6. By comparison, US farmers have experienced a decline in their current ratio from 2.87 in 2012 to 1.55 in 2016, according to FCC.
So, what explains the differing fortunes of US farmers and their Canadian cousins?
Exchange rates are a big factor. Declining corn and soy prices since 2013 coincided with a surging US dollar – a double whammy for US farmers. In Canadian dollar terms, corn and soy prices have not deteriorated to the same extent.
But beyond exchange rates there are important structural differences that have given Canadian farmers a significant advantage. Most investors don’t realize, for example, the extent to which the fortunes of US farmers are determined by just two crops – corn and soy. A stunning 55% of all US farmland – an area the size of France – is annually seeded to just those two crops. By contrast only 13% of Canadian farmland typically grows corn or soy each year in Canada. Far more Canadian farmland is used to produce crops which are not widely grown in the US, and which continue to enjoy strong demand (and prices) on world markets, such as canola and lentils. The result is a Canadian agriculture sector with a more evenly diversified mix of products that makes it better positioned to withstand declines in prices for any single crop.
Even within the corn sector Canadian farmers appear to have an economic advantage over many US producers. Using corn planting budgets and prevailing yield data from USDA and OMAFRA, we estimate Southwest Ontario corn producers have a 32% economic advantage over producers nearby in the US Mid-West, owing primarily to differences in land and input prices in local currency terms. Economic advantages like those can mean the difference between a profit and a loss when corn prices are low – like now.
Will the fortunes of Canadian and US farmers continue to diverge? In the short-term, corn and soy prices will determine the answer. But in the longer-term, Canuck farmers have some powerful structural advantages that should help them continue to prosper. Unlike most US farmers, Canadian farmers will see net benefits from a changing climate. While most US farmers are facing increasing heat and drought, Canadian farmers will benefit from more heat units, a longer growing season and access to plentiful stores of clean, renewable water. Most importantly, Canadian farmers are world leaders in sustainability. The Economist Intelligence Unit’s 2017 Sustainability Index, ranked Canada’s primary producers 2nd only to Germany, and 1st amongst the world’s major exporters. By comparison, the US ag sector ranked 19th behind the likes of China and Ethiopia. In an increasingly hot, polluted and dry world, sustainability will be the most important competitive advantage any farmer can have.
The current market environment is creating a dilemma for investors. On one hand, the economic picture remains bright: corporate earnings appear strong, unemployment is low and inflation, while rising, remains benign. On the other hand, warning signs abound:
- We are in the midst of one of the longest bull markets in history: stock markets have enjoyed a 10-year upward run with few interruptions.
- Stock prices, by almost any measure, are more expensive than they have been at any time in history other than just before the 2001 “Dot Com” crash.
- Bond yields are rising, and interest rates are headed up (which is bad for stock prices).
- Individual debts are at all-time highs and, more worryingly, margin debt (debt borrowed to buys stocks) is at unprecedented levels.
- Bitcoin, blockchain and cannabis stocks are clearly in speculative bubbles.
- Geo-political and international trade uncertainties abound, and (to put it mildly), the response of world leaders to any potential shock cannot be predicted.
In the last 34 years we have experienced five significant bull-market runs, four of which ended in large stock market declines or crashes. The first began in 1984 and ended on Black Monday in October 1987. The second started in 1994 and ended with the Asian Flu currency crisis in September 1998. The third began in late 1998 and ended in the Dot Com bust of 2001. The fourth started in March 2003 and ended with the Global Banking Crisis of 2008, and the fifth began in March 2009 and has continued until today, more or less uninterrupted for much of the past decade.
Just how exceptional has our current bull market been? Figure 1 provides some context. The previous 4 market cycles lasted an average of 29 months and saw the S&P 500 rise by an average of 97%. In comparison, our current bull market run has, so far, lasted an incredible 107 months and seen the S&P 500 rise by 354%
Figure 1: our current bull run is the longest in decades…
Figure 2: …and it takes a long time to recover after long bull runs
As Figure 2 indicates, it typically takes a long time to recover losses incurred in stock market crashes that have followed long bull runs. In the previous four cycles, the recovery period (ie. the length of time it took to fully recover the losses incurred from market declines) lasted 77% as long as the preceding bull market run – an average of 43 months. Recoveries from the Dot Com and Global Financial Crisis took significantly longer – 81 and 65 months respectively.
Simply put, it took between 5.5 and 6.7 years for investors to make up the losses they incurred in the previous two stock market declines.
What conclusions can we draw from these historic patterns?
- We are surely in the latter stages of one of the longest bull markets in history, and the longer it goes on, the greater the risk of a significant decline.
- At current equity valuations, future market gains will, almost certainly, be less than those of recent years and with interest rates increasing, bond returns are likely to decrease from recent levels as well.
- As the prospect of further returns diminish, market risk is increasing – creating a poor risk/return outlook for both stocks and bonds.
Figure 3 illustrates how the current risk/return pattern has significantly changed from the past few decades. Using historic annual returns since 1990 for the S&P 500 and 10-year Treasury Bonds (all figures in US dollars without currency conversion into CAD), we estimated the stock-and-bond portfolio mix that would have produced a similar 10% total return as that generated by Canadian farmland over the same period.
