One of the most important and frequently asked questions in the farmland real estate world is “what is my farm worth?” In the United States, farm real estate typically accounts for 80% of the total value of farm assets, according to the USDA.
How do you value farmland?
There are a variety of ways that farmland is valued, but these are the most common two:
- Sales Comparison Approach
- Income Approach
For both methodologies, you’re going to need to gather some information about your farm (the subject property) before you can determine a valuation estimate. Here’s a short list of data points and definitions, which will be important to understand as you work through these back-of-the-napkin examples.
- Total acres: Number of acres included in the subject property.
- Tillable acres: Number of acres capable of being farmed.
- Soil rating: Soil productivity ratings based on soil composition and quality.
- Comparable sales (aka: comps): Sales with similar land characteristics within your area.
- Price per acre: The total sales price divided by the total acres.
Price per tillable acre: The total sales price divided by the tillable acres.
- Price per soil rating (ex: $/CSR2): The price per acre (or tillable acre) divided by the soil rating.
- Net operating income (NOI): Rental income minus expenses. This is used to analyze the profitability of land real estate investments.
- Capitalization rate (cap rate): NOI divided by the purchase price.
- Return on investment (ROI): Another term for capitalization rate.
How to use the sales comparison approach
The sales comparison approach is one of the most commonly used ways to gauge the value of farmland. Have you ever found yourself looking at auctions in your area to get a good idea of what land is going for? This is a sales comparison approach in its most rudimentary form. For this approach, you’ll want to find a pool of sales in your area with similar characteristics to your subject property. This method of thinking takes into account that each property feature either adds to or takes away from its overall value. By putting your property side-by-side to comparable sales using metrics like percent tillable, soil rating, etc. - it helps you to better understand the value of your land. The more metrics you have to sort each sale comparable, the more accurate your value estimate will be.
How to use the income approach
The income approach uses all the same metrics as sales comparison, but the buyer is going to be coming to the table from a different point of view. They are not looking at the value of the land itself, but rather looking at the value of the land’s return on investment (ROI). In most cases, the ROI calculation will be important to the buyer if they’re an absentee or a non-operator landlord since they’re purely looking for a financial return instead of farming it themselves. To get the ROI for farmland, you will use two formulas. Step #1: Calculate the Net Operating Income (NOI). Here’s the calculation:rental income - expenses = NOI. Keep in mind that expenses for owning a property could be anything, such as real estate taxes, insurance, improvements, etc. Step #2: calculate the Capitalization Rate (Cap Rate or ROI). Here’s the formula: NOI / purchase price = Cap Rate. The Cap Rate is expressed as a percentage, which measures the return of capital based at a particular moment in time.
Here’s a sample of what the NOI & ROI calculations look like:
- Purchase price: $950,000
- Rent: $32,000
- Taxes: $3,500
- Net operating income: $32,000 - $3,500 = $28,500
- Cap rate: $28,500 / $950,000 = 3%
Why do we care?
We care because if you’re the seller and understand these parameters, the negotiation of value becomes a collaboration for you, not mortal combat. We care because if you’re the buyer and you understand these parameters, you’ll be able to collaborate with the seller to put together a fair deal. Best of all, you can have confidence in the sale price going forward. Hope isn’t a strategy when it comes to a fair price.
At the end of the day, we hope that FarmlandFinder can be a resource for you. We have a dedicated team that is compiling the auction results, listed properties, USDA reports, soil ratings, crop history, and more - all so you can find this information in one place. Our hope is that when empowered with information, data and knowledge, you can have confidence the next time you step forward to buy or sell land.