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2. Financial Assessment

 

What you’ll learn

  • How to assess your financial readiness to buy or rent land
  • Financial implications of leasing vs. purchasing
  • The loan process: lender expectations and the cost of borrowing money
  • Conventional and non-traditional lenders and investors 
  • The role of conservation easements in farm affordability
  • Land and infrastructure valuation

Farming as a business entails financial opportunity and also some degree of financial risk. It is important to understand those risks as well as the level of risk you are comfortable with and capable of managing, particularly when it comes to how you acquire land and at what cost. It is also important to understand the risk levels and considerations that are acceptable to lenders and property owners as they interact with your farm business. Most importantly, you need to consider how the finances associated with your farm business and with securing farm tenure may affect the quality of life for you and your family.

This lesson is divided into three sections:

  1. Personal finance, which covers assessing your family living needs as a basis for determining the type and structure of farm acquisition that is affordable to you.
  2. Farm business finance, which examines how your farm business plan can help determine your capacity to lease or buy a farm property, and to support your family living and help secure farm financing.
  3. Farm acquisition finance, which covers the valuations of farms, the process of securing financing, and special circumstances that may influence farm affordability and financing.

Next section –  B. PERSONAL FINANCE

Personal finance

Determining your family living needs is the starting point for determining your farm acquisition plan. To be truly sustainable, farmers need to meet their financial goals for farming. For some farmers, a farm business will provide enough net income to support family living. However, most farms in the US rely on off-farm income for a large part of family expenses, and many provide for themselves entirely from off-farm income. Regardless of where this income comes from, it is important to know how much you need for family living. Many families seriously underestimate how much money they need to live, if they have any idea at all. Being unaware of, or unrealistic about, the budget can lead to serious cash flow problems that interfere with the viability of pursuing farming as a career. Financial stress will inevitably lead to personal and family stress. To avoid this, it is important to start with a family budget, based on a combination of past expenses, and projecting new expenses based on new wants and needs.

One of the biggest challenges to developing a family budget is often poor or non-existent record keeping. Records of family living expenses should be kept on paper or on a computer or a combination. Many farm families will use record-keeping software, such as QuickBooks or Quicken, to not only keep track of farm income and expenses but also of family living expenses. This is highly recommended. It is also important to develop a good file system for receipts and paid bills for the family living expenses as well as the farm expenses.

One often-overlooked task is to establish separate checking accounts for farm and personal expenses. This helps make it easier to keep track of both family and farm budgets and to more transparently determine if the farm is profitable or not. When a farm is profitable and able to contribute to family living, then checks may be written from the farm account to the personal account as a “farmer draw” or as a formal paycheck.

Instead, if checks are consistently being written from the personal to the farm account it’s a sign that the farm is not profitable and is being subsidized by personal income and/or savings. (For some people, this meets their goal and is okay.) Likewise, it is also important to either use separate credit cards for farm and family expenses or to itemize the expenses on the credit card based on whether they are farm or personal expenses and then pay the bill proportionally from the appropriate checking accounts.

Knowing your family living needs can help you determine the size of your farm business. Successful small farm businesses typically net between 10-30% above fixed and operating costs. If you aren’t including your farm income in the operating expenses, then this net income will represent what is available for your family living. Making an assumption of the percent net income and using your family living needs calculation, you can make a very crude calculation back to an estimate of the gross sales which will be required to meet all of your family living needs. For instance, if you have calculated your family living needs to be $30,000/year and you assume 20% net income over fixed and operating expenses, then the farm’s gross sales need to be at least $150,000/ year ($30,000 divided by .20 = $150,000).

Keep in mind that until you actually do your farm business plan, this is very crude and only hypothetical. For instance, you may find that you can only achieve 15% net income on that level of sales, in which case $150,000 in sales still would not be enough to meet your family living needs. But perhaps you may expect to continue to have some off-farm income and the net farm income at that level may be sufficient.

Housing is generally considered affordable if it makes up less than 30% of your gross family income or family living budget. Keep in mind that if you rent or buy a farm that includes housing, housing costs will be a proportion of your rent or mortgage, property insurance and property taxes. In this case, you should adjust your family living budget accordingly. It often can be useful to make an estimate of the dollar amount of the rent or mortgage (as well as property taxes and insurance) that is attributed to housing costs. Then assign those costs to your family living budget and assign the remainder to the farm budget. This provides you a more transparent picture of what is a farm expense and what is a family living expense. Lastly, it is important to know that agricultural lenders will also be looking for reasonable estimates of family living expenses, and a description of how these expenses will be met. If a lender does not believe that you have taken this seriously, they may question the family living expenses and the overall credibility of your plan. In the Worksheets section, you will find a spreadsheet and a guidance document for developing a family living budget.