During the 1990s, it was possible to replicate farmland’s 10% total return (through capital appreciation plus dividends and interest) by investing 39% of one’s assets in 10-Year Treasury Bonds and 61% in the S&P 500. Moreover, this strategy required no debt leverage and had a modest level of volatility at 11.6%
The Dot Com bust of the early 2000s created an entirely different story for investors during that decade. The only way an investor could have generated a 10% return from 2000 to 2010 would have been to put all of one’s portfolio into Treasury Bonds, lever it by 300% and buy the S&P with the proceeds of the debt leverage. No sane investor would have done this, and even if they had, they would have experienced a ridiculous level of volatility (69%).
The Goldilocks bull market run that we have experienced since 2010 changed the portfolio mix again. Declining interest rates and strong stock returns meant that an investor could have put 76% of their portfolio in Treasury Bonds and just 24% in the S&P 500 and still generated a 10% total return with a volatility of just 8.2%
Figure 3: portfolio mix required to match Canadian farmland’s long-term total return of 10%
This historic what-if analysis puts the changing risk/return environment in perspective. Looking forward, however, is trickier. 2018 consensus estimates for the S&P 500 and bond returns, suggest that, in the current environment, one would need to put 88% of their portfolio in the S&P and just 12% in bonds to generate an anticipated return of 10% in the coming year. But this assumes that we do not experience a significant market correction in 2018, and, as I have argued above, the likelihood of a significant correction occurring is increasing with each passing month. Clearly, the classic portfolio of 60% equities and 40% bonds no longer generates an attractive risk/return for investors.
So, what is a prudent investor to do? Moving to cash is the obvious option for capital preservation, but at the cost of low-or-no real returns. How can one protect their capital while still generating an acceptable long-term return?
Increased market and geo-political risks for future stock and bond returns, stand in stark contrast to the prospects for continued steady returns to owning Canadian farmland, all of the core investment themes for which remain intact:
- a growing global population, significant portions of which face serious food insecurity;
- a changing climate that is benefiting Canadian farmers and challenging most other food producing regions of the world;
- plentiful access to water for food production in Canada while much of the world faces drought, water shortages and water quality challenges; and
- Canadian farmland prices that have not increased significantly relative to Canadian farm earnings (in contrast to rising valuation metrics for public equities).
Is Bonnefield predicting an imminent market collapse? Certainly not. We are neither skilled enough nor smart enough to call a stock market top.
There is no doubt, however, that the lessons of history and the precarious risk/return profile of current markets are clear signals to investors seeking capital preservation and steady returns: now is the most important time in recent memory to rebalance away from public markets into alternatives like Canadian farmland – a proven steady performer, with low volatility and bright prospects for continued steady returns.
President & CEO
Bonnefield Financial Inc.
Canadian farmland has a long track record of producing steady, equity-like returns that are uncorrelated with the ups and downs of other financial assets. Bonnefield’s research has shown that long-term farmland returns are highly correlated with, and are primarily a function of, the long-term improvement in the productive capacity of farmland. Simply put, as crop yields have improved over time, and as farm operations have become more efficient through consolidation and technical improvements, the “earnings power” of the underlying farmland itself has increased, leading to an increase in both farmland values and farmland rents.
An analogy is to think of farmland like shares in a public company. If the productivity of a company improves, one would expect its profits to improve and the price of its shares to increase accordingly. But if, in management’s drive to improve the company’s productivity and profitability, they take on too much debt or weaken the company’s financial liquidity, then its profitability (and, therefore, share price) is put at risk.
The same is true of farmland. If the farm sector’s debt load were to increase to the point where farmers’ financial liquidity deteriorates substantially, farmland prices and rents would potentially be at risk. Such was the case in the early 1980’s when a debt boom coincided with declining crop prices and skyrocketing interest rates, resulting in a rare period of widespread farmland price declines.
So the obvious question is: How financially sound are Canadian farmers? Most farmers rely on debt to capitalize their operations. Are they sufficiently liquid to withstand a period of crop price stagnation and/or interest rate increases? Are we potentially at risk of a 1980’s-style farm crisis?
Statistics Canada’s most recent Farm Financial Survey suggests that the clear majority of Canadian farmers are in sound financial shape.
Recent analysis by Farm Credit Canada concluded that in 2015, 82% of Canada’s grain and oilseed producers had debt-to-equity ratios of less than 0.3. 77% of vegetable producers and 63% of potato producers had similarly low debt levels. More importantly, Canadian farmers appear well positioned to continue to service those debt levels as indicated by healthy debt-service ratios (net income divided by annual debt service payments). More than 2/3rds of all grain, oilseed, vegetable and potato producers in Canada had debt service ratios greater than 2.5, the result of several years of strong cash receipts and low interest rates.
FCC’s analysis also concluded that the “overall liquidity position of Canadian agriculture is strong”. The average current ratio (current assets divided by current liabilities) of all Canadian farmers was 3.0 in 2015, with the grain and oilseed sector especially strong at 3.6. To put this in perspective, FCC considers a farmer’s financial liquidity to be adequate if they have a current ratio of 1.5 and most Canadian farmers have current ratios well in excess of these levels.
