What you’ll learn
- Farm ownership basics
- Pros, cons, and implications of farmland ownership
- Alternatives to ownership
- Home ownership basics and its relationship to farm ownership
- The farm purchase process
Farm ownership basics
Purchasing a farm or farmland is a big step. For many farm seekers, farm ownership is their ultimate dream. It is a goal that can be achieved by various strategies, and often requires patience and perseverance. By evaluating the farm ownership options – and your readiness for owning a farm – you will be better prepared to meet with real estate agents, landowners and lenders.
Being informed about ownership models, the sales process and terms will help you assess your options, avoid common pitfalls, and make the best decision for this important long-term investment. The road to farmland ownership can be an emotional and financial roller coaster. Considerations of location, price, value, debt, availability, and appropriateness all come into play.
The decision to buy land is a deeply personal one, reflecting your and your family’s values about property, ownership, assets, investment and the use of capital. With farm ownership as a goal, it may be that you start renting and move into ownership down the road. It may be that you buy some of your land—say, your primary farmstead—and lease additional land. The formula and timing for owning land is unique to each farmer’s circumstance. There is no one best way.
Land ownership has been a way of building equity (meaning the value of an ownership interest in property) in the United States since colonial times when written descriptions of land became the norm, thus making it possible to buy and sell real estate. The most common form of land tenure in our culture and in many others, is ownership. Private land ownership inherently gives the owner a bundle of rights, such as tilling the soil, harvesting trees, hunting and fishing. The limitations of ownership are defined by regulations (zoning) and eminent domain.
The U.S.’s Jeffersonian ideal of ownership argued that land ownership and the economic security it provided offered owners the freedom to speak their minds―the key to a strong democracy. Many people consider ownership the most “secure” form of farmland tenure since they believe that the farmer will not be “kicked off” the land, and that the terms of land use will not be altered. However, even with ownership, the core principles of land tenure, like security, equity and legacy, may be altered subject to changes in zoning, regulations and other factors in the community that affect property value. For example, in the latter category, a new park or a parking lot may increase or decrease the value of all three aspects.
Farm ownership can take different forms and evolve over time. You might purchase a farm with home, barn, land and all the fittings suitable for immediate and future needs. Or, you might purchase (or lease) a base of operations—home, barn, some land—and look toward leasing additional land as needed. Another option might be to buy a home near a farm that one could lease to build a business, and then sell the house in the future having built equity and a down payment to purchase another farm property. There are many possibilities and pathways to owning farmland.
There are many possibilities and pathways to owning farmland. Whichever pathway you plan out or ultimately take, understanding the issues below will enable you to do all you can to pursue some form of farm ownership.
Pros and cons of farm ownership
As with leasing, there are pros and cons to farm ownership.
The advantages of ownership include:
- Security: no risk of insecurity associated with limited-term rental of land and land owner’s changing plans; your plans not subject to landlord
- Equity: the value of an ownership interest in property
- Collateral: security pledged for the payment of a loan
- Ownership of improvements: you own what you build or improve on your property
- Legacy: the legal and personal aspects of passing your farm property on to others, typically as a bequest
- Emotional connection: the value and feelings associated with owning and caring for your own land
The disadvantages of ownership include:
- Ties up capital: cash, assets, net worth
- “Too permanent:” less flexibility to divest of the property
Next section – B. STRATEGIES
There are several ways to achieve land ownership, including:
- Purchase with conventional financing
- Purchase with government financing programs
- Real estate—direct loan
- Down payment assistance
- Joint financing
- Guaranteed loan
- Land contract guarantee
- Mortgage through Farm Credit financing
- Land contract or installment sale
- Purchase money mortgage
- Equity investors
For a deep dive into and comparison of these myriad options, see the Fact Sheet Ownership and Tenancy Options in the Resources section)..
