Lease Negotiations

Lease Negotiations Annie’s Project Coweta Oklahoma February 20, 2007 Cash and share lease agreements  What portion of the income do I receive?  What portion of the costs do I contribute?  What portion of the risk do I bear?  What crop and land management practices will be followed?  What will be the condition of the land and improvements at the end of the lease? Cash lease agreements  Tenant pays landlord a fixed amount per acre per year.  May be single or multi-year.  Government payments go to tenant.  Can add flexible component. Cash lease advantages Landlord  More stable income  Payment can be scheduled for any time of year  Eliminates or greatly reduces cash expenditures  Reduced management responsibility  Shifts risk  Fewer potential conflicts about sharing and marketing crops Tenant  Total managerial freedom  Fewer chances of conflict over decisions  Receive all benefits of a “good year” and superior management  Eliminates time and effort associated with dividing crops and input purchases as well as the related record keeping Cash lease disadvantages Landlord  Can become inequitable due to changes in prices, costs and technology  Fewer opportunities for income tax management  Will not realize benefits of good price and/or yield years if the agreement is not flexible  Greater chance of soil depletion, neglected improvements Tenant  Must shoulder all the price and yield risk if the agreement lacks flexibility  Large capital requirements for inputs  May be required to pay part of the rent early in the year before the crop is planted  Landowners may attribute above average yields to soil rather than management Adding flexibility to the cash agreement  Can reduce need for frequent adjustments  Distributes more of risk  Price risk adjustment  Multiply base rate by actual price/estimated price Multiply base rate by actual yield/estimated yield  Yield risk adjustment  Share lease agreements  Landlord and tenant share proportionally in costs and risks of production, then share benefits accordingly  May be single or multi-year  Government payments shared in same proportion as crop Share lease advantages Landlord Tenant  Receives benefits of good price  Less capital may be required and/or yield years  Less experienced tenants can benefit from the landowner’s  Land and improvements are managerial input more likely to be maintained  Share price and yield risk with  Relieved of some operational landowner decisions  Easier to establish “material participation” Share lease disadvantages Landlord  More variable income and increased risk  Need to discuss management practices with tenant on a continuing basis  Increased capital requirements associated with share of cash expenses  Must maintain records of shared expenses  Increased responsibilities  More possibilities for conflicts with tenant Tenant  Need to discuss management practices with landlord on a continuing basis  Joint decisions result in more opportunities for conflicts  Must share benefits of a “good year” and superior management  Must maintain records of shared expenses and divide crops Put the agreement in writing!  Encourages understanding by both parties  Serves as a reminder of terms agreed upon  Legal resource and guide for heirs Consult with a lawyer. Terms that should be specified in all agreements  Parties to lease and description Date the lease is entered into Names and addresses of the landlord and tenant Legal description of the leased property Binding to heirs Signatures of the landlord and tenant Terms that should be specified in all agreements  General terms  Beginning and ending dates of the lease  Rental amount, respective shares  When and how rent will be paid and penalties for late payment  Who will carry insurance on the property and crop  Statement that no partnership is intended  Conditions under which the tenant may or may not sublease the property  Records to be kept Terms that should be specified in all agreements  Termination  When and how the lease may be terminated  Requirements for notice of termination  Acts of the tenant that would constitute default of the lease  Reimbursement provisions for crop nutrients, lime and/or completed fieldwork upon termination of the lease  Tenant’s rights if the property is transferred or condemned during the lease period.  Reimbursement provisions for a crop in the ground when the lease is terminated. Terms that should be specified in all agreements  Operation and maintenance  Desired or prohibited farming practices, including types of chemicals that may not be used on the property  Process of measuring and maintaining soil fertility and pH levels  Which party is responsible for controlling noxious weeds  Which party is responsible for maintaining fences  Whether the tenant has the right to make improvements and be compensated for improvements, terms for reimbursing tenant Terms that should be specified in all agreements  Operation and maintenance (continued)  Stocking rate  Whether the tenant has the right to utilize improvements made by the landlord.  Provisions for soil-conservation practices.  Statement regarding the existing environmental status of the property and responsibility to minimize activities that may cause contamination.  