The healthy financial liquidity of the Canadian farm sector stands in contrast to that of US farmers who, according to FCC, have experienced a decline in their current ratio from 2.87 in 2012 to 1.55 in 2016. Unlike their US counterparts, Canadian farmers have been insulated to some degree from lower corn and soy prices by a favorable USD/CAD exchange rate and a more diversified mix of crops (especially canola and pulses, the prices for which continue to be strong).
Indeed, Statistics Canada released figures in late November showing that Canadian farm revenues (“farm cash receipts”) for the first 9 months of 2017 were up 3.3% versus the same period in 2016. This increase is the 7th year in a row in which Canadian farmers have experienced year-over-year increases in revenues. Moreover, Canadian farm profits, as measured by realized net farm income, were up 4.2% in 2016, the 6th such increase in the past seven years.
The bottom line is that we are reassured by Statistics Canada’s most recent Farm Financial Survey showing that the clear majority of Canadian farmers, particularly grain, oilseed, potato and vegetable producers (the sectors that Bonnefield focuses on) are in sound financial shape.
The Liberal government’s proposed tax changes will likely cause the greatest destruction of wealth for Canadian farm families since the 1980s farm crisis. But unlike the crisis of the 1980s, from which farmers eventually recovered, the proposed changes are a permanent, structural change that will cause a drop in farmers’ income and net worth from which there will be no recovery.
Finance Minister Morneau and Prime Minister Trudeau have said that the proposed tax changes are aimed at wealthy Canadians who use “tax loopholes” to unfairly pay less tax than “middle class” workers. But the legitimate small business tax planning tools, which the Liberals plan to change, have been used for decades by small business entrepreneurs in all sectors across Canada to help manage and mitigate the financial risks associated with starting, building and selling their businesses.
The implications of these changes for all small business entrepreneurs are huge, but given the unique nature of farming, the impact on Canadian farm families will be especially severe. Farming, more so than most other businesses, rely on the entire family’s participation and support to succeed. Children, spouses and extended family members typically support the farm business, whether directly in the farm’s operations, or indirectly in unpaid, but essential ways. Canadian farm families typically incorporate as small businesses to enable them to efficiently share the income from their farm operations among family members. But the proposed tax changes will severely restrict a farmer’s ability to split income among family members, even though the reality for most farmers is that the entire extended family participates in one way or another in supporting the business.
Moreover, for most farm families, their primary (and sometimes sole) source of wealth for their retirement is their land. Because of the capital-intensive nature of farming and the volatility of most farm incomes, farmers often do not have significant other sources of retirement savings such as TFSAs, RRSPs and investment savings. By incorporating as small businesses, and having multiple family members as shareholders, farmers have been able to use legitimate tax planning tools to maximize capital gains exemptions and reduce the tax burden when it comes time to sell the farm to finance their retirement. The proposed tax changes will eliminate farmers’ ability to use multiple capital gain exemptions and will thereby dramatically reduce their retirement savings.
The extent of this pending wealth reduction for farmers is hard to estimate and is based on individual circumstances, but it is not hard to imagine that for a typical farm family like those we deal with every day at Bonnefield, the proposed tax changes could destroy a third, maybe even half, of the wealth they have accumulated over their career through land price appreciation.
Bizarrely, the proposed tax changes will make it far more advantageous from a tax perspective for a farmer to sell their business to a large conglomerate, rather than sell the farm to the next generation and keep it in the family. The 2016 census showed that the average farmer in Canada was 55 years old. So, over the next decade a substantial portion of Canadian farms are going to change hands.
At Bonnefield we often work with young farmers to help them finance the transition of their parent’s farm and expand their operations. The proposed tax changes will dramatically reduce the amount of after-tax cash available to retiring farmers and make it harder to transition the farm to the next generation.
For anyone concerned about the disappearance of family farms in Canada, the pending tax changes are a looming disaster.
Everyone agrees that tax fairness is an essential principle for a civil democratic society like Canada. But one’s tax burden should not only be proportionate to one’s income. It should also take into account the risk and sacrifice entrepreneurs incur to earn their income, as well as the benefit to society that results from their entrepreneurial spirit. Canadian farmers represent the best of that entrepreneurialism and risk taking, and all Canadians benefit from a thriving agricultural sector.
I urge you to contact Minister Morneau, Prime Minister Trudeau and your local MP and urge them to stop these ill-conceived, disastrous tax changes.
The volatile weather expeienced across Canada so far during the 2017 growing season has, once again, reiterated the need for a well-diversified farmland portfolio amidst unpredictable and challenging farming conditions. At the time of writing this blog, there are more than 150 wildfires burning throughout the interior of British Columbia due to abnormally dry weather and forcing over 6,000 people from their homes. In Saskatchewan over 60% of the province’s topsoil is considered short or very short of proper moisture levels. Meanwhile in Ontario, accumulated rainfall to date is 4 times that of 2016. The Maritimes have had relatively normal conditions so far this season.
The dry conditions in the prairies made for ideal seeding conditions but continued dryness will, with the exception of irrigated areas in southern Alberta, likely depress yields across much of the west in 2017. The rains in SW Ontario that delayed planting show little sign of abating, however, progressive farmers using good management techniques should expereince reasonably good yields.
