Buying farmland? Do you have a plan?

The farm business, the raising of crops and livestock, creates income and provides the farm family with a revenue stream to cover its living costs.

Rick Dehod

A farmer does not have to own farmland to be in the business of farming, but ownership of farmland secures resources required to generate income and the equity in a fixed asset that allows the farm business to manage economic adversity or leverage for farm business opportunities.

As farmland values have appreciated, the funds required to purchase farmland has greatly increased. Many producers have considered either cash or leverage-investment purchases into an active farmland market.

With tightening margins, increasing costs and the possibility of interest rates rising, a well-researched farmland purchase plan will guard against ill-prepared emotional decisions.

A strong plan is required to determine if farmland purchase is the best use of your financial resources or other investment opportunities would provide a better return.

Producers have to decide, given their farm’s current financial health, if a farmland purchase makes more sense than leasing additional land. Having a plan is not only a financial plan but also a purchase plan regarding the physical property and the investment aspects of the purchase.

Before purchasing farmland, here are 16 questions to ask yourself and your farm business partners.

Why do you want to buy farmland? This question relates to the business plan and overall farm or investment strategy, where the farm is in its business life cycle and how this purchase fits with planned goals to expand, bring in a new partner, ensure control of productive acres, etc.

Determine if the decision is a business decision or an emotional decision, and if business partners are in agreement.
What is the farm business’s financial condition? Consider needed investments, expected expenditures and crop conditions to determine if buying land is the best use for your cash or if other opportunities would provide a better return.

Be sure the farm is financially healthy enough to handle the increase in debt and decrease in cash from the proposed purchase.
Have you created a pro-forma cash flow? Research the expected revenue of the potential land to determine if the purchase fits into your plans.

It is important to confirm that the potential return will meet your goals and objectives, and that the farm can service the additional debt. Know the risk this purchase will put on your current equity.
Given your revenue forecast, are you overpaying? If you are paying a premium land price, calculate how long it will be until you recoup your investment.

Determine how much debt your farm can prudently service and the total revenue required to service that debt. Be sure to stay within your limits; land purchase is a long-term commitment and investment.
Have you given it long and careful consideration? Never be rushed by a real estate broker, and never confide your best price or financial goals with the party working for the seller.

Don’t buy impulsively or make a deal before visiting the property numerous times. In Alberta, there is a standard real estate contract.

Most competent and experienced lawyers will be happy to meet with you prior to your making any offer and can provide useful advice as to particular matters to review in the area where you are buying.

It is not sufficient to add a clause such as: “Subject to lawyer’s approval,” as your lawyer is not allowed to change or renegotiate the basic terms of a signed offer and can only correct errors and mistakes.

Always obtain a current copy of title to see who is listed as registered owner. All owners must sign any real estate purchase contract or amendments to that contract.

As well, if there is a yard site on the property, dower consent from a spouse whose name is not on title may be required.In addition to ordering a copy of title, always order copies of all registered encumbrances such as easements, caveats or rights of way.

You need not necessarily worry about ordering copies of mortgages or inter-oil company transactions, but you should read and understand the wording of relevant encumbrances.

Consider asking the vendor about any verbal leases (leases for up to three years are protected without the need for a caveat to be filed).

It is much simpler to deal with verbal leases prior to making an offer than after the fact when you become the bad guy for going after the vendor for failing to disclose the lease.

It is often prudent to add a clause providing that the “Vendor shall terminate all existing leases (except registered surface leases) and pay and satisfy all claims for remaining field work and as may arise out of the termination of any farm or residential leases.”
Does it make more financial sense to lease the land than own it? Leasing rates have risen recently, but leasing versus purchasing frees up cash.

In making the decision, calculate what the total land payment per cultivated acre owned will be and how this compares to lease rates in your area.

However, it is often difficult to lease land for an extended term, and many landlords prefer the flexibility of shorter-term three- to five-year leases.

Even with renewal options added to a lease, many of the renewal provisions amount to a non-binding agreement to try to agree unless the rental payable during the renewal term is specified or clearly calculable.

As a result, you can face some uncertainty and risk if you are equipped to farm a set number of acres, but lose 20 percent or more of the acres if leases are not renewed.
Should you go all-in with your cash? Talk to your banker or accountant about alternatives to using all cash in the purchase transaction.

Land is an illiquid asset, and using all of your cash will impact your farm’s liquidity and possibly its ability to meet all commitments as they come due.