Next section –  C. FARM BUSINESS FINANCE

Farm business finance

Once you have determined how much money you need for family living, the next step in your farm acquisition plan is building a farm business plan. As illustrated in the Personal Finance section, family living projections can be used to do a crude calculation of the size of the farm business you need to cover all of those family expenses. However, it is the business planning process that is used to refine that estimate to create more realistic projections of what the farm business will look like.

The process of developing a farm business plan will help you determine the capacity of your farm business to support your family living and the costs of securing farmland. That is, how much money will likely be available from farm income to cover family living expenses and the costs of farm rental or purchase? If farm income is insufficient to cover capital, operating, depreciation, debt service, family living and farm access expenses, there will need to be additional steps taken to address these deficits. This is common so the planning process often involves solving “chicken and egg” type circular problems. Through the business planning process, it is common to find that it is not possible to cash flow purchasing a farm during the early years of the business. This is where leasing and other tenure scenarios can become important options for farmers, especially beginning farmers. In other cases, hybrid scenarios of owning part of the farm and renting the remainder may be viable. It is extremely common for off-farm income to make up part or all of the deficits.

There are many resources to help existing and prospective farmers develop strong business plans. These resources include individual professionals, courses, websites, and full technical assistance programs. Many are listed in the Resources section, and an online search for “farm business planning” will turn up many others.

Next section –  D. FARM ACQUISITION FINANCE

Farm acquisition finance

This section focuses on pulling all the pieces of your financial plan together, and on farm financing and special issues that influence affordability and financing.

Once you have determined your family living and farm business needs and capabilities, you can focus on farm acquisition financing. Your business plan combined with your family living expense budget and your off-farm income projection will determine how much money is available to either cover farm lease or purchase costs. It is not uncommon that a new farm business cannot generate enough income in the first few years for the farmer to be able to purchase a farm from the outset unless there is a substantial outside subsidy. For many farmers, leasing the farm or at least parts of it turns out to be in the best financial interest of the farm for the long-term. Most farms in New England, including long-established operations, rent a portion of the land they need for their business.

Renting vs. buying

For a comparison of renting versus owning,  rental rates outlined below can be compared to examples of the cost of buying and owning the land. Remember the figure of $3,000/acre used in the scenario below represents only a proportion of the total land cost. Most lenders will expect the purchaser to make a down payment on the land, and there will also be upfront costs at the closing. If you don’t have the money for a down payment or closing costs, then even if you could afford the mortgage payments, you still may not be able to afford to buy the land.

However, let’s look at one financing scenario in which you are borrowing $3,000/acre at 6% interest for a thirty-year term. The payments would be calculated as follows:

At 6% interest for 30 years, an amortization chart tells you that your loan payments will be $73 per year for every $1000 borrowed. You can use the Amortization Calculator in the Worksheets section. So, if you are borrowing $3000/acre, then multiply $73 by 3 to determine your annual loan payment of $219/acre/year. If we assume the land is enrolled in a farmland property tax program, then depending on the state and the formula, in general, the property taxes will be less than $10/acre/year. So the total annual cost of owning the land will be about $229/acre/year, or the sum of your annual loan payment plus property taxes.

Other examples of potential financing scenarios include:

  • $3,000/acre borrowed @ 5% interest for 40 year=$58 x 3= $174/acre/year plus property taxes
  • $5,000/acre borrowed @ 6% interest for 30 years= $73 x5= $365/acre/year plus property taxes
  • $5,000/acre borrowed @ 5% interest for 40 years= $58 x5= $290/acre/year plus property taxes

Can you lease similar land in the same area for less than the costs of financing a purchase plus property taxes? If you can, it might make sense to lease in the near term.

Can you find land that costs less per acre to purchase and finance? If you can, then it might make sense to consider purchasing land.

By comparing the cost of owning versus renting land, you can determine which makes the most financial sense at least over the short term, and if the rental rate set by the property owner seems reasonable.

For another example that compares the impact of renting versus owning on net family income, see these Farm Tenure Financial Scenarios. Prepared by Jon Jaffe of Farm Credit East, this resource compares the net return to family living under three scenarios: 1) purchase of a farm at market value, 2) purchase of a farm with development rights removed, and 3) rental of a farm and home.

