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LEASING LAND WORKSHOP
David Armstrong
AK Consultants
19 July 2010
Issues to discuss
Leasing options/definitions Objectives, tenant and landowner Risks and rewards The lease agreement The financial value Other issues Golden Rules
Leasing or share farming Difference – who takes the risks Production and market risks Lease – tenant usually carries the risks Share-farming; risks are shared
Leasing, for a paddock or property; short or long term. General principles apply.
Objectives Landowner and tenant – may not be “in
sync”
Landowner - Income - Resources maintained or improved
Tenant – Profit - Growing his business - Increasing scale
So, why lease land? In 2008/09 69% of Tasmanian Farms had
EVAO < $150,000
So, lease to gain economies of scale.
Owner of a small operation can not justify modern, efficient and large scale equipment.
Lessee can justify newer and more productive equipment.
Tractor overhead costsExample, 130 HP FWA tractor, 2007 costs
Overhead costs include interest, depreciation, insurance, shedding, registration
Hours use/year Overhead cost, $/hour
250 hours (2.9% of a year, 5 hrs/week)
$75/hr.
500 hrs(5.7%, 10 hrs/week)
$39/hr
1,000 hrs(33 hrs/week, 30 weeks)
$20/hr
1,800 hrs(38 hrs/week 48 weeks)
$12/hr
Other benefits of scale
More efficient, reliable and safer equipment is justified.
Larger businesses - better negotiating power.
More worthwhile investing in training and research.
More attractive to contracting companies.
So, a tenant may bring something of higher value to land that the landowner cannot.
Risks for the land ownerRisk Mitigation
Tenant degrades land (soil) or pasture
Agreement – cropping intensity - Fertiliser applications
Tenant does not maintain infrastructure
Agreement – details maintenance - Check initial condition - Document condition (photos etc) - Owner to maintain - Be realistic
Tenant does not pay Agree on payment procedure and late penalty
Tenant over-stays Agreement – penalty for late exit
Tenant cannot afford lease fee Owner to be sympathetic?
Risks for the land ownerRisk Mitigation
Tenant does not meet owner’s expectations
Expectations to be documented
Tenant does not meet agreement
Agreement to have dispute resolution procedureOwner to check references
Owner may want to sell Be aware of the constraint.First offer to tenant.
Tenant over-stays Agreement – penalty for late exit
Dispute with tenant Communicate early.Have resolution procedure.
Benefits for the land owner
Potential benefits Ensuring the benefit
Rental income Agreement – payment procedures - Penalties for late payment
Releases owner from work
Releases owner from production and market risks
Opportunity to do other things; e.g. earn income elsewhere.
Retains benefit of appreciating land value
Risks for the tenantRisk Mitigation
Crops do not perform Check land beforehandCheck water securityBonus or increase/reduction clause in the lease agreementBudget conservatively
Markets fall income reduced Tie lease fee to market; or bonus?Budget conservatively
Insufficient capacity to handle the larger area
Make sure resources adequate
Inability to meet agreement Communicate early
Dispute with owner Communicate directly and earlyNegotiate a solution
Benefits for the tenant
Potential benefits Ensuring the benefit
Increased scale with economies
Apply skills etc to larger area
Increase scale without financial risks of land purchase
Business growth without purchasing land.
Improved profitability Make sure you have a good agreement with the landowner, & communicate
The Lease Agreement Must have a written agreement.
Define the area & exclusions
What else is included; particularly water
Duration, options or rights for renewal. Is renewal a right for the tenant; what conditions Rolling leases.
Premature departure by the tenant; replacement with another tenant?
The Lease Agreement Agreed departure date.
Penalty for late departure Delay could preclude future cropping opportunity
Commencement date; Autumn is often a good time.
Payment; amount, timing, procedure. Annual fee adjustment, cpi
The Lease AgreementRepair and maintenance issues Agreement – maintain present condition
record what that is at start
Soil fertility – agreed fertiliser. Tenant to provide evidence, or Owner applies. Apply extra to hay/silage paddocks. Consider sale of hay/silage from the property.
End of lease – same pasture area
Weed control – specify weed species
Fences, yards, buildings, roads etc.
The Lease Agreement
Cropping paddocks. Specify cropping intensity Paddock to be sown down at end of lease
Access to water Who has priority of limited
Capital improvements – clarify ownership
Conflict resolution – establish a procedure
Other payments – rates, licences insurance etc
Valuing the lease
Percentage of land value
Percentage of Gross Margin
Percentage of Gross Income
Check the market; real estate agents.
Valuing the lease
Percentage of land value
Historically, 4-6% for grazing 6-8% for cropping
These values now too high
Perhaps double what is realistic
Valuing the lease Percentage of Gross Margin
25-33% of GM. Level depends on risk.
The remainder is required for: Contribution to overhead costs, including R&M Contribution to interest Return for the Tenant’s time and effort Return for taking the risks
Examples: Sheep, GM ~$25/dse, lease 33%, $7-8/dse Potatoes, GM $4,000/ha, lease 25%, $400/ac.
Valuing the lease Percentage of Gross Income
16-22% of Gross More common in US for cropping land, 20%
Justifiably lower here because tenant has more maintenance obligations.
Value of water
Should water be valued separately?
I suggest not.
The cost of land and water should not be more than 25-33% of the GM.
Leasing livestock
Sometimes considered.
Value is the interest cost, and for the risk.
Requires continuation of breeding strategy.
Leasing equipment
I generally advise against including equipment in a farming lease:potential for disputes over maintenance.
Who is responsible for maintenance?
Objectives inconsistent.
Leasing a centre pivot
A Pivot is fixture.
Who is responsible for repair and maintenance? I suggest the tenant.
Responsibility for negligence?
Leasing cost for a centre pivot
What are the annual costs? If asset purchase ($6,000/ha capital, 6 years @ 7%), $1,258/ha.
Interest & depreciation over 15 years, $925/ha.
Share farming Shares risks and rewards.
Assume a Joint Venture approach: Owner gets a lease fee for the land. Share farmer engaged as contractor. Share farmer paid for management. The JV shares cash costs.
Proceeds shared equally.
Risks are shared equally.
Share farming
Joint Venture
Pays Owner for land
Pays SF for managing
Pays for materials
Pays SF workProfits divided
equally
Golden Rules
Benefits are not without risks. The potential for economies of scale. Tenant may allow land to be used for higher value
purposes. Responsibility and costs borne by beneficiary. Know and trust each other. Ensure documentary evidence.