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5. Leasing Farmland

 

What you’ll learn

  • The pros, cons, and implications of leasing
  • Lease types and terms
  • Developing a basic lease agreement
  • The diversity of landlords
  • Determinants of rental rates
  • Being a good tenant

About leasing

In the U.S., nearly half of farmers lease some or all of the land they farm.  Leasing is a reality, and it has both advantages and disadvantages over owning land.  Leasing land or a farm can be an attractive option.  It doesn’t have to be complicated, although it can be!  And leasing doesn’t have to be seen as “second best” to owning.  Increasingly farmers – especially new farmers – see leasing as a realistic and business-savvy option on their farming path.  Leases can offer you affordable, flexible and secure access to farms, land, and buildings as well as higher net revenue during your start-up years.  As one farm management professional states, “Control, not ownership, is the critical issue in efficient production.”

Most farm advisors urge farmers to separate the business from the real estate.  As a tenant, you would rent the real estate but own your own business.  The landlord is not involved in your business unless your agreement is specifically designed that way.  You own the name of your business.  However, if the property has a name that you want to use for your business, this needs to be worked out between the parties.

What is a lease?  Put simply, a lease agreement is a contract between the property owner and property user.  It specifies the rights, limitations, and obligations of both parties. In U.S. agriculture, the vast majority of leases are annual handshake agreements.  But that doesn’t mean that’s the best approach.  Most advisors will say, “Get it in writing.”  More states are requiring written leases.  Most farmers want clarity and security. Banks or other funders and government agencies such as NRCS require a written lease to fund projects on leased land.

In agriculture, leasing and renting are synonymous.  (In housing, rental usually is for a short term – month by month – and automatically renews unless terminated by written notice, whereas a lease is for a longer, specified term.)

Types of leases.  There are several types of agricultural lease arrangements, and they can be of almost any length.  (See more detail below.) Basic types of leases are:

  • Short-term (annual to 3 – 5 years)
  • Long-term (5 – 99 years)
  • Rolling term (term “rolls forward” so that it’s always, for example, 3 years)
  • Ground lease (long-term, where tenant rents the ground and owns the improvements)
  • Residential lease (preferably separated from the lease for land and farm structures)

Farmers can rent whole farms or land only.  They can also rent buildings, machinery and equipment, and livestock, although these are less common in our area.  Equipment is often rented from equipment dealers but could be rented from private owners as well.  Sometimes the residence has a separate lease that addresses specific state laws. Innovative leases can be very long-term (99 years).  They can include provisions for building equity and assuring continuing affordability for subsequent tenants.  Landlords and tenants can choose to share in the risk of farming and in investing in the stewardship of the land.  Leases can be part of a farm succession or transfer plan.  There are different ways to calculate lease fees (the rent).

Landlords.  Nearly 90% of farm landlords are not farmers.  This means that current and potential landlords may not be familiar with farming realities.  People, organizations and public entities with agriculturally capable land have various motivations for making their land available for farming.  They can be supportive partners to farmers willing to forge and maintain good relationships with them.

Next section –  B. PROS & CONS

Advantages and disadvantages of leasing

One of the main advantages of leasing is the ability to get on with farming without the enormous capital investment required to purchase land. In addition, though, some farmers like short-term arrangements because they experiment with new enterprises or locations without a long-term commitment. This flexibility is particularly useful for start-up farmers.

A short-term lease can enable a farmer to test whether her farm plans are financially feasible or whether he is comfortable with his landlord. It allows both parties to decide if a longer-term arrangement would work A short-term lease also allows the tenant to limit financial risk.

Advantages of short-term leasing

• Lower costs (initial and monthly) than purchasing
• Tax deductions for leasing costs
• Rights to terminate
• Allows savings or investment in short-term capital needs
• Test period for enterprises, locations, and markets

Leases have disadvantages, too. Foremost among them is insecurity of tenure with shorter-term leases. This can lead to disruption of the operation and difficulty in making long-term business plans or personal decisions. Another major disadvantage expressed by farmers is the inability to build equity from the land. Lenders may balk at financing long-term assets such as equipment or livestock if the borrower does not have a written lease covering the loan period. Tenants may have less financial incentive to invest in longer-term conservation practices or install conservation structures.