The word “value” means different things to a landowner, farm seeker, lender, neighbor or developer. A landowner‘s flat, fertile 10-acre field may mean valuable cropland to you, house lots to a developer and a future gift to a landowner’s relative. Circumstances dictate the value of a farm.
Many factors play into the market value of a property. On top of basic market factors might be another layer of considerations. For example, is the owner willing to sell for less than top market value? Is the sale taking place when real estate values are high or low? Is the owner in favor of what your operation will do in a position to give you a good deal? You may encounter these and other subjective factors that influence a property’s value.
What should you expect to pay for a farm and how much can you afford? Here are some things to consider regarding purchasing a farm. When purchasing a farm, the farm value is typically determined by an appraisal performed by a professional appraiser. Lenders will base their lending decisions on an appraisal, not the asking price or the offered purchase price. It is customary for the sale to be contingent on the appraisal.
A formal appraisal will often play a large role in establishing value. An appraisal of the value of farm real estate is a professional appraiser’s opinion of the value of the land and improvements—house, barn, sheds etc. The preparation of an appraisal involves research into appropriate market areas; the assembly and analysis of information pertinent to a property; and the knowledge, experience, and professional judgment of the appraiser. Appraisals may be required for any type of property and for a variety of reasons. They are usually required whenever a farm is sold, mortgaged, taxed, insured, or even partially developed. For example, appraisals are prepared for:
- Mortgage lending purposes
- Tax assessments and appeals of assessments
- Negotiation between buyers and sellers
- Government acquisition of private property for public use
- Business mergers or dissolutions
- Lease negotiations
Farms are often valued at more than what most farmers can afford. One reason for this is because farmland is valued at the so-called “highest and best use” for the land which is often considered to be development (residential, commercial or industrial, depending on the zoning).
There are several ways to bring the price of farmland down.
Bargain sale: A bargain sale of a farm or land to a nonprofit tax-exempt entity is a form of transaction that is part gift and part sale. Through an agreement in which a landowner sells real estate to an eligible buyer for less than its fair market value the difference between the fair market value and the purchase price is considered a charitable gift for which the donor will receive an income tax deduction. Thereby, the new owner receives the farm at a discounted or “bargain” value.
How does a bargain sale work? An interested landowner works with an eligible charity such as a land trust. The two parties agree on a purchase price below the property‘s fair market value as determined by a qualified independent appraiser. The land trust pays the purchase amount upfront. The seller deeds the property to the land trust and files an income tax return reporting the sale and claiming the deductions. (See IRS Form 8283) The tax deduction may be used to offset up to 30% of the seller‘s income during the year of the donation and over an additional five years.
Easement: An easement creates limited property rights for a third party to do something on land that belongs to her or him. In other words, when a property owner grants someone an easement, that person has been granted legal rights regarding land that doesn’t technically belong to him. Because the easement is an encumbrance, the value of the land is likely to be reduced by some amount. Most commonly, easements are granted to utility companies to run power lines and cable lines. However, you may also grant an easement to your neighbor if your property is in the way of his access to a road, or to anyone else who needs to have a legal right to access your land.
Easements can be either express (stated by the landowner formally) or implied. In either case, the easement generally provides only a limited amount of rights. In other words, if the owner grants her neighbor an easement to use her driveway to access his farm stand, then the farmer has the right to invite customers to do that one thing on that land only: move their cars in and out. He can’t plant a garden, install picnic tables or do anything else on that driveway.
In general, property rights law divides easements into two categories: easement appurtenant and easement in gross. Easements classified as “appurtenant” are said to “run with the land” which means that they are part of the formal ownership of the land. In the above example, if the owner‘s easement were an easement appurtenant, then when the owner sold the property, the new owner would have the right to continue to use the driveway. The other type of easement, easement in gross, is a personal easement that doesn’t necessarily transfer when the ownership of the land transfers.
A conservation easement is a type of easement. It is also known as a conservation restriction. See the Community Partners section for details on conservation easements for farming.