Look at the loan amortization length and resulting loan payments to see if the payments meet your cash flow and your ownership goals. A longer loan amortization with a prepayment privilege may provide less stress on cash flow should crop margins tighten.
How much land are you acquiring? This sounds simple, but many times there is confusion about how much land is actually being purchased. Know exactly what you’re getting before making a bid.

See if the buildings are actually on the property. Have a clear understanding of what are fixtures (buildings, fences, etc.) and what are chattels (equipment, i.e., portable corrals, grain bins on skids).

Chattels included in the proposed purchase should be scheduled in the offer to purchase.

In many cases, a vendor may leave old chattels behind after the closing date. Consider adding a clause to confirm that those chattels will be automatically transferred to you on closing or add a provision for a holdback of funds pending the vendor cleaning up any garbage or debris by a certain date.

Generally, a vendor should not change the condition of the property after accepting an offer, but it is a good idea to add a clause confirming that the vendor is not allowed to remove any fencing or corrals and is not allowed to cut trees or sell lumber rights or enter into any other agreements between date of offer and closing.

If the property boundary is not clear, or the building location and the property have not been surveyed, consider having the land surveyed and determine who will pay for it.

Make sure there are no special easements tied to the land. If there are, spend time studying them and understanding them completely. Alberta has a vast underground pipeline system, and building construction has specific setbacks from pipelines.

With the increasing size of farm equipment, specific equipment crossing points may be in the easements.
What is the current estimated market value of similar land? Find out if there are comparable sales available for your area. Although real estate appraisals and evaluation reports have a cost, they are the best indicator of land values.

Even if you don’t get a full appraisal, attempt to find some comparable sales to determine estimated market value. Talk to knowledgeable farm realtors and farm lenders; they often have the latest trends of farmland values readily available in your area.
What is the soil story? What is the capability of the soil you are buying and how does this impact your revenue forecast? Good soil is paramount. Know the soil you’re buying and the history of annual crop rotations with herbicide and pesticide applications.

With club root becoming more prevalent, these are important questions to ask. Any seller should be more than happy to provide you with information about past farming practices.
What is the water source? Is the property irrigated? Are water rights part of the purchase price? Adequate water is essential to establishing the value of the property.

Account for water cost in your financial plan to ensure this cost doesn’t negatively impact your return. Make sure all water wells are registered and licensed as required.
What do you know about the oil, gas, mineral and wind rights for the property? Are they currently under lease? Is the surface lease active and, if so, under what terms? Is the lease an assignable part of the purchase?

Have a thorough knowledge of property rights, as mining and drilling can have an impact on surface and water quality, access to the property, erecting buildings and the viability of the farm or ranch.

Be sure to determine if there are pipeline easements registered on title, and if there are legislative setbacks from pipeline easements varying on the size of pipe and what is flowing through that pipe. These can affect your use and the development of the property.
How is the property zoned? Before purchase, you need to know if your plans for the property could conflict with existing zoning restrictions.

Factors such as conservation easements (i.e., Ducks Unlimited) which could be a restrictive covenant regarding the use of the property can have a significant impact on your valuation of the property, particularly if your plans conflict with the current zoning or easement restrictions.

Make sure you understand the leases and easements that go with the property. Alberta has a lot of pipelines and power lines crossing properties. Obtain a copy of the land title at any registries office throughout the province.

Ask your county development office if there are any active or potential applications for development on any adjacent or reasonably close properties.
Are there any environmental problems? The last thing you want to buy is a costly environmental problem. Ask the owner regarding the history of the property.

Paying for an on-site environmental audit before you buy the land may be worth the cost and help ensure you’re not buying into an expensive cleanup.

Factors can include things such as any abandoned wells on the lands you are proposing to purchase.
How will you register the title to the property? Will you register it individually, jointly with a spouse, a partner, a family member or a family-owned corporation or trust? The pros and cons of how you own the land will depend on your long-term goals.

How does ownership affect your estate and succession plans when you decide to exit agriculture or transfer this asset to your successors? Seek the advice of your lawyer or accountant.
How long will you actively farm? Make sure your financing plan matches the rest of your intended career as an active producer. Will you fully retire all debt from the purchase before you retire?

Do you have sufficient life and disability insurance? Make sure you have enough cash to meet your living costs.

Buying land in this market is an important decision and will impact your farm business. Use all of the resources available to do your financial and cash flow planning.

Speak to your banker, your accountant or your farm adviser. Speak to your lawyer regarding issues that could affect title ownership. A strong purchase plan will aid in making the purchase of land a good investment.