FSR 2007 Developing Fair Rents for Farmers Landowners

FSR 2007 Developing Fair Rents for Farmers & Landowners Don Breece Farm Management Specialist OSU Extension What is Fair? • Average rate of return • Should cash rents be to farming over time is based upon between 3 and 5 %. productive capacity of the land? • Example: $3500 farmland * 4% • What about drainage (risk)? = $140 (plus • How should something for RE government Taxes) payments be Is this fair? factored? Indiana Land Values & Rental Rates 2003 Land Top Aver. Poor Value $2715 $2173 $1630 Corn Yield 157 127 98 Rent $140 $112 $86 Rent/Bu $.89 $.88 $.88 Fixed Number of Bushels Per Acre or as a “Rule of Thumb” The range could be 25% - 35% of expected yield with the higher rate on more productive ground. Example: 165 bu. Corn @ $3.10 plus value of Direct Payment of $22 X 33% equals $ 176 rent Landlord & Tenant Views • Fixed Cash Rent • Flexible Cash Rent Risk Profit • Share Rent Complexity • Custom Farm Cash Rent-Fixed Price Flexible Cash Rent Flexing for Both Price and Yield Ratio Method: 1) Base Rent x Local Price x County Yield Base Price Base Yield An example for soybeans might be: $95 x $ 8.00 x 45 = $ 142.50 $6.00 40 2) Percent of the harvest time crop value Flexible Rent Based on Both Price and Yield (cont.) • $125 x (local price/$2.50) x (county yield/140), plus half value of FSA direct payment. Price determined by the average of local elevators close on the second Monday of December-April. Flexible Rent Ideas • Consider both a minimum and a maximum rent, plus some type of crop insurance to control the risk. • Under a flexible lease, a split payment can be incorporated. The advance payment may be for the fixed amount, while the variable portion becomes the final payment. Cont’ • Flexible rents almost always require the agreement to be in writing. • Reviewed by an attorney. Follow FSA Guidelines ! Share Rent • Generally thought to be very fair to both parties • 50%-50% most common, but may require some adjustments: Who pays for liming? Custom spraying? Will the landlord pay for harvesting? Will No-Till change the percentages? Custom Farming Custom operator performs all the machine operations for a set fee Landowner pays for all seed, chemicals and other inputs and keeps all the crop Custom Farming – Farmer’s View • • • • • • Less returns over time Reduced risk Spread machinery cost over more acres Enhance cash flow – known returns No cash outlay for production inputs Knowledge of machinery cost? Custom Farming – Landlord View • • • • • • Interested in Maximum Return Ability and mindset for risk taking Assumes all cost for production Markets all the crop Receives all government program benefits Material participant for tax purposes Responsibilities/Questions • • • • • • • • • • Close communication Accurate acres Agreed upon field operations Freedom to modify the plan? Who scouts the fields? How are inputs purchased? How is decision to harvest made? When are custom payments made? Fixed rate or paid by operation? Bonus for yield or performance? FairRent Provides the Information Required to Answer Your Questions • How much can I afford to pay per acre? • What if yields are 10 percent below historical averages? • Can cash costs be covered if prices go down? • What yields will it take to break even at the asking price? • Which is better, a 60/40, 50/50, or 45/55 share rental arrangement? FairRent output provides a full analysis of the land rental picture, including cash and share rental analysis, comparisons between differing rental arrangements, and rent sensitivity based on variations in prices and yields. FairRent can also be used to calculate the yields and prices required to break even at a specific cash rental rate. FairRent evaluates both cash rental and share rental arrangements based on expected yields, prices, government program payments, and expenses. The results calculate a break even cash rental rate and help develop a realistic bidding range for cash rental negotiations. The share rent results show whether sharing production and expenses will result in a fair economic return for the operator. Sample Analysis using OSU Extension Budgets • Current projections for 2008 • Assuming 999 acres cash rented • Three OSU Budgets used for a rotation of Soybeans-Corn-Corn 2nd year • All costs are covered to include: interest, machinery, operator labor and management • The most one could bid for rent (what remains) or breakeven across all crops is $158 from this example. • Remaining for rent from each crop: Soybeans $221, Corn $159, Corn 2nd yr. $ 95 Sensitivity tables show how break even bids change with varying yields and prices, to include government payments Written Farmland Leases A written agreement can go a long way in preventing bitterness, misunderstanding, unfairness and costly legal proceedings. A HANDSHAKE IS NOT ENOUGH! Farm Lease Requirements Term Up to 1 year 1 to 2 years 2 to 3 years Legal Requirements Verbal is enforceable. Must be in writing and signed by both parties. Must be in writing, signed by the parties, notarized, & recorded in the county where the land is located. Must be in writing, signed by both parties before two witnesses, notarized, & recorded in county where the land is located. 3 years or more Memorandum of Lease • Maybe used to record a lease at the court house by providing only enough information to let a future buyer know the land is under lease. Written Farmland Leases Advisable to have an attorney for one party prepare the lease, with review by the attorney for the other party Items to consider: – Time period of the lease – When and how rent is to be paid – Penalties for late payment Written Farmland Leases Items to consider: (cont.) – Notice of termination – Prohibited farming practices – Landlord right to cancel – Federal Farm Programs – Arbitration of differences – Not an intended partnership – Tenants rights if land is transferred Time Period Covered The provisions of this agreement shall be in effect for ___year(s), commencing on the _____day of _____, 20__. This lease shall continue in effect from year to year thereafter unless written notice of termination is given by either party to the other at least ____ days prior to expiration of this lease or the end of any year of continuation. NCR-76 Lease Termination • Periodic Tenancy: Initial period of time, renews automatically unless proper notice. • Tenancy for Years: Lasts for a specific period and automatically terminated. • Notice of Termination: Ohio does not define a notice period. Case law suggests written notice at least 3 months prior, some courts require 6 months. Ohio’s “statute of frauds,” which prevents abuse of verbal agreements, a contract lasting for more than a year must be in writing and signed… Exception: The rule of partial performance… …Where one party has begun performing under the verbal agreement, the law will enforce the agreement even if it is not in writing. No Partnership Intended It is particularly understood and agreed that this lease shall not be deemed to be, nor intended to give rise to, a partnership relation. NCR-76 Binding On Heirs The provisions of this lease shall be binding upon the heirs, executors, administrators, and successors of both landlord and tenant in like manner as upon the original parties, except as provided by mutual written agreement. NCR-76 Conservation Control soil erosion according to an approved conservation plan; keep in good repair open ditches, inlets and outlets of tile drains; preserve all established watercourses or ditches including grassed waterways; and refrain from any operation or practice that will injure such structures. NCR-76 Building Rental Must cover the DIRTI costs: Depreciation Insurance Repairs Taxes Interest May total 12 to 24 % of building value/year Also, will there be utilities to be paid? Taxes on Cash Rent • Generally landlords use Schedule E to report income and expenses • Income on Schedule E is not subject to Self Employment Tax • Unless, the landlord is materially participating in the farming business. If M.P., SE taxes will be collected from agriculture commodity profits Shared Rent Income Tax Reporting • Either Schedule F or Form 4835 may be used by share rent landlords. • Income reported on a 4835 is not subject to SE Tax • Allowed to report on Form 4835 only if not materially participating in the farm business under rules of IRC § 1402. Fair Rent Computer Program • University of Minnesota Center for Farm Financial Management sells the computer program for analysis of fair rent. www.cffm.umn.edu http://ohioline.osu.edu Fact sheets---Farm Rental Series