You’ve been farming a while now. You’re well-established, have solid cash flow and a farm down the road is for sale. This would add 160 tillable acres to your operation. Is it time to expand your operation?
Although the decision may seem daunting, a number referred to as cash rent equivalent (CRE) can help you conduct a simple analysis. CRE tells you what you are paying to own land. It also helps compare the cost of ownership to the cost of renting.
Cash Rent Equivalent
Your CRE is all your land loan payments (principal and interest) plus real estate taxes divided by the number of acres you own. This number looks at only your owned acres and the cost to own them.
It does not factor in land improvement costs or operational expenses, such as seed, fertilizer, labor, fuel, etc. It also does not account for labor and family living expenses or for the cost of renting or leasing land. So you will need to consider more than just CRE before making a farmland purchase.
Let’s take a look at our example operation and calculate the CRE.
- You currently own 640 total acres.
- 480 acres have been in your family for three generations and are paid off.
- Real estate taxes are $9,600 per year.
- The other 160 acres were purchased 10 years ago on a 20-year term at 5.5 percent interest.
- Principal and interest payments are $40,540 per year.
- Real estate taxes are $3,200 per year.
Currently, your cost to own your land is $53,340 per year. When you divide that over the full 640 acres, the cash rent equivalent for the farm comes out to $83.34 per acre.
Now let’s examine your CRE if you buy the farmland down the road. The purchase price for the 160 acres is $6,000 an acre, or $960,000. If you finance the full amount over 20 years at 4.5% interest, your annual payment would be $74,201 per year, plus another $3,200 in real estate taxes. This new total divided over the full 800 acres yields a CRE of $163.43.
So what does this number tell us? Ultimately, it allows you to easily compare your land loan payments to the cash rental rates in your area. If your CRE is significantly higher than cash rental rates, it may make more sense to rent land until you can build up your working capital. Conversely, if your CRE is significantly lower than going rates in your area, your operation may be set up for expansion.
Making the Decision
Understanding your CRE can help inform your decision. However, it’s critical to understand your farm’s full financial picture before making a purchase.
You’ll need to closely examine your other expenses (inputs, family living, etc.) to determine whether a land purchase will work from a cash flow standpoint. Our articles on land affordability and cash flow considerations can help as you review your options. At the end of the day, you want the revenue you are bringing in to cover all your expenses.
Your lender or financial advisor can help you understand how a land purchase impacts the overall financial stability of your operation and how such an important decision aligns with your short- and long-term goals.