Farming Magazine - May, 2008


Opinion: Bad Day at Black Rock?

By Martin Harris Jr.

Readers with long memories will recall the political howls-of-anguish that accompanied a seemingly new trend in American farmland ownership back in the ’70s; it looked as though every pointy-shoe, thin-attache-case, three-piece-suit entity ranging from Merrill Lynch’s newly-set-up farmland investment fund to corporate foreign asset investors, like Nippon Bank in Japan and Barclay’s in England, was buying American grain land and hiring former Jeffersonian-model yeoman farmers as tenants and contractors. Well, the suits are back, but this time there’s no outcry—yet.

Latest straw-in-the-wind (a little ag analogy, there) is the news that, in the words of a recent Wall Street Journal story lead, “London money managers are shopping in the countryside, not just for weekend houses, but for investments.” The next paragraph continues with an explanation: “Investors have been snapping up farms, rural estates and other agricultural land in the U.S. and [other countries], as rising commodity prices, growing food demand from China and the push to turn crops into biofuels have made rural land more popular.” By popular, of course, WSJ Writer Beth Carney means “potentially profitable.” A subsequent paragraph describes how “U.S. money manager Black Rock, Inc. started a London-based agricultural hedge fund to invest in commodities, equities and farmland,” and goes on to speak of Arab oil money underlying the new acquisition trend. It continues with this expression of investment faith—“we believe that agriculture is in a secular bull market”—and concludes with this one, “We feel that land prices will continue to rise.” As I was reading of Black Rock, Inc.’s new land investment strategy, I was reminded of another Black Rock more than 50 years ago, a 1955 Spencer Tracy movie, which, on the surface, was about some mean white guys in a small town, but which also had an ag-land subtheme. The movie was titled “Bad Day at Black Rock.”

The main story line is well-known: one-armed WWII vet visits whistle-stop Black Rock to present a war medal, awarded to a Nisei combat buddy who saved his life by sacrificing his own, to the hero’s father, only to find that he has been murdered because of his Japanese ancestry, and there’s a town-wide cover-up nearly costing Tracy’s character his own life as he stumbles onto it. The subtheme reveals that the father had found water in the desert, creating valuable ag land (which the mean guys coveted) from worthless desert, and was killed for that reason, not his genetic background. My analogy question is: Will the new Black Rock have its own bad day, and will it end as Spencer Tracy’s did, escaping the situation with his life, but with little to show for the effort?

If there is an answer, it probably starts with the recognition that farmland isn’t your “normal” investment. Unlike a factory that produces and sells at a loss, farmland is still deemed an asset of considerable value, even when its crop output is worth less than the input costs; maybe that’s because more factories can always be built, but farmland is finite. As Will Rogers once said, “Buy land; they ain’t makin’ any more of it.” Unless you go back to the few post-WWII years of relatively high net farm income, it wasn’t until last year that most basic commodity crops were leaving the farmgate at a profit to the producer, and so, by the normal rules of economics, farmland as the underlying asset should have been worth about zero; but it was always, over that half-century, selling for a lot more. Every theory from the Will Rogers explanation to federal crop-price supports farmland’s potential value as house lots to pure gambler’s speculation-motive has been invoked to explain the inexplicable. One clue shows up in a comment by the management of Grainger PLC, another land investment entity: “Just because we feel that land prices will continue to rise.” If past is, indeed, prologue (see Shakespeare’s Tempest for this nice turn-of-phrase), this invest-where-it-feels- good strategy will pay off simply because as the historical record has shown, for all those decades when commodities were leaving the farmgate at a loss to the producer, the impersonal judgment of the market was still assigning a value substantially higher than zero to the underlying acreage. Take wheat as an example; now that the front-month futures market is assigning it a per-bushel value of $25 (quite a contrast to the recent historical $2 to $3), you might well expect the newly profitable crop’s arithmetic to boost cropland values, bearing in mind that they were already well over any value that would normally derive from crop profitability back when it wasn’t. Consider these USDA numbers, based on a 1998 study:

