Q: Aside from financial models, how do you evaluate the
quality of a farm?
A: We look at soil types, slope of land, elevation, percentage of tillable
acres and layout of fields. We try to maximize tillable acres and buy farms
with minimal slope because these issues are incurable. However, we buy farms
of various soil types and elevation because they can still be productive
farms it is just a matter of what price you pay to buy them and what level
of income they will produce.
Q: Why have you chosen to focus on the eastern grain belt?
A: The key to our success is having an outstanding network of farmers that
we partner with. We identify farm groups/families that recognize the need to
grow to gain economies of scale and who need us to acquire more land for
them. These farmers take care of our farms as if they are their own and they
pay us the highest rents. We started in northern Indiana because of existing farmer connections and now we have expanded to
central IN, southern IN, north eastern IN and southern IL. We will continue
to branch out but we will always buy where we find the best land values and
have good farm tenants. Our existing farmer networks have capacity for well
over ten thousand acres and we have a pipeline of good undervalued farms to
choose from.
Q: If grain producing farms have such upside, why are they being sold? What
is keeping the farmer from buying the land? By selling the land, is the
farmer essentially increasing his ROE and is able to farm more acres?
A: We rarely buy farms from an existing farmer and then lease it back to
him. Generally we are buying the farm from a trust, widow or other relative
who has inherited the farm and has no interest in farming. They usually have
been renting the farm at below market rents and finally see the increased
interest in farmland as a means of exiting. This is a generational shift
that is occurring and that will eventually exhaust itself as farmland
ownership becomes concentrated in corporations, large farmer networks and
investor groups like Ceres. Farmers prefer to own the land that they farm,
but they have found it more efficient to combine land ownership with leased
land so that capital can also be deployed in their operations and for
improved equipment.
Q: What global macro factors do you think are driving the demand for
commodities and farmland?
A: There are four global macro events occurring that led us to invest in
farmland initially and which continue to be driving factors: (1) “demand”
for food from the rising Asian and emerging markets’ middle class, (2)
biofuels, (3) depletion of arable land for agriculture production, and (4)
resurgent inflation….in this order. Americans underestimate the global
demand for food which will expand U.S. exports of grain. The rising middle
class in the emerging economies want to eat like Americans and when people
improve their living standards, one of the first things they want to do is
to improve their diets which means eating more protein. It takes 2 pounds of
grain to produce 1 pound of poultry, 4 pounds of grain for 1 pound of pork
and 7 pounds of grain to produce 1 pound of beef. China is already the
largest consumer of pork and soybeans in the world; they also just became a
net importer of corn in May 2008. In addition, as the dollar weakens versus
the Chinese Yuan, our exports are cheaper in the local currency and China’s
demand for our food products will increase.
Q: How does the purchase price paid by Ceres for farmland compare with the
average sales price paid by others?
A: Generally speaking, Ceres pays less per acre for its land than other
farms in the same areas. This is due to the fact that properties are often
brought to our attention by our existing network of farm contacts before
they are ever officially listed with a realtor. Also, because of our ready
source of funds and established borrowing lines, we can get farms under
contract while others are still scrambling to find funding. Finally, at
times we may purchase a large tract of farmland for an overall lower cost as
compared with someone who is willing to pay a higher price for a small
parcel within this tract; a concession is granted to the large-scale
purchaser.
Q: Is Ceres Farms scalable or are there limits to your growth?
A: Yes, our model is very scalable. As we acquire additional farmland, we
will gain efficiencies and economies of scale on many levels. For example,
our fund operating expenses will benefit as the portfolio grows. Our
established network of high quality farmers will continue to grow. These
proven farmers manage all of our farms as tenants of Ceres Farms owned
properties. Once a new farm is acquired, our ongoing involvement in farm
management consists primarily of negotiating multi-year leases, monitoring
these farmer relationships, and overseeing the various aspects of property
management aside from daily farming operations. We do not see any limitation
on the Funds’ capacity as to number of farms in the portfolio. Our plan is
to selectively add additional human resources as we experience further
growth in number of farms and expanded geography of farms in the portfolio.
Q: What is the investable target universe for farms? Are only the largest
farms an appropriate fit for this type of portfolio?
A: The target universe consists of millions of acres of prime Midwest
farmland. We continue to follow our acquisition strategy, which is to
purchase under-valued farms ranging from 100 acres to 1,000 plus acres.