Challenging growing seasons such as these also highlight the benefit of partnering with top-grade farmers who use progressive practices and sophisticated agrology analysis in their farm management techniques. We are seeing dramatic differences in the fortunes of farmers across the country between those who use excellent management techniques and those who do not. The former are experiencing average-to-good yields at this point in the season, while many others are seeing poor yields.
The revenue impact to Canadian farmers from a rebounding Canadian dollar has largely been offset by stronger agricultural commodity prices across the board and global demand for Canadian-based crops such as canola and lentils remains strong.
While Canadian farmers are facing challenges this growing season, most are coping reasonably well and maintain a bright outlook for years to come. Sadly, recent news from abroad is not so positive for farmers elsewhere.
Against this backdrop, investing in a widely-diversified portfolio of farmland in Canada – a politically stable country whose ag sector is expected to be a net beneficiary of climate change – looks very attractive indeed.
Reuters recently reported that Canada Pension Plan Investment Board (CPPIB) has decided against making further farmland investments. Is CPPIB’s decision an indication that farmland is a poor investment, or were other factors at play? In this note I’ll look at what went wrong with CPPIB’s farmland strategy and what lessons can we learn from its experience.
Firstly, let’s appreciate the enormous task CPPIB set for itself when it decided to begin investing in farmland more than 5 years ago. CPPIB manages almost $300 billion of assets (as at year end 2016). To make a meaningful impact on overall returns, they presumably need to deploy a minimum of 1% to 2% in any given asset class, maybe more. So by implication, they needed to deploy $3b to $6b in farmland and continue to increase that investment over time as CPPIB’s assets continue to grow. To put that task in perspective, it has taken a decade for TIAA-CREF the world’s largest farmland investor, to deploy that much on behalf of itself and approximately 20 other large pension funds. Given the amount of capital CPPIB hoped to deploy and the relatively small number of mature markets it was targeting for investment, CPPIB’s goals were aggressive – perhaps even unprecedented.
CPPIB set an added goal for itself to deploy a minimum of $500mm in Canadian farmland. Institutional investment in Canadian farmland is still relatively new. Bonnefield is the largest institutional investor in farmland in this country, and it has taken us 8 years to build the necessary specialized teams, investment processes, local knowledge, sourcing and property management systems, as well as the third-party appraisal, agrology and support networks necessary to meet the institutional-grade governance, reporting and oversight standards required to deploy at this scale across such a large geography as Canada. CPPIB’s goal was to deploy more than twice what all pension funds had invested to date in Canadian farmland in just a few years.
Complicating the deployment challenges CPPIB set for itself was its decision to build an in-house team of finance professionals based in Toronto and London to deploy its farmland allocation. This decision is perhaps understandable given the amount of capital CPPIB hoped to deploy, but it undoubtedly delayed their farmland investment program and increased the risk of success. By comparison, TIAA-CREF began its farmland investment program by committing capital to specialized farmland investment managers with deep experience and local knowledge. Only once TIAA-CREF had experience with the asset class and had deployed significant amounts of capital did they acquire a 3rd party farmland management company to bring their operations in-house. Farmland is a highly-specialized asset class requiring a rare mix of farming and finance expertise as well as “boots-on-the-ground” in local farm communities. People with these unique mixes of skills are in short supply on Bay St. and the City of London.
Owning farmland and leasing it to farmers has historically produced returns in the 9% to 12% range, mostly from long-term capital appreciation and the remainder from a small cash yield. While these historic rates of return are modest compared to expected returns on private equity, they tend to be much lower risk, lower volatility and highly correlated to inflation. Farmland’s attractive risk-adjusted-returns make it an ideal asset for pension plans looking to match long-term liabilities. It is not clear, however, that CPPIB’s return expectations were in line with these historic farmland returns – especially as regards cash yields. Like any asset, to achieve higher returns you need to take on higher risks and it appears that CPPIB’s $2.5b acquisition of a 40% interest in Glencore was a move in that direction.
Most critically of all, CPPIB repeated a mistake that several other Bay St. investors have previously made when investing in this sector – they approached farming and farmland like any other business and any other financial asset. Farmers do not view farming as just another business, and they certainly don’t view farmland as just a financial asset. There is an emotional attachment that farmers, farm families and farm communities have to their life’s work and the land they farm that goes well beyond typical businesses and typical financial assets. In Bonnefield’s view, the only way to successfully invest in Canadian farmland is to form long-term partnerships with farm families and to support local farm communities.
When CPPIB bought a $120mm farmland portfolio in Saskatchewan in 2013, they did so over the objections of many members of the farm community and over the objections of the provincial government. Rather than take a consultative approach and seek a mutually acceptable arrangement, CPPIB armed with legal opinions and M&A lawyers, concluded the transaction despite substantial concerns in the farm community. The resulting backlash was severe, prompting the Government to introduce legislation preventing any further pension funds or other institutional investor from owning farmland in the province. This legislation has undoubtedly hurt Saskatchewan farmers by cutting off their access to institutional capital that could help them grow their businesses, reduce debt and help transition farms to younger farmers. This legislation has also diminished the long-term value of the very farmland CPPIB bought in the province by reducing its liquidity. One wonders what would have happened if CPPIB had taken a more sensitive approach and worked with local Saskatchewan farmers and their communities to find an acceptable arrangement that would have minimized the concerns of those opposed, while creating a precedent for additional (and badly needed) institutional investment in Saskatchewan’s agriculture sector.
