THE ART OF THE RENTAL DEAL
BY LEE HART • ILLUSTRATION BY JASON LIN
Renting rather than purchasing land can be a smart short- and long-term farming strategy. While it makes especially good economic sense for young, cash-strapped farmers starting out, land prices in the $3,500 to $6,000 per acre range make renting a sound strategy for established farmers as well.
The most important caveat in doing so, farmers and renters must put the rental or lease agreement in writing. Handshakes and verbal agreements are valuable, but for everyone’s protection and peace of mind, a properly worded, legally binding rental agreement helps both parties avoid disappointments, surprises and outright conflicts.
While most farmers in Canada continue to operate with owned or deeded land, the most recent Statistics Canada census shows that more cropland is being farmed under rental agreements. Across the country there has been about a 2.25 per cent increase in rented land in the years between the 2011 and 2016, the census reports.
Jonathan Small, chief research officer with Global Ag Risk Solutions, believes renting just makes sense given the increasing value of farmland across Western Canada. This challenges a long-established paradigm that farmers must own land. Small agrees it’s nice to own if you can, but urges farmers to consider sustainability and profitability over ownership.
“Young farmers are facing all kinds of expenses, and have limited resources,” said Small. “Many desire to own land, to emulate their parents, but they really don’t have the money to buy land. I urge them to slow down, take a deep breath and perhaps don’t worry about owning land. Think about being profitable.”
Small uses the example of two young farmers, striking out to farm in an area where all land quality is the same. Each is given $1 million. Young Farmer A takes his or her money, leverages it to borrow another $500,000 and then sets out to buy as much land and machinery as possible with $1.5 million.
Young Farmer B takes his or her $1 million, leverages it to $1.5 million, but decides to rent both land and machinery. Farmer B ends up farming five times more land, than Farmer A. They both apply the same skills and inputs to produce crops with the same yield.
“Farmer A may net more dollars per acre than Farmer B, but then Farmer A only has 20 per cent of the land base of Farmer B,” said Small. “Farmer B can use their profits to continue cropping more rented acres.
“Farmer B can improve their size and scale of operations and efficiency and hopefully one day have those surplus dollars that they can invest in buying land,” he said. “I have seen many situations where a young farmer pours every dollar they have into buying more land. In terms of farm growth, it is like putting both feet on the brakes—they don’t realize the implications.”
Small said renting also makes sense for established operations that need to grow as one or more children join the family business. It provides the flexibility to expand the farm, increase production and increase profits.
GET IT IN WRITING
Stuart Person, senior vice-president of agriculture with MNP, emphasizes the importance of having a proper rental agreement to protect both landlord
“As farmers plan to expand their operations, and with increasing land costs, we are seeing a larger percentage of rented crop land,” said Person. “And we are also seeing significant tracts of land owned by investors who are just looking for someone to farm it. Unfortunately, we still see too many of these rental deals based on handshakes or verbal agreements.”
Person recommends both sides create a rental agreement with a three- to five-year term. It can then be reviewed annually or at least a couple of times. Agricultural lenders and farm management advisors can provide advice in drafting these documents. Person strongly suggests rental agreements should be prepared or reviewed by a lawyer.
Farmers can face a variety of difficult and potentially expensive situations when no written agreement exists. For example, a farmer fills a grain bag in the fall and leaves it on rented land. If the land is subsequently rented to another farmer, when must the bagged grain be removed? Similarly, if a farmer applies anhydrous ammonia to rented land in the fall and in spring is informed the land has been rented to someone else, how will he be compensated?
Needless to say, if a farmer has built an equipment line around a certain number of acres, losing a portion can really mess with efficiency and economics. “With a three- to five-year agreement, both parties can have stability,” said person.
Alberta Barley region two director Jeff Nielsen is familiar with the consequences of not having a written agreement. A verbal agreement made between a landlord and his grandfather more than half a century ago had been passed on to Nielsen. Ownership of the land had passed from the original landlord to his own granddaughter. While the arrangement worked well, one day it simply evaporated.
“I had bought one quarter section from them previously when they just decided they weren’t going to rent to me anymore,” said Nielsen. “I offered to buy the last quarter, but the granddaughter decided they were just going in a different direction. So, that was it.
“It is very tough when you don’t have an agreement in writing,” he said. “I never liked it over the years because there was always this feeling of insecurity.”
MAKING IT WORK
Merle Good is a farm tax expert and farm succession planning consultant. He uses a four-point plan for developing rental agreements that are secure, flexible and fair.
“About 85 per cent of my clients are developing wills where they leave some land to non-farming children,” said Good. In response, he created a mechanism that works for rental agreements between farmers and their off-farm siblings, but that he also suggests can work for most rental agreements.
1. To determine a fair cash rent value, generally 20 to 30 per cent of gross revenue per acre, Good uses a formula based on crop insurance coverage rates that would be assigned to a beginning farmer. This fairly representative figure is referred to as the proxy. The beginning farmer crop insurance coverage is calculated by using average land prices and yields in a certain area. In the Didsbury area, for example, that beginning farmer crop insurance coverage might be determined to be $275 per acre. If the cash rent is to be about 30 per cent of gross revenue per acre, then 30 per cent of $275 is $82.50 per acre, which is the average cash rent in the area. If the coverage rate drops, the cash rental amount drops, and vice versa if the coverage rate increases.
2. For a rental agreement term, Good recommends what he described as a rolling lease, a three-year term reviewed annually. The landlord and renter square up on rental fees for the current growing season. If everything is good, the rental agreement rolls ahead to be reviewed again the next year. It allows the renter to plan at least a three-year rotation, and also forces renter and landlord to talk at least once a year. “Rather than just send a cheque in the mail, it forces them to communicate, which is important,” said Good.
3. In the event of a landlord’s death, Good encourages the inclusion of a discovery period in the rental agreement. “What happens if the landlord dies and the spouse or estate decides to sell the land?” said Good. “It is not likely the rental agreement will give the renter a right of first refusal, so rather than the renter one day seeing a for-sale sign on the land, this clause in the agreement allows for 60 days to discuss things.” The renter can then discuss options or plans with the landlord’s family or estate before the land goes on the market.
4. Good encourages the inclusion of a break-fee clause in the event the landlord decides to sell the land. “So, we have this three-year rolling lease, but partway through the year the landlord decides they are selling the land,” said Good. If they do so midway through the growing season, then the crop belongs to the renter, but as a fee for breaking the agreement, the landlord also agrees to refund one-year’s cash rent.
Good said a properly worded rental or lease agreement simply makes good business sense. It’s not about lack of trust on either side. It merely ensures clarity of the terms and can be crafted in such a way that it is fair and protects both parties while also encouraging open communication.
The prosperous renter
Jonathan Small offers three tips to farmers who rent
1. Good working relationships are important. Be a good communicator and keep your landlords informed.
2. Don’t put all your crops into one rental basket. Aim to work with multiple landlords to reduce risk.
3. Always be prospecting for more rental acres. Even though rental agreements may be in place, situations can change. Again, it’s good risk management to have rental options available to maintain or increase cropped acres.