How much will a farm property cost? How much should you expect to pay for a farm and how much can you afford?

Here are some things to consider for leasing and for purchasing.

Determination of farmland rental rates. Rental rates on land are highly variable. They depend on the quality of the land and the interests of the property owner. See the Leasing Lesson, which includes more detail on rental rates.

In New England, you might expect to pay in the neighborhood of these rates:

  • $15/acre/year for pastureland
  • $25/acre/year for hayland
  • $50-$250+/acre/year for tillable land suitable for field crops or vegetables.
  • $.50-$1.00/tap/year for sugarbush. In a well-stocked parcel of 70-100 taps per acre, this translates into a per acre rental rate similar to other cropland.

Lower values for tillable soils are more typical in more remote places, where farmers grow lower value field crops such as corn silage, grains, or forage crops, or where farmers have long-standing agreements with the property owners. Higher rental rates are more typical in higher land value areas, where more land competition exists among farmers, where soil quality is particularly good (such as prime ag soil along rivers) or where farmers are growing high-value crops such as fruits, tobacco, or vegetables.

It is not uncommon for property owners to expect higher rental rates than those listed above, especially in high land value regions. Conversely, in some rare cases, the landowner may pay a farmer a land maintenance fee instead of requesting rent, especially where there are few farmers interested in the land.

Sometimes an owner may not require any payment because they count the current use property tax advantage as adequate “compensation.” By having the land in active agricultural use, the landowner becomes eligible for a significant property tax break through enrolling in the state’s preferential tax program, often referred to as “Current Use.” Taxes on land in Current Use are typically $5-$15/acre/year, which usually represents a significant savings to the property owner.

Rents on buildings and infrastructure. Building rents can be tricky to determine. Some owners may base the rate on the rental rate of an equivalent building for storage. In dairy barns, the rental rate may be based on the number of cows that it can hold and a market rate in that area. Sometimes, hay storage is based on the number of bales of hay that the barn can hold.

Various other formulas can be used. One commonly accepted approach to determining the rental rate on buildings (and on land as well) is the “DIRTI 5,” which consists of:

  1. D: Depreciation on the building over its useful life
  2. I: Insurance that the property owner pays (or an expectation that the farmer insures it)
  3. R: Repair costs based on an estimate of the annual owner expenditures
  4. T: Taxes (property)
  5. I: Interest, either the rate paid by the owner as debt service on the building and/or a rate that provides a return on investment on the owner.

Even when using the DIRTI 5, adjustments may be made. Some owners may only need taxes or building maintenance to be covered by the tenant’s rent. It may take some negotiation to come up with a rent that seems fair to both the property owner and the tenant.

Property valuation when purchasing. When purchasing a farm, the final farm value is usually determined by an appraisal performed by a professional appraiser. All lenders will base their lending decisions on the appraisal, not the asking price or the offered purchase price. It is customary for the sale to be “contingent” on the appraisal in a purchase and sales agreement. (See more about appraisals and purchase agreements in the Owning Farmland lesson.

The sale of the development rights, also called “conservation easements,”  “agricultural conservation easements,” or “conservation restrictions” can have a large influence on the final purchase price of a farm property. By removing the right to develop the property forever, the price may be cut by as much as half from the “fair market value.” To determine the value of the conservation easement and the (remaining) conserved value of the farm, a more extensive appraisal is completed than is typically done for a residential property. (Read more about Conservation Easements in the Community Partners lesson.) Other covenants on the property, such as affordable housing covenants, will also play a role in the final value of the property.

In most of New England, a farm for sale on the open market will not be listed at its agricultural value unless there is a conservation easement in place. It will be listed for its “highest use” that in most cases is commercial, residential or industrial development. This means that the asking price for a farm will generally be higher than what a farmer living solely on farm income can afford. In some cases, this is also true of conserved farms where there are no restrictions on the resale price. In these cases, the price is based on what non-farmer buyers with means are willing to pay for the farm as a large open parcel. Housing on the farm will often be major determinant in the price of a farm property. Unless there is a deed restriction on the sale value of the house, the value of the house will play a big role in the property value even on conserved farms.

What is the “agricultural value” of a farm or farmland? That becomes a bit subjective. It starts with the quality of the soils as well as the quality and usefulness of the infrastructure to a farmer. For instance, a river bottom farm will justify a much higher per acre value than a hill farm suited mainly for pasture. The farm income potential per acre is greater in the former than the latter. The answer to what is “affordable” farmland for the individual farmer lies mainly in the farm business plan and how much debt service the combined farm and off-farm income can support. Determining what you can afford is addressed in the Financing a Purchase section of this lesson.