A decade back, the average farmgate wheat price was $2.65 a bushel. That was enough to balance operating costs for putting in and taking off the crop (also $2.65, for 80 percent of wheat farms), but not enough to balance total costs, which averaged $3.97 a bushel. In theory, wheat land should have been worth less than zero. In actuality, however, all farmland in that year averaged just over $1,000 an acre, with no special break-out for wheat land since it is easily convertible to other crops. You can proffer your own thinking (or feeling, as in the case of Grainger money-managers) as to the basis for the $1,000 an acre value, but history says pretty clearly that you would be on solid ground (no pun intended) to evaluate farmland as you would gold or diamonds: little or no intrinsic worth (after all, you can’t eat ingots or carats), but lots of extrinsic (it’s worth it because it’s worth it) value.

If you’re not comfortable, as Black Rock, Inc.’s pointy-shoe folks are, backing your investment feelings with cold cash (and bear in mind that most of their funds are OPM (other people’s money), entrusted to Black Rock by well-heeled investors somehow persuaded to pay handsomely for their investment judgment in pursuit of promised splendid returns) you might take solace from the judgment of history. Making forward-looking predictions is tough (particularly when it involves the future, as baseball expert Yogi Berra once observed), but looking backwards requires only a reference book: the average American farmland acre was worth $20 in 1900, the USDA’s number crunchers and data gatherers tell us. Adjusted for inflation, that would be $509.44 today, in terms of equal purchasing power, adjusted for inflation, we learn from, a Web-based worksheet sponsored by the Economic History Association. Actually, the marketplace now values it at almost four times as much, or $2,160 an acre in 2007. Not so bad, considering that, for most of the intervening century-plus, commodities were leaving those acres at a loss to the producer.

But, not so good compared to the equities market, which, over the same time period has returned an annual average of 8 percent to plain-vanilla stocks and bonds investors: if you (more likely, your grandfather) had somehow, in 1900, invested $20 in the market averages, bearing in mind that such averages-funds that exist now didn’t exist then, and if your family had let it compound, untouched, for 107 years, you’d now have—drumroll—$75,400.08. If you compare the farmland gain—$2,140—with the equities gain—$75,380—you can see that the equities investment did 35 times better than the farmland investment. That’s been the standard case in the U.S. for a long time, as the following Wikipedia paragraph illustrates:

“In the 1830s, John Jacob Astor figured that the next big boom would be in the build-up of New York, which would soon emerge as one of the world’s greatest cities. Astor withdrew from the American Fur Company, as well as all his other ventures, and invested all his proceeds on buying and developing large tracts of land, focusing solely on Manhattan real estate. Foreseeing the rapid growth northward on Manhattan Island, Astor purchased more and more land out beyond the current city limits. Astor rarely built on his land, and instead let others pay rent to use it.”

Reduced to a single sentence, Astor’s financial acumen was based on his understanding that the way to extract maximum value from farmland was to change its function from supporting plants to supporting buildings. With his farmland-selection skills, Astor ended up as the all-time wealthiest man in America. And that was back when farming was still profitable, a situation that was to change forever by the end of the 19th century as a triumvirate of forces—the growing political power of urbanites, the enormous productivity gains of agricultural mechanization and the pretty- near-total failure of agriculture to manage its own production and profit requirements—combine to pull the rug from under farmland value as the yardstick of commodity-production profit. Maybe it’s relevant that it was in those same decades, just as domestic farmland values were going extrinsic from intrinsic, that foreign capital—mostly English, then—was buying lots of mid-Western and High Plains U.S. acreage for the first time.

What, then, of Black Rock, Inc.’s current foray into farmland? Do its resident speculators hope to defy the averages and pull an Astor-quality result out of farmland investment based entirely on their supposedly prescient selection of acreage about to be converted to high-end urban uses? Or, are they just blindly diversifying beyond equities, where the real money, historically, has been made? Or, will they end up like Spencer Tracy’s character at the end of his cinematic (bad) daylong foray into farm country: battered but surviving, no better off than before, but then not noticeably worse off either? Maybe it’s worth noting how the movie ends: Tracy manages to get himself aboard the last train for the day back to the big city, maybe with a little more knowledge of ag-land values, but with no visible indication of an enhanced portfolio.

The author is an architect and former farmer.