Farmland’s attractive risk-adjusted investment prospects have not changed from the time CPPIB decided to enter the asset class. The Reuters article suggests that despite its farmland investments in the US and Saskatchewan, CPPIB’s new Chief Executive Mark Machin became frustrated with the lack of progress in meeting deployment targets and ordered an internal review that concluded farmland “was not sufficiently scalable to justify further investment”. In retrospect, it is hardly surprising that CPPIB’s overly aggressive deployment targets, its decision to build an in-house team from scratch, unrealistic investment hurdle rates and its failure to recognize the unique sensitivities of local farm communities, all conspired to slow deployment.
When all is said and done, it appears that CPPIB’s original decision to invest in farmland was sound (attractive risk-adjusted returns with low volatility), but how it went about doing so was flawed.
In retrospect, CPPIB would have done well to heed General Dwight D. Eisenhower’s words – words that are written in huge letters on Bonnefield’s boardroom wall:
On February 9, 2017, Bonnefield appeared before the Standing Senate Committee on Agriculture & Forestry. The Committee is undertaking a “Study on the acquisition of farmland in Canada and its potential impact on the farming sector”
A video replay of Bonnefield’s remarks can be viewed by clicking here (beginning at the 9:10:30 mark of the video).
And here is the text to what we had to say:
Thank you, Senators. It is an honor to meet with you this morning.
My name is Tom Eisenhauer and I am the CEO of Bonnefield Financial. I apologize for not being able to join you this morning, however, my friend and colleague Wally Johnston is with you in person. Wally represents the 5th generation of a farm family from there in the Ottawa Valley and he is also our Vice President of Business Development at Bonnefield.
Wally and I, along with our partners at Bonnefield, founded our company back in 2009 out of a sense of frustration. Back in the mid-2000’s one of our sister companies – Manderley Turf Products, Canada’s largest turf grass farm – found itself in a situation that is familiar to many Canadians farmers – we needed to reduce debt and to find additional capital to grow our business.
So we tried to do what many non-agricultural businesses do – we tried to arrange a sale leaseback. Simply put, we wanted to find an investor willing to buy some of our land and to lease it back to us under a secure, long-term lease, so that we could use the sale proceeds to reduce our debts and to finance Manderley’s growth. As you know, sale leasebacks of this sort are common financial arrangements in sectors such as commercial real estate, the hotel industry, manufacturing, airlines and even the Canadian banks themselves sometimes use sale leasebacks to finance their operations. However, to our surprise and great frustration, we could find no investor in this country willing or able to provide sale-leaseback financing on farmland. So we decided to form Bonnefield in 2009 to do just that.
Since that time we have raised over $400 million, entirely from Canadian individuals and Canadian pension funds, and we have used that capital to arrange sale and sale-leaseback transactions with Canadian farm families in British Columbia, Alberta, Saskatchewan, Manitoba, Ontario, New Brunswick and Nova Scotia. To date, we have helped over 75 Canadian farm families to:
- reduce debt
- transition their farm businesses from one generation to another
- help young farmers grow their business without heavy reliance on debt; and
- provided farmers with long-term secure access to farmland that they had previously leased from others on a short-term, insecure basis.
In the process, we have, so far, secured over 80,000 acres of prime Canadian farmland and ensured that it will remain “farmland for farming” indefinitely and that it will be monitored, maintained and operated in a sustainable and ecologically responsible manner. In short, we have developed a business model that uses capital from Canadian individuals and Canadian pensioners to support Canadian farm families and to protect Canadian farmland.
So our prime reason for meeting with you today is to ask this Committee to advocate for responsible, evidence-based regulations that protect our farmland, while ensuring that farmers have ample access to the capital they need to operate their businesses profitably – including institutional capital.
I would now like to turn to five key points we would like the Senate Committee to consider in its ongoing study.
POINT 1: Farmers, not investors, determine the price of farmland in Canada
This point has been made by previous witnesses who have appeared before this Committee – notably, by JP Gervais, Chief Economist of Farm Credit Canada . JP pointed out that most farmland transactions in Canada are between farmers, and that the small number of investor purchases in Canada are not sufficient to drive farmland prices.
As further evidence, consider this:
- Statistics Canada, based on farm census survey data, pegs the total value of farmland in Canada at approximately $400 billion. Bonnefield’s internal estimates, based on actual land mapping rather than survey results, suggests that the total value is likely much higher than that – perhaps as much as $590 billion. Compare these figures with the total amount of dollars invested by institutional and high-net-worth investors in farmland across Canada in the past 10 years – likely in the range of $1 billion in total. So by implication, less than ¼ of 1% of Canadian farmland is likely owned by investors. It is simply not credible to assert that investor purchases of farmland – which we estimate constitute only 0.5% to 1% of total farmland transactions in any given year – could drive prices in a market that may be as large as half a trillion dollars.