Buying the farm: financing a purchase. Sources of financing to purchase farmland include conventional banks as well as specialized private and public agricultural lenders. A list of regional agricultural lenders can be found in the Resources section of this lesson. Many conventional, private banks in New England do not lend to farm businesses, and some that do may not have the expertise to completely evaluate farm businesses and their loan applications. There are some banks in New England that are interested in – and capable of – making farm loans, although not always for land purchases. These typically have designated agricultural loan officers with expertise in ag lending.

Farm Credit is a national farmer-owned, cooperative lender network that is guided by the federal government. The USDA Farm Service Agency (FSA) offers favorable terms and interest rates to qualifying farmers.Traditionally known as the “lender of last resort,” FSA aims to serve farm businesses that are unable to acquire loans through other traditional lenders. FSA also has programs specifically for beginning and limited resource farmers. FSA also offers loan guarantees in partnership with other lenders. The loan guarantee means that if the borrower defaults, FSA will guarantee payment of a certain portion of the unpaid principal due to the other lender, be it a private or another public lender. Some states have agricultural lending programs, too.

It is best to introduce yourself to different lenders and inquire about their programs and requirements prior to actually applying, sometimes even months or years before applying. It is unlikely that a lender will give you a farm real estate loan based on projections for a business that you haven’t started, or for a business that is dramatically smaller than what would be necessary to pay for the farm. A lender with whom you already have a history, such as the one that gave you a loan for start-up expenses and equipment on your leased farm is more likely to work with you on a real estate loan. They already know you and your business. See “Your First Farm Loan” and “A Farmers Guide to Ag Credit” in the Resources section for more discussion on what lenders are looking for and on how to communicate with them.

The costs of farm ownership: what can you afford?

When purchasing a farm you will have two main categories of costs: upfront costs and ongoing costs. See the Ownership lesson for more on this topic. coverage on this subject.

Credit scores, credit reports, interest rates, and loan terms.

Interest rates are determined by a number of risk factors as well as prevailing market rates.

Two factors that play a role in determining the interest rate on your loan, as well as whether or not a lender will even approve your loan, are your credit report and credit score. (See the Resources and Worksheets sections.) You can get one free credit report from each credit bureau per year. It is a good idea to check your credit reports at least annually to look for mistakes and identity theft. Beware of scams that trick you into paying fees. For credit scores, also known as FICO scores, you will need to purchase the score to see it. Ideal scores are greater than 720. 620 is considered the bare minimum for being considered for a loan.

You will want to check your credit report soon before you approach a lender. Lenders will require you to pay for the credit report and credit scores they use even if you have purchased them independently. Still, there is an advantage to seeing the credit score prior to going to the lender so that you are aware of how your score may affect your prospects, and to see if there are any errors on your credit report.

Another factor in determining interest rate is whether you are applying for a commercial or residential loan. Lenders consider commercial loans riskier. These usually have a higher interest rate―often a percentage point higher or greater. If a farm being purchased includes a home, it may be considered a residential loan, or a hybrid residential-commercial loan depending on the lender’s criteria and whether the expectation is that the loan is being paid through farm income or an off-farm job. If there is no off-farm income, then the loan will likely be treated as a commercial loan.

FSA, Farm Credit, and conventional banks usually will list their current interest rates on their websites. If FSA offers a loan guarantee, the other lender(s) may give a reduced interest rate since their risks are reduced.

As the length, or term, of the loan increases, usually the interest rates also increases, but the payments are usually still smaller on the longer-term loans. While a 30-year loan is not uncommon for a residential loan, commercial loans rarely go past 20 years. The FSA direct farm loan program will go out as far as 40 years to help with cash flow. FSA may work with private and state lenders to create hybrid mortgages where FSA is loaning part of the funds and the other lender is covering the balance. These loans may have different term lengths. This can help significantly with cash flow for the farmer buyer. It is important to note that FSA and state lenders don’t always have funds available due to budget constraints and government budget cycles.

It is important to enter into early discussions with these and other agricultural lenders so that you are aware of funding availability, the lender’s specific loan criteria including the percent down payment required (or loan-value ratio), current interest rates, and the term length available so that you can include these variables into your farm loan projections and business plan.

The Resources section of this lesson contains guides and links for working with agricultural lenders in New England.