Multiple buyers: Farm seekers may decide to partner with each other or with an investor with compatible objectives to acquire a property. At a time when many individual farm seekers struggle to find quality properties they can afford, some are considering not only working together but owning together. Balancing control with communication, complexities with practicalities can be challenging. While multi-party ownership is not right for all, for some it can provide tremendous opportunities to obtain larger parcels of higher-quality farmland than they could with their resources alone, while at the same time meeting the needs of several other interested parties.
One business structure for multiple parties is the limited liability company (LLC). It allows farm seekers and investors to attain the core goals of secure tenure, equity, and legacy. LLCs are business entities created and regulated by state law. They are legal in all fifty states and are the most common type of business entity formed in the past decade, far outpacing corporations. This is because of their flexibility, liability protection, and lower cost to maintain and tax exposure. Members in an LLC hold “membership interests” (somewhat akin to stocks in a corporation). Ownership can be separated from day-to-day management responsibility and rights to income can be defined almost any way you like.
Multiple parties can use the LLC to invest in, own, and manage farmland. The parties can be several farmers and can also include investors. The LLC can own the real estate and farm businesses can rent portions of the real estate from that LLC.
The types of issues that investors, owners, and operators of farms must sort out are largely the same as for any other type of business: what if investors bring different or unequal contributions (money, equipment, knowledge) to the business? What if they have different needs for income, long-term security, growth? How do we value labor or “sweat equity”? How do we transfer ownership of the company over time? What if one of us needs to get out and get our investment back? Small business and estate planning lawyers, accountants, and consultants are familiar with these issues and how to fit them into the framework of an LLC operating agreement.
What are some limitations and risks involved in using LLCs to own farmland? Aside from the usual business risks – that you will not be able to produce enough, find markets, anticipate shifts in demand or competition – there are well-recognized risks to owning land together, the principal one being that people have different needs and desires, and the more people involved in a venture, the more complicated it becomes (though this is not a feature unique to business entities). With respect to farmland, one common need is for the farmers to be housed on the property, and non-farmer investors or part-time farmers may also want or need housing on the farm. Homes in America are typically owned by individuals, and several valuable benefits to individual home ownership could be lost by owning one’s residence in an LLC or other business entity, such as the home mortgage interest income tax deduction, and shelter from the Medicaid lien for nursing home expenses against the residence of a spouse who continues to live in the home. One can quickly run into other complications, especially with large groups, such as State and federal securities laws – so while LLCs are powerful and relatively simple to create and operate, you need competent legal, financial and tax advice to do it.
Ground lease: In an agricultural ground lease, the farmer has a long-term lease on the land (ground) and owns the improvements on the land. The farmer may purchase existing improvements such as a house and barn, or may—within the terms of the lease—build a house or other structure at his or her own expense. In either situation, the farmer-tenant can sell the improvement to the next tenant or back to the landowner, depending on the arrangement. Typically there is an equity limitation formula so that the improvements remain affordable to the next buyer or tenant. Ground leases are typically for ten years or more, up to 99 years depending on state law. Learn more about agricultural ground leases and farming from Equity Trust.
Cooperatives: The cooperative model (e.g., food co-ops) has also been widely utilized for producer and housing co-ops. Since production and housing are major parts of a farm operation, individuals wishing to work together using various co-op models may want to explore that model. Links to find out more can be found in the Resources section.
Next section – C. COSTS
Costs of farm ownership
The costs of farm ownership can be divided into two categories: upfront costs and ongoing costs
Upfront costs of farm ownership include those associated with a farm purchase:
- Down payment
- Appraisal fees
- Legal and bank fees
- Building inspections
- Well and other environmental systems testing
- State property transfer tax
Closing costs: With the exception of the down payment, the other costs listed above are known collectively as “closing costs.” They can total $3,000-$5,000. In the case of a sale that involves a conservation easement sale at the time of a farm purchase, the conservation appraisal alone might cost $5,000. The conservation appraisal cost may be the sole responsibility of the buyer, or it may be split between the buyer and seller and/or subsidized by the state or a conservation organization.