Disadvantages of short-term leasing

• Cannot recover lease costs as equity in land
• Cannot benefit from appreciation in land value
• Limited control over land and improvements
• Less ability to plan or make improvements
• May be unable to get credit from lenders
• May lose investments in infrastructure and land if lease is terminated

Long-term leases have several distinct advantages, and disadvantages also. Compared to short-term leases, they offer far more security. A longer lease gives the operator time to build the business as well as the soil, and establish markets as well as community relationships. It is possible to borrow against a long-term lease, and to participate in USDA conservation programs.

In a long-term ground lease, the tenant rents the land but owns the improvements (existing or placed) upon the land (much like a condominium or commercial property), so she can build equity. When the lease terminates, the tenant sells the improvements.

Advantages of long-term leasing

• Longer planning horizon for business and resource stewardship
• Allows farmer to capture the useful life of investments made to the leasehold
• Legacy to the next generation with renew and inherit lease provisions
• Security to participate in community life
• May increase borrowing capacity when the value of the lease is used for security along with tenant-owned improvements on the property.

Disadvantages of long-term leasing

• Reduces net income without contributing to long-term accumulation of wealth in property
• Cannot rely on land appreciation as a retirement fund
• Typically more complex legal documents and higher legal costs
• Can make loans more difficult or impossible to get without land as security for a loan
Next section –  C. TYPES & CONTENT

Types of leases

There are three main categories of leases: short-term leases, long-term leases and ground leases. Leases can cover farm buildings, equipment and livestock. Residential leases address farm family and/or farm labor housing and are typically separate from the farm lease.

A short-term lease is generally annual or up to 3 years. Often such agreements are oral “handshake” agreements, and although there is a long tradition of such arrangements, most advisors urge written leases regardless of the length of the term. A lease may have a “rolling” long-term where, for example, a three-year lease is renewed annually for another three years.

A longer-term lease can be for 5, 10, 20 or more years—up to 99 years, the legal limit after which ownership is assumed. In some states long-term leases may be inheritable or the tenant may sell the lease to another individual. Some states limit the allowable length of the lease term.

In a ground lease (usually long-term), the tenant rents the land but owns improvements on it.

Lease-to-own models provide mechanisms to move from leasing to ownership. There are two basic types of agreements that enable a tenant to acquire ownership of the rental property in the future. In a Lease with Option to Purchase the lease grants the tenant an option to purchase the property at a time in the future. Usually the price and the terms of the purchase are set forth at the outset. The option may run for the length of the lease or for only a portion of the lease period. The lease payments are not part of the consideration of the purchase price unless the terms specifically allow for that. In a Lease-Purchase Agreement, the tenant leases the property and is obligated by the terms of the lease to buy the property. Here too, the rent can go toward the purchase price.

What’s in a lease?

A written agricultural lease can be as short as one page or more than twenty. Five basic, minimum provisions make a lease a legal contract.

1. The parties (tenant and landlord)
2. Start and end date
3. Rental rate
4. Identification of tenant and landlord that are parties to the contract
5. Signatures of the parties

More complicated leases may address such topics as:

1. Conditions of access to leasehold
2. Repairs and maintenance
3. Means for establishing and modifying rental rates
4. Payment requirements and schedule
5. Permitted and prohibited uses of the property any land use restrictions
6. Capital improvements (i.e., what is permitted, procedure for approval, who owns them)
7. Termination
8. Subleasing and assigns
9. Insurance and liability issues
10. State and Federal lease law considerations
11. Default and eviction
12. Reference to easements and/or other liens on the property
13. Landlord’s right to enter
14. Procedures to resolve disputes
Next section –  D. RENT

Determining and calculating rent

One of the most common questions from tenants and landlords alike is, “How do we determine the rent?” There is no one formula or best practice. The rental rate should take into consideration both parties’ financial and other goals. Landowners need to consider the income tax consequences of farm rental income.

Rent can be approached in several ways. There is no one preferred approach. It depends on the situation and goals of parties to the agreement.

Market rental rates: Determine the market rental rate in the area for comparable land by asking local farmers, County Extension agents, agriculture departments and other reputable sources.

USDA county average rental rate: The USDA National Agricultural Statistics Service provides data on cash rents in many, but not all U.S. counties. The average rate won’t tell you much about the range.

Landowner fixed or carrying costs: This approach addresses the landowner’s costs associated with owning the property. Typically, these fixed costs include the “DIRTI-5”: depreciation, insurance, repairs, taxes, and interest. Keeping land in agriculture gives some landowners a lower property tax rate. In some cases, landowners charge no rent because the tax advantage they consider the tax advantage adequate benefit. However, landowner costs could be higher than what a tenant could reasonably afford.