Use of non-cropland, garden plots, trees, buildings, grain bins, pasture or other areas not rented for cropland. Terms that should be specified in all agreements  Landlord rights and government payments  Landlord's right to enter the property for specific purposes (entry, hunting and fishing, harvesting pecans)  Landlord's right to a security interest in the crops or other provisions for ensuring payment.  Statement of which party will participate in federal farm programs, including responsibility for eligibility and receipt of payments.  Nature of landlord participation in management (may impact income and self-employment, taxes, social security payments, and estate planning) Terms that should be specified in all agreements  Arbitration of differences Provision that any amendments must be in writing and signed by both parties. Procedure for resolving disputes, including the applicable state statutes. Terms that should be specified in all agreements  Crop-share provisions  Sharing of crops and tenant's contribution of machinery and labor.  Sharing of operating expenses.  Storage and/or delivery of landlord’s share of crops.  Compensation upon termination of the lease.  What records are to be kept by whom and how will this information be shared. Terms that should be specified in all agreements  Miscellaneous Willingness to sign security agreement Plan to pay property taxes, repairs, insurance on improvements Compliance with FSA, NRCS, other agency requirements Mineral rights Other environmental clauses What is fair? What is not fair?  Fair does not equal legal.  Legal does not equal fair. Everything is negotiable up front. Determining a Fair Cash Rent  Market approach  Landlord’s ownership costs plus return to equity  Residual income method Northcentral Northwest East Southwest Oklahoma Farmland Leasing Regions Average Annual Dryland Cash Rental Rates ($/acre) NW Wheat Alfalfa Grain Sorghum Native Pasture Bermuda Other Pasture 7.06 2-15 10.13 5-30 12.55 7-20 12.15 2-30 10.12 2-30 13.60 2-30 18.20 10-40 Source: OSU CR-216 and CR-230, 2005 SW 29.93 15-47 NC 34.80 8-50 E 31.43 10-45 State 30.21 8-50 39.62 25-90 25.60 18-45 9.66 2-30 13.09 2-30 15.87 6-40 27.63 10-46 Dryland Wheat Cash Rental Rates 40 35 30 25 20 15 10 5 0 37 31 20 9 2 < $10 $10-19.99 $20-29.99 $30-39.99 $40-49.99 Rental Rate ($/acre/year) 2 >$50 % of Responses Source: OSU CR-230, 2005 Determining a Fair Cash Rent  Landlord’s ownership costs plus return to equity Property taxes on land Improvements     Repairs and maintenance Property taxes Insurance Depreciation $2 Desired return on equity $800 @ 4% Determining a Fair Cash Rent  Residual income method  Returns  Grain, government payments, other  Variable costs  Seed, fertilizer, chemicals, fuel, harvest costs, labor, etc.  Fixed costs  Machinery and equipment depreciation, interest on investment, taxes, insurance  Management fee (e.g., 5-8% of gross receipts) Review wheat budget  Establish expected returns to overhead, land, risk, management  Determine what each party is contributing. Overhead Risk Land Management Determining a fair share rent  Determine the percent contribution of total value of fixed items contributed by each party  Share variable expenses in the same percentage as crop is shared  Adjust share arrangements to reflect the impact of new technologies, improvements, land quality  Share total returns in the same proportion as total expenses are contributed  Compensate tenant at the end of the lease for the unused portion of investments Valuing fixed contributions  Land    “Safe” rate Divide annual cash rent by per acre land value Divide per acre net income by per acre land value  Machinery and equipment  Management  Percent of average capital invested  Percent of gross farm receipts  Labor Typical Oklahoma cropland share lease agreements Income items shared Crop Gov’t. payments, other income Expense items shared Seed None Landlord’s share 1/3 1/3 Fertilizer Pesticide Chemical applications Harvesting Lime application Irrigation 1/3 1/3 (or none) 1/3 (or none) None 1/3 None (or 1/3) Source: OSU CR-230, 2005 Tenant’s Share of Herbicides 45 40 35 30 25 20 15 10 5 0 41 45 12 0 0 0 1-35 1 36-63 64-71 72-99 100 Percent of Responses Source: OSU CR-230, 2005 Tenant’s Share of Lime Application Costs 40 35 33 N=34 37 % of Responses 30 25 20 15 10 5 0 0 0 1 - 35 36 63 64 71 10 3 72 80 0 81 99 17 100 Landlord's Share Source: OSU CR-230, 2005 Effect of land quality and farm cost on crop-share rental arrangements Annual yield per acre Costs ½ tenant 2/3 tenant Annual operating cost per acre ($) Most productive land Least productive land Coming to agreement....  Both tenants and landlords should estimate their contributions to production  Use of area standards or traditions may not be in the best interest of either party  Worksheets and spreadsheets are available to summarize contributions and analyze alternatives  Equitable agreements are negotiated References http://osuextra.okstate.edu/, choose Department, Agricultural Economics         Oklahoma Pasture Rental Rates, OSU CR-216 Oklahoma Cropland Rental Rates, OSU CR-230 Developing Cash Lease Agreements, OSU F-214 Developing Share Lease Agreements, OSU F-215 Tax Aspects of Leasing, OSU WF-940 Tax Consequences: Cash vs. Crop Share Leases, OSU WF-941 Breeding Livestock Lease Agreements, OSU WF-571 Stocker Lease Agreements, OSU WF-572 Also, MidWest Plan Service website located at http://www.mwpshq.org/ To do  Develop written agreements  Review agreements annually in advance of the renewal date  Update, modify agreements when the operating environment changes significantly