LEASING LAND WORKSHOP

David Armstrong

AK Consultants

19 July 2010

Issues to discuss

Leasing options/definitions Objectives, tenant and landowner Risks and rewards The lease agreement The financial value Other issues Golden Rules

Leasing or share farming Difference – who takes the risks Production and market risks Lease – tenant usually carries the risks Share-farming; risks are shared

Leasing, for a paddock or property; short or long term. General principles apply.

Objectives Landowner and tenant – may not be “in

sync”

Landowner - Income - Resources maintained or improved

Tenant – Profit - Growing his business - Increasing scale

So, why lease land? In 2008/09 69% of Tasmanian Farms had

EVAO < $150,000

So, lease to gain economies of scale.

Owner of a small operation can not justify modern, efficient and large scale equipment.

Lessee can justify newer and more productive equipment.

Tractor overhead costsExample, 130 HP FWA tractor, 2007 costs

Overhead costs include interest, depreciation, insurance, shedding, registration

Hours use/year Overhead cost, $/hour

250 hours (2.9% of a year, 5 hrs/week)

$75/hr.

500 hrs(5.7%, 10 hrs/week)

$39/hr

1,000 hrs(33 hrs/week, 30 weeks)

$20/hr

1,800 hrs(38 hrs/week 48 weeks)

$12/hr

Other benefits of scale

More efficient, reliable and safer equipment is justified.

Larger businesses - better negotiating power.

More worthwhile investing in training and research.

More attractive to contracting companies.

So, a tenant may bring something of higher value to land that the landowner cannot.

Risks for the land ownerRisk Mitigation

Tenant degrades land (soil) or pasture

Agreement – cropping intensity - Fertiliser applications

Tenant does not maintain infrastructure

Agreement – details maintenance - Check initial condition - Document condition (photos etc) - Owner to maintain - Be realistic

Tenant does not pay Agree on payment procedure and late penalty

Tenant over-stays Agreement – penalty for late exit

Tenant cannot afford lease fee Owner to be sympathetic?

Risks for the land ownerRisk Mitigation

Tenant does not meet owner’s expectations

Expectations to be documented

Tenant does not meet agreement

Agreement to have dispute resolution procedureOwner to check references

Owner may want to sell Be aware of the constraint.First offer to tenant.

Tenant over-stays Agreement – penalty for late exit

Dispute with tenant Communicate early.Have resolution procedure.

Benefits for the land owner

Potential benefits Ensuring the benefit

Rental income Agreement – payment procedures - Penalties for late payment

Releases owner from work

Releases owner from production and market risks

Opportunity to do other things; e.g. earn income elsewhere.

Retains benefit of appreciating land value

Risks for the tenantRisk Mitigation

Crops do not perform Check land beforehandCheck water securityBonus or increase/reduction clause in the lease agreementBudget conservatively

Markets fall income reduced Tie lease fee to market; or bonus?Budget conservatively

Insufficient capacity to handle the larger area

Make sure resources adequate

Inability to meet agreement Communicate early

Dispute with owner Communicate directly and earlyNegotiate a solution

Benefits for the tenant

Potential benefits Ensuring the benefit

Increased scale with economies

Apply skills etc to larger area

Increase scale without financial risks of land purchase

Business growth without purchasing land.

Improved profitability Make sure you have a good agreement with the landowner, & communicate

The Lease Agreement Must have a written agreement.

Define the area & exclusions

What else is included; particularly water

Duration, options or rights for renewal. Is renewal a right for the tenant; what conditions Rolling leases.

Premature departure by the tenant; replacement with another tenant?

The Lease Agreement Agreed departure date.

Penalty for late departure Delay could preclude future cropping opportunity

Commencement date; Autumn is often a good time.

Payment; amount, timing, procedure. Annual fee adjustment, cpi

The Lease AgreementRepair and maintenance issues Agreement – maintain present condition

record what that is at start

Soil fertility – agreed fertiliser. Tenant to provide evidence, or Owner applies. Apply extra to hay/silage paddocks. Consider sale of hay/silage from the property.

End of lease – same pasture area

Weed control – specify weed species

Fences, yards, buildings, roads etc.

The Lease Agreement

Cropping paddocks. Specify cropping intensity Paddock to be sown down at end of lease

Access to water Who has priority of limited

Capital improvements – clarify ownership

Conflict resolution – establish a procedure

Other payments – rates, licences insurance etc

Valuing the lease

Percentage of land value

Percentage of Gross Margin

Percentage of Gross Income

Check the market; real estate agents.

Valuing the lease

Percentage of land value

Historically, 4-6% for grazing 6-8% for cropping

These values now too high

Perhaps double what is realistic

Valuing the lease Percentage of Gross Margin

25-33% of GM. Level depends on risk.

The remainder is required for: Contribution to overhead costs, including R&M Contribution to interest Return for the Tenant’s time and effort Return for taking the risks

Examples: Sheep, GM ~$25/dse, lease 33%, $7-8/dse Potatoes, GM $4,000/ha, lease 25%, $400/ac.

Valuing the lease Percentage of Gross Income

16-22% of Gross More common in US for cropping land, 20%

Justifiably lower here because tenant has more maintenance obligations.

Value of water

Should water be valued separately?

I suggest not.

The cost of land and water should not be more than 25-33% of the GM.

Leasing livestock

Sometimes considered.

Value is the interest cost, and for the risk.

Requires continuation of breeding strategy.

Leasing equipment

I generally advise against including equipment in a farming lease:potential for disputes over maintenance.

Who is responsible for maintenance?

Objectives inconsistent.

Leasing a centre pivot

A Pivot is fixture.

Who is responsible for repair and maintenance? I suggest the tenant.

Responsibility for negligence?

Leasing cost for a centre pivot

What are the annual costs? If asset purchase ($6,000/ha capital, 6 years @ 7%), $1,258/ha.

Interest & depreciation over 15 years, $925/ha.

Share farming Shares risks and rewards.

Assume a Joint Venture approach: Owner gets a lease fee for the land. Share farmer engaged as contractor. Share farmer paid for management. The JV shares cash costs.

Proceeds shared equally.

Risks are shared equally.

Share farming

Joint Venture

Pays Owner for land

Pays SF for managing

Pays for materials

Pays SF workProfits divided

equally

Golden Rules

Benefits are not without risks. The potential for economies of scale. Tenant may allow land to be used for higher value

purposes. Responsibility and costs borne by beneficiary. Know and trust each other. Ensure documentary evidence.