Many people overlook the need to make sure funds are available for closing costs. While it is possible to include the closing costs in the purchase loan (particularly through USDA-FSA loans and loans from state agricultural lenders), you should not rely on this. Instead, strive to budget to have this money available from a personal source.
Down payment: The down payment amount is customarily 20-30% of the appraised value of the property. However, some lenders may require a 50% down payment for vacant land—property without housing and farm buildings. Through the USDA FSA’s direct and guaranteed loan programs, as well as some state programs, it may be possible to reduce the down payment required. FSA has a down payment program for beginning farmers. Even with these programs, there is an expectation that the farm buyer put down 5-10% of the purchase price.
For example, on a $300,000 farm this could mean that the buyer may need to have at a minimum $15,000- $30,000 in cash for the down payment, and more likely $60,000-$75,000 if financing through a conventional bank, Farm Credit, or a state program without the involvement of FSA. So if you want to buy a farm, plan to save enough money for both the down payment and the closing costs. The percentage of the purchase price that you put down becomes your initial equity in the property. This equity will increase as you make principal payments through your mortgage.
Often a lender will refer to the loan-value ratio. This is simply the ratio of the amount of the loan relative to the appraised value of the property. So, if the farm you are buying is valued at $300,000 and you are putting up a down payment of $60,000 (20%), the loan value will be $240,000 and the loan-value ratio will be 80%. Lenders sometimes will say they have a required maximum loan-value ratio, rather than saying they have a minimum down payment requirement. These fundamentally mean the same thing, except if the purchase price is different than the value from an appraisal contracted by the lender.
Infrastructure improvements: It is not uncommon when buying a farm that you will find significant infrastructure improvements are necessary to make the house livable or your farm business viable. These may be fixed improvements that will remain with the property, or they may be equipment that is not fixed and that can be sold separately from the property. Some of improvements, particularly fixed improvements, might be included in the mortgage, but not always. Sometimes farm infrastructure improvements can be financed with separate, short-term (5-7 year) operating or “chattle” loans.
Even when these improvements are included in a mortgage or addressed through an operating loan, there usually will be an expectation that a portion of the cost be paid directly by the buyer since the lender will not want to risk loaning the full cost of the improvement. Often, the borrower will be expected to supply additional collateral to cover a portion of the value of the improvement, especially if improvements are not fixed or are paid through an operating loan.
It is also important for the farmer-borrower to recognize that one dollar invested in improvements almost never translates into a one dollar increase in the value of the property. For instance, if you spend $5,000 in rewiring the barn, the barn value will not increase by $5,000. It may not go up at all. Or, if you install a cheese house to make cheese, and it costs you $30,000, a real estate appraiser may only value that building the same as a $10,000 storage shed and so the farm value may only go up $10,000. (This circumstance is called “lost capital.”) Therefore, there is not a dollar for dollar increase your equity when you make improvements. Most potential return in investment to the farm will not come from an increase in the value of the farm property, and instead come from improved farm profitability. Thus, it is important that the infrastructure improvements be truly warranted and determined through careful analysis completed through the farm business planning process that demonstrates how the improvements will increase profitability directly, or reduce the risk of farm losses, such as reducing the risk of an electrical fire in the barn.
Since it is hard enough for most people to save enough money for the down payment and closing costs, it is not uncommon for them to come up short on the capital necessary for desired improvements. But this can put the farm in jeopardy from the outset if those infrastructure improvements are necessary to make the farm financially sound enough to cover operating costs, family living, and the ongoing costs of ownership.
