Dear Michael: We were recently reading in the paper that land has gone up by fifty percent in the past two years alone and has doubled, and in some cases, quadrupled in value in the past decade. What is the cause of this and what long-term effects will this have on our farming son and non-farming children? Last, but not least, when do you think the bubble will burst? – Escalating
Dear Escalating: In my office, when we do our periodic reviews of our long-time clients, the numbers – based on the value of total assets – we are seeing is way up, just as you stated above.
The effect on clients past planning efforts has been interesting, to say the least.
For example, ten years ago we helped set up some clients with the following plan. The son on the farm purchased four hundred thousand dollars of life insurance on Dad and Mom on a second-to-die life insurance policy. This was to provide for the entire equity his non-farming siblings were to receive. He was to receive the other five hundred thousand dollars in farm equity based on his years he had worked on the farm, his sweat equity, and, ultimately, that was what Dad and Mom wanted.
As we did our review of this 2002 plan, we checked on the new numbers.
What was once a one million dollar operation in 2002 had grown to a three million dollar equity position in 2013. The new values dwarfed the four hundred thousand dollar buy-out plan we had in place. What was once enough to provide for the entire equity position of the non-farming heirs was now only enough to provide a decent down payment but still left the farming son leveraged to the tune of forty-five to fifty percent debt to asset ratio.
We need to be more creative in our estate planning methods if we are going to keep up with this situation.
Farmers and/or ranchers who have a farming child and are over the age of sixty need to quit buying new equipment or land and let the next generation build equity by letting them buy replacement equipment, livestock, and/or land.
Most of the time, older farmers are doing this for tax reasons ñ which means too much of the income is going into the first generations pocket and not enough into the second. It's been a good decade for farming but mistakes have been made by Dad and Mom by letting too much of this inflationary growth grow in their names and, thereby, really complicating future issues for the farming child.
A good business plan would put more of the income into the second generation.
Start, by letting farming children take on more acres, or livestock, so they can afford the costs and expenses of replacement equipment and acquisition of new assets to the farm business. If done properly, your 'net' income should be the same and the only difference will be you'll be driving your son's tractor rather than him driving yours!
Realize enough is enough, as you age, and you have enough assets for a safe retirement and now it's time to focus on building the next generations assets.
I always tell my clients you only get one time a year to make money in the farming and/or ranching business. If you make Jr. wait until he is forty-five to start acquiring assets, you are going to limit his one-time annual chances to acquire assets down twenty or less for his lifetime. With only twenty opportunities to acquire assets, and a show-down with the non-farm heirs waiting in the wings, I don't like this next generation's chances, in the future, to be where you are today.
If we're serious about letting our farming children have the same opportunities you had ñ tough though they were, no argument there – we have to quit putting our heads in the sand and deal with the new reality of agricultural numbers. Just about every farm operation today is a million or multi-million dollar business and you need to plan for these numbers.
Are farmland values going to drop? No. Why? Because as long as farmland continues to produce a better rate of return than other comparable investments (such as C.D.'s, bonds, etc.), farmland will continue to hold and/or rise in value. If interest rates rise to four to seven percent and borrowing rates rise to six to nine percent, then we'll see new land values level out.
But drop? We'd have to see double digit interest rates, a drop in productivity and value in the crops produced, and other investments providing solid, dependable returns in the eight to nine percent range before land will drop in value. An asset only drops in value when the return is less than the investment compared to other similar investments – and there's nothing on the economic horizon that's shows we'll be facing these possibilities for at least another five years and possibly not for another ten to fifteen.