I would also like to reiterate a point that was made to this Committee by Michael Hoffort, CEO of Farm Credit Canada: that farm producers are sometimes willing to pay much higher prices than investors – especially when a plot of land becomes available that is in close proximity or fits well with their existing farm business. A rational investor, on the other hand, should be willing to pay no more for a plot of farmland than the capitalized value of the sustainable rent that the farmland can yield. So contrary to popular opinion, investors, particularly disciplined institutional investors, may serve to moderate farmland price increases in some markets.
POINT 2: Recent increases in Farmland prices across Canada have, with very few exceptions, been driven by increases in farm profits and are in line with increased profit levels.
Slide #3 of the exhibits we provided, compares the change in average Canadian Farmland prices-per-acre (the grey line) with crop revenue per acre (the green line). You can see that farm income has grown dramatically over the last four decades and in the past decade in particular. Between 2005 and 2015, Canadian farm income more than doubled from $6.8 billion to $15 billion. You can also see that farmland prices have risen in lock step with farm incomes. Indeed, farmland prices have remained generally as affordable today (relative to income) as they were a decade ago.
We agree with Mr. Hoffort from the FCC who told this Committee that “strong land values are an indicator of the farm sector’s financial strength, not a warning signal or a threat to farm profitability”.
POINT 3: Farming is a capital-intensive business, and Canadian farmers need access to a broad range of capital sources – including institutional investors – to finance their businesses and to remain internationally competitive.
The agriculture sector in Canada is predominantly made up of businesses run by farm families – large and small. Some of these farm families operate very large sophisticated businesses but, contrary to popular belief, there are very few if any, “Corporate Conglomerates” operating farms in Canada.
Canadian farm families, however, find themselves competing against well-capitalized, low-cost foreign conglomerates when they go to sell their products on world markets and even when they compete against low-cost imports in domestic markets. To become and remain competitive, Canadian farm families need scale, efficiencies and access to capital. But if there is one area where Canadian farmers are at a significant competitive disadvantage, it is their lack of access to a broad range of capital from investors. We hear time and time again, from our farm partners – their number one complaint – is their inability to access capital.
This problem is especially acute for young farmers. We often hear that “there are not enough young farmers in Canada”. I beg to differ. I think there are lots of young people who want to farm, but they don’t want to farm like their mom and dad did – at a small scale, perennially undercapitalized, heavily indebted and financially insecure. Keep in mind, that to be optimally efficient, a canola, wheat and lentil farmer in Western Canada probably needs secure access to 3,000 acres of farmland, maybe more. In Eastern Canada, a young corn and soy farmer likely needs upwards of 1,000 acres or more to optimize a full line of modern farming equipment. The capital required to establish and operate a profitable farm business is often simply out of reach of many young farmers. As a result, young farmers often leave the farms to find employment elsewhere, leaving small towns to the elderly and our farm communities deserted of young, energetic, vibrant business people.
This is why we urge the Senate Committee to promote farmland ownership regulations that balance the protection of farmland for farming, yet encourages new and varying sources of capital to invest in agriculture – especially institutional capital which can bring the size and scale necessary to fill such a large void, in such a large industry. Canada falls well behind countries like the US, Australia and most South American and European countries in the depth and range of financing vehicles available to farmers. Farm Credit Canada and the Chartered Banks do an outstanding job of lending to Canadian farmers. But sale-leaseback businesses like Bonnefield play an important role in providing an alternative to debt. Private equity players are also needed, as are farm sub-debt providers, revenue streaming companies, equipment leasing, cooperatives and other innovative capital providers. In short – farmers should have the same access to investor capital that other Canadian industries have.
POINT 4: The biggest threat to Canadian farmland is not who owns it. the biggest threats are urbanization and re-zoning and the conversion of farmland for real estate development, quarries and industrial uses.
Indeed, our largest transaction to date was our purchase in 2013 of a large tract of mostly class 1 farmland located in Dufferin County, Ontario, from a US-based hedge fund that wanted to convert it into what would have become North America’s largest aggregate quarry. I am proud to say that 3 years after Bonnefield purchased this land with institutional capital, it is now being sustainably farmed by 6 local farm families, and some 30 farm buildings and 24 houses that were mostly vacant and in various states of demolition and depopulation, have been repaired, sold and now house families who contribute to the local tax base and a vibrant and growing local community. We have been proud to support and work with local groups such as Food & Water First and the North Dufferin Agricultural and Community Task Force, who are examples of grass-roots community groups who have been open to institutional investment as a means of protecting and enhancing their local farm communities, and who present a fantastic model of “how to do it right” for other Canadian farm communities faced with similar threats to their farmland and water resources.
Statistics Canada reports that 2.4 million acres – 2.6% of Canada’s arable land – was lost, primarily to urbanization, in the decade between 2001 and 2011. This is a staggering statistic that dwarfs all other threats to Canadian farmland.
Keep in mind, however, that it is not just institutional and foreign investors who threaten farmland with conversion and redevelopment. There is an old adage that farmers are cash poor but asset rich. As Prof. David Connell from University of Northern British Columbia told this committee in November, farmers sometimes have a perverse incentive – especially those who have made the decision to retire or who live on the fringe of urban centres – to seek rezoning of their land and to sell to it to developers. This is a problem that sale-leaseback financing of the type Bonneield provides, can help solve. With a sale leaseback, a farm family can access some of the equity locked up in their land, without the need to sell it to a developer.