Resource capacity: Rental rates may be calculated as a function of the soil type and condition, size of the parcel, and other factors that can vary a great deal from state to state, farm to farm, and even within the same field. Some states have classified these soils further into prime and important agricultural soils. You can obtain the soil classifications for the rental property from NRCS. But keep in mind that soils vary, so a field-by-field assessment of soil type and health should be part of the calculation.

Social goals: Some landlords base the rent on their personal values and goals such as the social benefits of local food production or providing an opportunity to a beginning farmer. They may choose to subsidize the farmer with a below-market rent, or by asking for non-monetary rent such as clearing trails. Some landlords give their tenants credit for improving the soil or facilities.

Organizational landlords may accept a lower rent if the farming operation demonstrates or otherwise furthers the organization’s mission. These non-market factors can be difficult to measure and take into consideration in setting a rent. Tenants need to maintain appropriate accounting practices for tax purposes, and organizations need to protect their IRS tax-exempt status.

Paying the rent

There are two basic approaches – and one variation — to paying the rent:

Cash leases. Cash lease payments are a fixed amount, usually calculated based on the market. They are simple and straightforward. They do not take into account yield, price, the cost of production, or other variables during the current year. Sometimes the landlord considers other factors besides the market in determining the rent. Cash rent leases are typically re-negotiated annually according to an agreed-upon approach or formula.

Share Leases. A crop or livestock share lease can save a farmer a substantial amount up front. Crop share leases typically distribute at least some expenses, such as inputs, machinery (and of course, land) to the landowner. The landlord shares in the risks and rewards of the farming operation by taking a percent of the crop or the value of the crop. Share leases can lower the cost of land, as well as the risk to the tenant.

A third approach, the flexible cash lease, is a sort of hybrid between cash and share leasing. Flexible cash lease arrangements establish a baseline rent based on low prices or output. When prices or output exceed expectations, the farmer pays a higher rent according to an agreed-upon formula. Flexible cash rent reduces some of the risks to the tenant of a bad year and rewards the landowner in good years.

Farm structures and residences

Determining the rental rate for farm structures is not straightforward. There are few comparables and lots of variables. For example, barn rent may be based on the number of livestock the facility can house. Sometimes rent is by the square foot. How to proceed? Ask around. Make a proposal to the landlord based on your budget. Remember to be clear about who pays for utilities and repairs.

In most situations, a residence is considered separately from the farmland and farm structures. It’s usually advised to have a separate residential lease. One reason for this is that rigorous tenants’ rights laws apply to housing but not the rest of the farm. However, whole farm leases are possible. You can find residential lease models (as well as information about residential tenancy) online.

Types of landlords

Many farm landlords are farmers or former farmers themselves. These landlords are familiar with farming and are embedded in the culture of rental agreements. Some handshake agreements endure for many years—sometimes across generations—based on trust and mutual understanding.

As land becomes less available, especially in urbanizing areas of the country, the pool of available land is not sufficient or affordable (even to rent) for entering farmers. At the same time, communities are increasingly concerned about the sources and quality of their food, and about the preservation and management of agriculturally capable, and other, open land. This makes for new win-win arrangements between farmers and citizens, community groups and public entities—landlords who do not farm and who don’t know much about farming.

What are the interests of these non-traditional landlords? Every landlord is unique, but there are several strong emerging themes among non-farming landowners. Many have strong conservation values and goals. At the same time, they may be relatively unfamiliar with farming practices and realities.

Who are these new landlords?

  • Widows and other heirs (children) of farm operators
  • Second home and estate owners
  • Land trusts and other conservation organizations
  • Conservation buyers
  • Churches and religious orders
  • Municipalities with conservation land/open space
  • States with institutional and other properties with an agricultural history or capability (e.g., state mental hospital and corrections facilities), state-owned conservation and open space properties, and state-owned parkland
  • Federal lands such as park land, rangeland, forest land and Tribal lands
  • Community farms
  • CSA members
  • Intentional communities (e.g., co-housing)
  • Agriculturally focused subdivisions (Prairie Crossing, Agritopia, Serenbe)
  • Educational and other non-profit organizations
  • Schools, colleges, and universities
  • Incubator farms

Next section –  F. RESOURCES

Resources

  • Land For Good’s Leasing Toolbox – A clearinghouse of practical tools and resources for farmland leasing, including “thought pieces” that address the interests of the community in long-term farm leases, and landlord-tenant relations.
  • FairRent – A midwest-centric tool developed by the University of Minnesota that claims to help farmers “Quickly and easily evaluate land rental decisions.”

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