By Mike Estadt, OSU Extension Educator
It was reported by the Federal Reserve1 this week that U.S. consumers have accumulated a record $17 trillion dollars of debt or which $12.04 trillion related to mortgage debt. Especially concerning was the increasing amount of credit card debt at $986 billion as reported by the Federal Reserve report.
The USDA Economic Research Service in its Farm Income and Wealth Statistics2 report released on February 7, 2023, reported U.S farm real estate debt is expected to be at record levels at $375.9 billion in 2023. Farm sector real estate debt has been increasing since 2009 and is expected to reach an amount that is 87.5 percent higher in 2023 compared with 2009 in inflation-adjusted dollars. (Table 1.)
The combination of low interest rates, increasing net farm income over the past six years (Table 2), and stronger equity positions because of increasing asset valuation, farmers have found themselves in the position to be active participants in the farmland market.
Taking on additional agricultural real estate debt comes with certain risks that should be carefully considered. Here are some of the key risks associated with increasing agricultural real estate debt:
Financial Risk: Increasing debt means higher interest payments and potentially higher overall financial obligations. If your agricultural operations face challenges such as fluctuating commodity prices, adverse weather conditions, or market uncertainties, it may become difficult to meet the increased debt obligations. This can lead to financial distress and potential default.
Market Risk: Agricultural markets can be volatile, influenced by factors such as global supply and demand, trade policies, weather events, and changing consumer preferences. If market conditions deteriorate, it may impact the profitability of your agricultural operations, making it harder to generate sufficient income to repay the debt.
Interest Rate Risk: Changes in interest rates can affect the cost of borrowing and your ability to service the debt. If interest rates continue to rise in the agricultural sector or if credit becomes harder to obtain, it will lead to higher debt servicing costs and potentially strain your financial position. It is essential to assess the potential impact of interest rate changes on your ability to manage the debt burden.
Property Value Risk: The value of agricultural real estate can fluctuate over time. If the value of the property decreases, it may affect your overall equity position and potentially limit your borrowing capacity for future needs. A decline in property value can also make it challenging to refinance existing debt or obtain favorable terms for additional loans. Current conditions in Ohio and throughout the corn belt, predicate that this scenario has a low probability of happening.
Production Risks: Agriculture is subject to production risks, including weather-related events, pests, diseases, and other unforeseen challenges. These risks can impact crop yields, livestock health, and overall farm productivity. If your agricultural operations experience significant production setbacks, it may affect your ability to generate income and meet debt obligations. Lenders will want to see adequate risk management tools such as crop insurance for example to guard against revenue decreases.
Operational Risk: Expanding agricultural operations requires careful planning and management. Taking on additional debt means assuming more operational responsibilities and potentially increasing complexity. If the expansion is not well executed or managed efficiently, it can lead to operational inefficiencies, higher costs, and reduced profitability.
To mitigate these risks, it is crucial to conduct thorough financial analysis, stress testing, and risk assessments before taking on additional agricultural real estate debt. Maintaining a diversified income stream, having contingency plans, and keeping a buffer for unforeseen events can help manage and mitigate these risks. Additionally, seeking professional advice from agricultural consultants, financial advisors, and lenders can provide valuable insights and guidance in navigating these risks effectively.
If a grower is thinking about expansion of their farming operations with a farm purchase, lenders will require a financial analysis of the existing operation. The Ohio State University Farm Business Analysis and Benchmarking program offers producers a complete a financial analysis of their farming operation. This analysis will help you understand where your areas of profitability are in the business. It will give you tools to understand the numbers behind your analysis and will show you how to use them to further your success. Visit https://farmprofitability.osu.edu/ for further information.