However, preserving and protecting our farmland from the very real threats of urbanization and re-zoning, is remarkably simple. It requires little, if any new regulation. It requires no change in farmland ownership regimes. It does not require Senate Committees to delve deeply into agricultural policy. It is as simple as enforcing existing zoning regulations already on the books of every municipality, in every farming region of Canada.
We believe that rezoning high-quality farmland for non-agricultural use should be expressly prohibited everywhere in Canada. Rezoning applications for farmland should not be the purview of unelected officials (as with the OMB in Ontario) or elected municipal officials who often favor rezoning as a means of increasing their local tax base. We recommend that rezoning applications for high-quality farmland should not be permitted, except with the agreement of elected government officials at the highest levels and only in exceptional circumstances deemed to be in the national interest. Full stop.
POINT 5: Foreign ownership of farmland is not a widespread problem in Canada
As other presenters have repeatedly told this Committee, there are no reliable data on foreign ownership of farmland in this country, and we need to begin collecting and monitoring such data. But what evidence there is, suggests a low level of foreign ownership in most farming regions across Canada.
We have included in your materials, an article by Prof. Brady Deaton Jr. which reports on a survey conducted by the University of Guelph which estimated that non-Canadian ownership of farmland in Ontario (where foreign ownership is not restricted) at approximately 1%. Our experience at Bonnefield supports this conclusion: in the past 6 years we have examined many hundreds of farmland transactions undertaken by ourselves and others, yet we are aware of only a handful of transactions that involved a non-Canadian purchaser – and in these few cases it was typically a non-Canadian who was moving to Canada to become a farmer.
We are aware of, and deplore, isolated purchases of farmland by non-Canadians in places like the lower mainland in BC, where farmland has been taken out of production and where the owners benefit from tax breaks intended for bona fide farmers. But these examples are not reflective of a widespread problem across the Canadian farm sector – and could be easily addressed through local zoning and tax regulations.
In our view, the bigger (and better) question to ask is this: Does it really matter who owns farmland in this country? Unlike other natural resources like oil, water, and minerals, farmland can’t be exported or removed from Canada. And from a farmer’s perspective, if he or she can obtain better terms from non-Canadian investors than from Canadian investors, why shouldn’t they be allowed to access foreign capital just like every other Canadian business owner can?
My bigger concern is not who owns Canadian farmland, but who farms Canadian farmland. We believe that Canadian farmers should farm Canadian farmland. And we’ve put our money where our mouth is: 100% of Bonnefield’s capital has gone to supporting Canadian farm families.
We respect the decisions of provinces like Saskatchewan and Manitoba to restrict farmland ownership to bone fide Canadians and landed residents. We view these regulations as well-intentioned but they are not evidence-based and they are short-sighted because they inadvertently:
- restrict the flow of capital to farmers, making them less competitive
- force farmers in those provinces to rely more heavily on debt than they otherwise would; and
- reduce the value of their farmland below what it would be in a free and open market, and thereby destroy the wealth and nest eggs of many farm families.
If we truly believe that farmland must be protected from foreign ownership – something that we do not see as a problem – there are far better ways of regulating it than by restricting the flow of capital to the sector. Why not follow the example of other industries that Canadians have determined are nationally sensitive – like our broadcast industry and our banking industry? In these cases we have devised ownership regulations that ensure these sectors remain majority controlled by Canadians without unduly restricting capital investment from institutions and non-Canadians. Why not, for example, follow the precedent set in Alberta which has adopted regulations that require farmland to be at least 51% owned by Canadians (including Canadian institutions) and – more importantly – farmed by Canadian farmers?
So to wrap up, we recommend that this Senate Committee advocate for responsible, evidence-based regulation of farmland ownership in Canada; regulation that protects farmland from the larger threats posed by urbanization and re-zoning. But in advocating for responsible regulation, we ask the Committee to consider measures that will not prevent Canadian farmers from accessing the capital that they desperately need – including institutional capital – to compete against global competitors in a capital-intensive industry.
Thank you for your time and attention.
Wally and I would now be happy to answer any questions you have.
US farmland prices, particularly in the Mid-West, are moderating and in some places actually declining modestly from their peak in 2013/14. US farmers have faced headwinds from a strong US dollar, soft USD-denominated commodity prices (particularly for soy and corn) and a continuing drought in some parts of the country. In contrast, the outlook for Canadian farmers continues to be bright. Farm Credit Canada recently forecast that farm cash receipts will increase by 5.8% in 2016 and increase further by 3.8% in 2017. Moreover, in a report released in September, FCC further highlighted the current financial strength of the Canadian farm sector relative to historical trends:
- liquidity is strong with a current ratio of 2.40, in line with the sector’s 15-year average;
- historically low debt-to-asset ratio of 15.5% vs a 15-year average of 16.7%; and
- return on assets of 2.3%, not far off the 15-year average of 2.6%
Why is the outlook for US farmers so different than for Canadian farmers? And how likely is it that soft or declining farmland prices in the US will lead to a similar trend in Canada?