It is not uncommon for farmers to underestimate the costs of these improvements. They may also overestimate the amount of time they will have to do the improvements themselves instead of hiring outside contractors to do the work. This is a recipe for burnout and financial distress. It is important to not let the dream of farm ownership cloud one’s realistic vision of what they can financially afford and what is truly needed to successfully carry out the farm business plan. When looking at purchasing a farm or saving money for a future purchase, take into account not only the down payment and closing costs, but also the infrastructure improvements that will likely be necessary. It would not be unheard of for a farmer to need $10,000 to $50,000 or more for such improvements, only a portion of which might be borrowed from a lender.
The ongoing costs of ownership include:
- Mortgage, composed of principal and interest
- Operating loans, specifically for farm infrastructure improvements
- Property taxes
- Property insurance (fire, property damage/loss, liability)
- Purchase Mortgage Insurance (“PMI” Usually required if your down payment is less than 20% of the appraised price of the property)
Next section – D. REAL ESTATE TERMINOLOGY
Real estate terminology
A glossary of terms used in real estate transactions.
Appraisal: an estimate of how much money something is worth, especially one given by an expert
Bridge loan: A short-term loan that is used until a person or company secures permanent financing or removes an existing obligation. This type of financing allows the user to meet current obligations by providing immediate cash flow. The loans are short-term.
Closing: a meeting among principals in a real estate transaction, during which legal papers related to the sale and purchase are signed and financial arrangements are made final and binding.
Debt coverage ratio: The debt service coverage ratio (DSCR) is the ratio of cash available for debt servicing to interest, principal and lease payments. It is the measurement of an entity’s (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. The higher this ratio is, the easier it is to obtain a loan.
Easement: a limited right to make use of a property owned by another.
Financial statement: statement(s) showing the assets and liabilities company or at a particular time.
Insurance: an arrangement by which a company gives customers financial protection against loss or harm such as theft or illness in return for payment premium.
Lien: the legal right to keep or sell somebody else’s property as security for a debt.
Mortgage loan document: a written contract describing the agreement between a borrower and a lending organization by which a loan is given against security.
Purchase and sale agreement: a legal document that has been prepared and agreed to by attorneys representing the buyers and sellers in a real estate transaction.
Property deed: a document that shows the ownership of a piece of land or real estate.
Right of way: a lawful route that may be taken across somebody else’s property.
Survey: to make a detailed map of an area of land, including its boundaries, area, and elevation, using geometry and trigonometry to measure angles and distances.
Title: a document giving the legal right to property.
Title insurance: insurance against the risk that a title to a property is not valid.
Next section – E. LEGAL ISSUES
Legal issues in farm ownership
Choosing a lawyer. Sooner or later you will need a lawyer. If you follow a few simple rules, you can enjoy a secure and successful transaction. The first thing to realize is that you aren’t looking for a friend; you’re looking for a lawyer. The qualities you’d want in a friend are not those you need in your lawyer. You are looking for a professional relationship, and expect nothing less than professional treatment. Be cautious about hiring a lawyer from an advertisement or online, although both can yield reputable results. For example, findlaw.com allows you to find lawyers by state or specialty.
A first step when looking for a lawyer is to ask friends, relatives, and acquaintances for recommendations. As with any business, word of mouth is the best advertising. It is also the best way for you to find out who has done well or poorly for people whose judgment you value (or at least can evaluate). For example, if you are selling a house without a real estate agent, you could check with the local title companies to see whom they have had good experiences with. Think about the attorney’s specialty; that is, make sure the lawyer you hire is the lawyer you need. If you need a real estate lawyer, don’t hire an estate lawyer, even if he is an old family friend.
Payment options. In general, there are two options when it comes to attorney fees: hourly or percentage. If you are hiring a lawyer to handle routine legal work (like completing a house sale or putting an estate through probate) expect to pay hourly. Despite the fact that this type of arrangement has a built-in incentive for your lawyer to run up your bill, this can actually work out quite well for you if you pay close attention and spell out in advance just exactly what your lawyer will be doing for you. When you are paying hourly, you generally have to pay some portion of your expected fee up front as a retainer.