Special circumstances. Lenders, particularly conventional banks, will consider raw (bare) land a higher risk loan since the value of land fluctuates more than buildings. If you are also looking for a home construction loan, lenders generally will consider you a higher risk. Lenders particularly shy away for home construction loans if the borrower intends to build the house herself or be the contractor. They are very concerned that borrowers may not have the capabilities to get the job done and then the lender will have nothing of value to claim in the event of a default on the loan.

Less traditional tenure situations such as community land trusts will also often give lenders some concern since the lender needs to know that in a default, they will have collateral that they will be able to resell without encumbrance. However, these are not insurmountable obstacles. By providing a well-researched and well-written plan that explains how you will mitigate risk and address the lenders concerns, you still may be successful in accessing capital for your farm purchase. This often will involve technical, financial, and legal consultation prior to approaching the lender.

Self-employment income also gives lenders cause for concern. If the off-farm, self-employment income will be key to making the plan work, then lenders will want to see a track record of steady or growing net income from the business for at least 2-3 years.

What to do if you are turned down by a lender? One of the hardest things to face is being turned down by a lender. Keep in mind that they are likely to have specific reasons for this. So, it is important to find out those reasons, preferably in writing. Sometimes you can address the lender’s concerns, perhaps over time or even immediately. It may be that you can’t meet one lender’s criteria but can meet another’s.

Or you might be able to qualify for a loan guarantee from FSA. This is one reason why it is important to meet with different lenders months or even years before you are looking to purchase a farm to better understand their criteria and your options. Or it may be that you need to improve your business profitability, adjust aspects of your business plan, or increase the amount of capital that you have available from savings, off-farm income, or investments from your community partners. In some cases, you may have to temporary hold off on your farm purchase until you increase your financial capabilities or find a farm with a price that is more affordable to the resources that you have available.

Alternatives to conventional lenders. It is a long-standing practice for farmers to rely on family members to assist in financing a farm purchase. But this still needs to be done with careful consideration to mitigating risk. It is important to decide how problems will be addressed in order to protect both family investment and family harmony. Legal and financial counsel is often in order.

Increasingly, farmers are looking to other non-traditional lending sources for funding their farm. These include:

  • Partners, co-investors, shared ownership and community land trusts
  • Sweat Equity (“work-to-own”)
  • Slow Money investors
  • Your customers, including CSA members and your community
  • Non-profits, including food cooperatives and conservation groups

For more information on some of these alternative sources of capital, see the Community Partners lesson, and“Holding Ground” and “Farmers Guide to Securing Land” in the Resources section of this lesson.

Next section –  E. RESOURCES

Resources

Family living planning resources

  • Farm Tenure Financial Scenarios by Jon Jaffe of Farm Credit East – A comparison of net return to family living under three scenarios: 1) purchase of a farm at market value, 2) purchase of farm with development rights removed, and 3) rented the farm and home.

Farm business planning resources 

Working with agricultural lenders

  • Guides
  • Lenders
    • Traditional Banks: Inquire at your local banks and credit unions about their interest in, and knowledge about, making loans to farmers. Some banks, for example, People’s United Bank (VT), have designated agricultural loan officers. At People’s United Bank (VT) also inquire about the “Socially Responsible Banking Fund” Agricultural Loan Program.
    • USDA Farm Service Agency (FSA). Use the state directory to find the county office near you.
    • Farm Credit:
    • State agricultural lending agencies in Vermont
    • Other organizations such as the VT Community Loan Fund
    • Alternative Tenure and Financing, Chapters 5 and 6 in Holding Ground (purchase from NESFI)
    • Equity Trust Fund – a revolving loan fund
    • “Fee Title Purchase with Sweat Equity” in Farmers Guide to Securing Land by CA FarmLink  (Out of Print)

Next section –  F. WORKSHEETS

Tools and Worksheets

1) Closing Cost Calculator. Calculates the cash needed to cover the costs of  “closing” on an agreement to purchase a property.
2) Annual On-going Cost of Ownership Calculator. Calculates the on-going costs of farm property ownership.
3) Debt Coverage Ratio Calculator.  A ratio used by lenders to determine if you have enough income to buy a specific farm, plus an adequate financial buffer to manage reduced income or unexpected expenses. A way to assess affordability of a farm purchase based on variables such as farm operating expenses, projected revenue, cash flow, and debt level.

  • Action Plan Map out your next steps to learn more, answer specific questions, and know where to find help.

 

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