In previous blog posts I’ve discussed the primary reasons for continued optimism for Canadian agriculture, despite the difficulties faced by the US sector, such as: stabilizing crop prices, a favorable and stable USD/CAD exchange rate, and robust export demand for a broad range of crops produced by Canadian farmers (especially canola and lentils) and the strong financial position of Canadian farmers.
In addition to these factors, there are structural differences between the Canadian and US agriculture sectors that tend to insulate Canadian farmers (and, therefore, Canadian farmland prices) from declining corn and soy prices that are the primary cause of US farmer’s current difficulties. At Bonnefield, we frequently point out the competitive advantages of Canadian farmland in terms of access to water, a more benign outlook for climate change and less degradation of soils.
However, a less-well understood advantage of the Canadian farm sector is its broad diversification. Canadian farmers are far less leveraged to corn and soy prices than their US counterparts. A staggering 178 million acres, or some 55% of all US crop land, is seeded to either corn or soy. That’s a significantly larger land mass than the entire country of France, devoted to the production of only two crops. In contrast, only about 13% of all Canadian farmland is used to grow corn and soy. Phrased differently, the entire Canadian corn and soy crop, covers only 5% of the land mass used to grow these crops in the US, an area much smaller than the Province of Nova Scotia. This fact is the single biggest reason why US farmland prices are so much more heavily levered to corn and soy prices than Canadian farmland.
The charts above illustrate the greater diversification of the Canadian agricultural sector. Indeed, if the US acres devoted to cotton production (a crop not grown in Canada) were removed from these figures, it would illustrate even more dramatically how leveraged US farmland prices are to the market prices of corn and soy.
An additional factor that exacerbates US farmers’ vulnerability to declining corn and soy prices is the prevalence of mono-cropping in the US corn and soy sectors. A combination of unique climate and agrological factors enable some large-scale US farmers – particularly in the Mid-West – to avoid traditional crop rotations and pursue mono-cropping of a single crop year after year. This practice is virtually non-existent in Canada. Mono-cropping puts additional stress on soils and requires intensive farming techniques involving significantly higher use of fertilizers, herbicides and pesticides in order to achieve consistently high yields year after year. The higher costs involved in these intensive farming techniques are not much of a concern in times of high and rising crop prices. But in a soft price environment, higher costs contribute to tighter margins and less financial resilience – a trend we are currently seeing in much of the US farm sector.
So are softening US farmland prices a leading indicator of what could happen to Canadian farmland prices? Potentially, but not likely. US farmers are far more exposed to soft corn and soy prices than Canadian farmers. Canadian farmers benefit from (i) greater crop diversification, (ii) strong demand, high prices and less international competition for leading Canadian crops like canola and lentils, (iii) a favorable US/CDN exchange rate, (iv) strong financial fundamentals of the Canadian farm sector, and (v) a bright outlook for continued farm profitability. In our view, any softness in Canadian farmland prices would likely be short lived and represent a buying opportunity.
A more likely scenario is that Canadian farmland appreciation rates will revert to long-term norms after several years of outsized growth in the 2010-2014 period.
Water is a central component of the Canadian farmland investment thesis – indeed Canadian farmland (as distinct from US or other farmland) might be seen as a proxy for investing in water itself for several reasons:
- Because the impacts of water shortages, droughts and climate change are anticipated to be less in Canada than in most other major Ag exporting countries, it stands to reason that Canadian farmland should, over time, attract premium values as compared to farmland that is more subject to these risks.
- As relative yields suffer and/or even decline in other parts of the world, it is anticipated that yields will increase in Canada (along with Brazil and potentially Russia). We are already seeing this trend in a significant shift in the corn belt north and west into Ontario and Manitoba.
- Some Canadian farming regions like Temiskaming and Grand Prairie should benefit disproportionately as compared to other countries and other regions that face climate, water and drought pressures.
- It is becoming apparent that China has adopted a policy of effectively “importing water” from countries like Canada by increasing imports of water-intensive products like soy and corn and concentrating domestic production on more less water-intensive crops due to the serious drought and water pollution issues they face at home. This trend will benefit Canadian farmland disproportionately as compared to farmland in water-stressed regions.
We here at Bonnefield view water as a key competitive advantage of Canadian farmland as compared to farmland in many other parts of the world. This is not to say that farmland in some parts of Canada will be immune from periods of drought as climate change progresses. But drought-related risks in Canada tend to be location and property specific. It could be argued that for Canada as a whole, the bigger water-related risk over time will be too much water as opposed to too little, since much of Canada is expected to see increased precipitation as a result of climate change rather than less. The risk of excess water is as important a consideration as too little water, when Bonnefield invests in farmland. Do the soils have natural drainage characteristics or can excess moisture be mitigated through tile drainage and surface shaping? Conversely it may be best to avoid investment in properties and regions that face a significant drought risk that can not be mitigated through some combination of irrigation or high-quality, moisture-retaining soils, etc.
Overall, Canada can expect to suffer less stress from climate-induced water shortages than many other parts of the world. Canadian farmers will certainly face increasing challenges in some parts of the country from both drought and excess moisture, but on the whole, these risks should be manageable through careful farming techniques and proper risk mitigation.