5.7 / 20 - Farmland and Timber Investments

Question 1

LO 20.1: Demonstrate knowledge of the motivations for, and characteristics of, farmland investment.

Answer 1

• List and describe three motivations that drive investments in farmland.
• Identify three key characteristics of U.S. farmland investment.
• Discuss investment opportunities in non-U.S. farmland.
• Contrast returns to farmland investment with those of U.S. timberland investment.

Question 2

What are the three primary motivations for investors to invest in Farmland

Answer 2

1. Diversified return source - no direct link between farmland and financial markets in the short run. Typically unlevered, and
2. Inflation Hedge - inelastic supply curve, linkage to energy and food production, farmland serves as valuable inflation hedge
3. Position as an asset tied to energy, food, and water - It is expected that demographic and economic growth will create a demand for agricultural products that will exceed production capacities, which will result in prices rising for existing farmland and the development of new farmland.

Question 3

What are the three uniqe characteristics to farmland in the United States?

Answer 3

Although farmland is considered a global asset class, the three characteristics unique to farmland in the United States include:

1. The farmland and agriculture data that is available for the United States exceeds what is available for any other country.
2. U.S. farmland is primarily privately held and market-based, with material government activity/regulation. This is similar to farmland in mature international markets such as Australia, Brazil, and Eastern Europe.
3. In the United States, farmland is a mature, relatively stable asset that has been free historically from large disruptions in organizational form, market structure, and the political economy.

Question 4

Risks of International Agriculture

Answer 4

• Due to the increase in integration between energy and agricultural markets, potential risks may develop in terms of risk correlations and price levels.
• expropriation, which occurs when the government takes control/ownership of assets that belong to foreign investors, either utilizing direct tactics (forced asset transfers or nationalization) or indirect tactics (predatory regulations and discriminatory taxation).

Question 5

US Farmland vs. Timerland return trends

Answer 5

U.S. farmland investments have seen increasing returns over a long period (even with recent slowdowns in growth), U.S. timberland investments have shown significant price reductions over the past 20-plus years. This has resulted in volume reductions in transactions related to U.S. timberland assets and has led investors to seek out returns in non-U.S. timberland assets.

Question 6

LO 20.2: Demonstrate knowledge of the global demand for agricultural products.

Answer 6

• List the primary macro factors driving global agricultural demand and supply.

• Discuss how changes in worldwide populations, incomes, and food affect the
performance of farmland investments.
• Discuss how the increasing production of biofuels affects demand for agricultural product

Question 7

What is the global demand for ag growth rate

Answer 7

growth rates for global demand averaging 2% since the 1960s (and projected to grow at approximately 1.5% through the year 2030), agricultural products should continue to represent a valuable investment opportunity into the foreseeable future

The three biggest macroeconomic factors expected to drive this growth include increased usage of agricultural products in biofuels/other non-food-based uses, higher incomes in emerging markets, and overall worldwide population growth.

Question 8

LO 20.3: Demonstrate knowledge of investor approaches to accessing the returns of agricultural assets.

Answer 8

• List and discuss the three primary approaches to accessing returns from agricultural assets.
• Discuss approaches investors can employ to capture improvements in agricultural yield, and calculate the change in a given crop yield.
• Describe the main factors that have driven historical growth in agricultural yields.
• Discuss the determinants of agricultural profitability.

• Describe the effect of government agricultural subsidies on agricultural returns.

Question 9

What are the three primary approaches investrs can implement to access returns from agricultural assets?

Answer 9

1. Purchase agricultural futures and/or other related derivatives.
2. Purchase the listed equities of agricultural firms.
3. Purchase the farmland itself in order to earn lease incom

Question 10

Crop yield formula , and change in in each formula

Answer 10

measures agricultural productivity over a period of time - in units produced per unit of land

Question 11

Four advances have driven growth in agricultural yields:

Answer 11

• increasing use of inputs (e.g., fertilizer),
• increasing usage of capital assets (e.g., machinery) and agricultural infrastructure,
• improvements in technology - includes genetic advancement, which has played a major role. 50 to 60% of corn yield gains in the last 70 years of 20th century directly related to genetic enhacement.
• improvements in agronomy.

Question 12

LO 20.4: Demonstrate knowledge of the factors that contribute to the returns to farmland.

Answer 12

• Evaluate the historical returns to U.S. farmland.
• Discuss macroeconomic factors that explain U.S. farmland returns.
• Evaluate the heterogeneity of U.S. farmland returns.
• Explain characteristics of indices produced by The National Council of Real Estate Investment Fiduciaries (NCREIF), and describe the NCREIF Farmland Index.
• Describe the causes and consequences of the significant price appreciation observed in U.S. farmland over the period 2009–2014.