Don’t be intimidated here by a lack of knowledge. Never give more for a retainer than the attorney can demonstrate is usual and customary for your request. A retainer potentially can be very expensive. Ask your lawyer to show you an itemized statement of what you can expect him or her to do and negotiate an appropriate retainer accordingly.
Tracking progress. Whether or not you get an itemized list of anticipated charges when you negotiate a retainer (you should request one), ask the lawyer to detail benchmarks to you so that you can keep tabs on your progress. If you haven’t paid in full, don’t pay any more until your lawyer catches up on the schedule.
Title insurance. Title insurance is indemnity insurance against financial loss from any defects in a title to real property and from the invalidity or unenforceability of mortgage liens. It is meant to protect an owner’s or a lender’s financial interest in real property against loss due to title defects, liens or other matters. It will defend against a lawsuit attacking the title as it is insured, or reimburse the insured for the actual monetary loss incurred, up to the dollar amount of insurance provided by the policy. Nearly all institutional lenders require title insurance to protect their interest in the collateral of loans secured by real estate.
What you should know about property deeds. Property deeds may be kept in a local town office or county office often known as the Registrar of Deeds. When looking for a deed, you will look for a book volume and number that correlates to a land map.
A property deed is an exact description of a land parcel and its location. It does not mention structures. The deed will contain the property boundaries and a description of the boundaries, right of ways and easements. Property boundaries in New England are often very old and may not be clearly delineated. Some boundary lines will follow permanent markings such as stonewalls. Most often, there is little or no evidence of a boundary line on the actual property.
The deed will show the individual(s), if and how ownership is shared and if there is a lender that owns the parcel of land and the form of ownership. Learn more about how to find a deed here.
What’s in a purchase and sales agreement? When you find your property, the real estate agent will provide an Offer to Purchase form for you to write your offer. The agent will present the offer to the seller. If the seller rejects the offer, the agent will assist you in negotiating the offer. A check for $500 – $1000 will be expected when you submit the offer. If your offer is not accepted, your check will be returned. Your offer should contain contingencies, allowing you to inspect the property for structural integrity, environmental defects, pest contamination, and condominium documents review. It also contains a clause to let you out of the purchase if you cannot acquire a mortgage. There are deadlines outlined in the Offer to Purchase that must be strictly adhered to or you could lose your right to purchase the property. If your offer is accepted, the seller’s agent or attorney will draft a Purchase and Sale Agreement for your review and signature. See the Resources section for a sample Purchase and Sale agreement.
Next section – F. STORIES
- Top Ten Things I Learned Buying a Small Farm – Great advice from a farmer who had just purchased a small farm in southern Oregon.
Next section – G. RESOURCES
- Ownership and Tenancy Option, excerpted from the UVM-LFG FarmLASTS Agricultural Land Tenure Curriculum
- Top Ten Things I Learned Buying a Small Farm (2007) – Great advice from a farmer who just purchased a small farm.
- First Farm Loan, a Land Link Vermont Fact Sheet – Good information on applying for your first farm loan.
- A Primer on the Owner-Financed Farm Sale by Ben Waterman – A post on the UVM New Farmer Project blog.
- Financing Your Farm: Guidance for Beginning Farmers (2001) by NCAT/ATTRA – Lays out financing options available to beginning farmers to start a farm and describes process of applying for a loan.
- Homebuyer’s Guide – A guide to the process of buying a home. Many of the ideas are similar with a farm.
- Sample Purchase and Sale Agreement (pdf)
- Equity Trust – An organization that promotes equity by changing the way people think about and hold property.
- Introduction to Agricultural Conservation Easements by American Farmland Trust – A basic fact sheet.
- An Overview of 1031 Like-Kind Exchanges for Farmers (2006), Farmers Legal Action Group – Overview of the tax codes concerning farm sales.