Question 13

Correlations for Agriculture based off spot prices for commodities from 1973 to 2009

Answer 13

A regression model showed an adjusted R-squared of 0.73 (making it statistically significant), with the most significant variables being:

• Consumer Price Index (CPI). Data indicates farmland is indeed a hedge against inflation because its relationship with the CPI is positive.
•Industrial production. Farmland’s relationship to industrial production is positive, suggesting that land prices are pro-cyclical, implying investors can buy farmland for growth, not simply as a store of value.
• U.S. Dollar Index. Higher land prices are related to a stronger dollar. This may reflect monetary policy or the external demand for U.S. land and agricultural products.
• Yield to worst. Yield to worst is a measurement used to determine the lowest yield on a fixed-income investment. Data on this measure indicate a negative relationship between farmland prices and interest rates. That is, higher interest rates imply lower farmland prices. This is logical in that higher interest rates mean higher investor-required rates of return and lower present values of future cash flows.

Question 14

LO 20.5: Demonstrate knowledge of investing in agriculture infrastructure

Answer 14

• Describe the four economic functions of agricultural infrastructure.
• Discuss three drivers of productivity of agricultural infrastructure.

Question 15

Describe Agricultural Infrastructure

Answer 15

consists of capital assets designed to enable and/or improve the efficiency of producing, handling, and distributing agricultural commodities.

Question 16

4 Major Economic Functions of Agricultural Infrastructure

Answer 16

1. Time. Harvested products can be stored in facilities that allow for delivery at critical times. These facilities also promote buffering and collection in order to improve efficiencies of scale in processing and transportation.
2. Location. Spatial efficiencies are improved by logistics and transportation, which allows for improved demand satisfaction and the optimization of inputs.
3. Input allocation and delivery. Fixed input delivery structures help to reduce production volatility, improve yields, and minimize the inputs needed per unit of output through controlled delivery.
4. Quality. Grading, blending, and basic processing facilities allow for the transformation of agricultural commodities into forms that are easier to trade, transport, and consume, as well as allowing for more efficient product matching with end users.

Question 17

The most critical economic function of agricultural infrastructure is the increase in productivity along the agricultural value chain. The three key drivers of agricultural productivity include:

Answer 17

• Specialization. Prescribed intertemporal crop rotation or monocropping.

• Extensification. Increasing or decreasing land use.

•Intensification. Additional inputs that lead to greater outputs.

Question 18

LO 20.6: Demonstrate knowledge of global investment in timberland

Answer 18

• Describe four key attractions to timber investment.
• Discuss the history and drivers of returns to timberland investing.
• Describe the risks associated with international timber investing.
• Evaluate the investment implications of timberland rotation.

Question 19

four key attractions to timber investment

Answer 19

1. The low cost of inputs (which leads to low sensitivity to rising prices).
2. The lengthy duration of the asset, which makes it suitable for matching to longer-duration liabilities.
3. The option to harvest, which represents a real option that will allow the owner to earn cash flows when demand is high.
4. The homogeneity of the products and overall usage throughout the economy, which reduces their sensitivity to price volatility.

Question 20

Specific risks of international timber investing include:

Answer 20

• • Currency risk*. Because timber investing tends to be a long-term proposition, hedging for currency risk is typically difficult and costly.
• • Legal risk.* The regulations that are applicable to land-based assets cover taxation, foreign ownership, indigenous rights, and environmental obligations. Much of this legislation tends to be relatively old and somewhat unusual. Also, environmental activism efforts may focus on timber-related projects.

Returns were comparatively higher IRR for non-U.S. based species.

Question 21

The time it takes (in years) for timber to achieve the size needed for economical optimal harvesting is known as (what term?)

Answer 21

rotation age.

Trees commonly require between 10 and 20 years (although this ranges from 5 to 60 years depending on species and location) before they reach a size that is optimal for harvesting. Once that time frame is passed, growth rates slow and timber may be harvested so new trees can be planted.

Question 22

LO 20.7: Demonstrate knowledge of farmland and timber investments, as compared with other real assets investments.

Answer 22

• Identify the investment characteristics of real assets.
• Discuss the risk and return expectations for agriculture investments.

• Discuss how the ease of investment, high liquidity, effective inflation hedging,
positive portfolio diversification, and low interest rate sensitivity of agriculture investments affect their appropriateness for an institutional portfolio.

Question 23

What are the characteristics that can make an asset a “real asset”?

(typically will have at least one of these)

Answer 23

• • Long term.* The asset offers long-term risk and return profiles that are appropriate for investors looking to fund their long-term liabilities.
• • Inflation hedge.* The asset has a positive correlation with either U.S. or European price levels.
• •Scarce input.* The asset tends to benefit from the increase in production input scarcity, primarily in economic sectors such as manufacturing, agriculture, and energy.
• • Intrinsic value.* The expectation is that the asset will maintain its value during difficult financial market periods or significant changes in the economic environment due to business cycle changes.
• • Economic infrastructure.* The assets represent key components to economic infrastructure, including transportation (air, roads, shipping, rail), the built environment (residential and commercial real estate), and major projects such as pipelines and telecommunications.

Question 24

Key Characteristics of Real Asset Classes

Answer 24