Attractive farm acquisition opportunities are not limited to only the larger
farms. We do not see any capacity issues as to potential investments or farm
acquisitions. Our relationships and building reputation in the Midwest
enable Ceres Partners to gain access to an increasing number of the best
under-valued farmland buying opportunities.
Q: Do you as the Manager place valuations on assets or do you use an
independent outside appraiser?
A: We utilize independent outside appraisers to establish asset values both
at the time of purchase and annually thereafter. In addition to local
appraisers who are familiar with local value trends, we employ a national
appraiser as Fund Administrator (BAAR Realty Advisors—MAI Valuation
Services) to oversee all valuations and to insure consistency of generally
accepted appraisal methods. These appraisal metrics are also used to bolster
our acquisition acumen. An extensive appraisal (Self-Contained or Summary)
is obtained at the time of purchase that meets or exceeds the requirements
of our lending institutions, and a limited (Restricted format) appraisal
update is prepared annually until either the third anniversary of the
property purchase or the Fund Administrator determines that circumstances
(i.e. market value trends and/or property specific issues) have changed to
such a degree that a new complete appraisal is necessary.
Q: Could you explain what happens tax wise if the value of the assets
increase annually but there are no withdrawals?
A: Investors are given a K-1 each year that provides your tax liability.
Generally there will be tax liability for current income, but there are some
things such as depreciation expense on irrigation equipment and other
improvements that will serve to lessen tax liability. Investors will be
given the opportunity to make annual withdrawals to cover this tax
liability, if they choose. Gains from the appreciation of land values will
only be taxable when the property is sold and this will generally be
long-term capital gains. Beyond this brief summary, we encourage investors
to speak with their tax attorney/accountant.
Agriculture during the 1970’s was characterized by a move to greater
efficiencies. Technological advances in equipment produced larger tractors
and harvesters that permitted a single farmer to dramatically increase the
amount of acres that could be farmed in the same amount of time. This
equipment was expensive and was purchased on credit. In order to recoup this
capital investment in equipment, farmers had to increase their tillable
acres and they choose to increase their debt loads further by purchasing
land on credit as opposed to leasing it. These land purchases caused a
generational consolidation of small family farm plots into large contiguous
tracts that accommodated the new and much larger farm equipment; it also
caused a significant increase in land prices. The credit incurred for these
equipment and land purchases caused the agriculture sector’s debt to equity
ratio to peak at 28.5% in 1986.
Throughout the late 1970’s and early 1980’s there was sufficient foreign
demand to absorb the increased production from these modernized efficient
farms. However this changed after Russia invaded Afghanistan which led to
President Carter’s imposition of a grain embargo. Suddenly with the export
market nearly shuttered there was a much greater supply of grain than could
be consumed domestically and prices declined. Interest rates also
skyrocketed at this time and farmers were simply unable to service all of
the debt that they had accumulated to make equipment and land acquisitions.
Farmers went out of business and as they did so, repossessed equipment and
land was sold at fire-sale prices which drove prices down even further. Land
prices bottomed in 1987 which in some instances was nearly 50% in nominal
terms. In inflation-adjusted terms, however, price declines were dampened
because this was also a time of high inflation; inflation-adjusted prices
returned to mid 1970’s levels.
Since the 1980’s, farmers have found that they can increase profitability
and reduce risk by using a combination of equipment ownership and partial
land ownership with leased land making up the additional acres needed to
obtain the optimal production necessary to cover their capitalized expenses.
Most farmers now recognize the advantage of outside investment capital and
seek land investors such as Ceres Farms who they can lease land from. This
has allowed farmers to increase their capital efficiency, reduce debt and
obtain better return on their investments. In 2009, the average debt to
asset ratio for the agriculture sector is only 9%.
Land values are directly impacted by the amount of revenue that can be
produced on that land. Currently agricultural supply and demand favors
farmers and landowners since foreign demand for food and domestic demand for
biofuels have depleted inventories which will support or apply additional
upward pressure on prices in the coming years. However if anything
dramatically alters this supply-demand balance, it will have an impact on
land prices. For example, if simmering protectionist rhetoric increases to a
point where international trade is materially impacted, then this could
cause an interruption in demand which could lead to a decline in farmland
values. But we give this scenario a low probability and even if it does
occur, a decline seen in the mid 1980s is not expected because farmers
are in a much better position financially with low debt levels.
Q: How do I invest? Can I invest qualified plan assets such as
my I.R.A.?
A: After fully reviewing the Private Placement Memorandum and other Offering Documents, interested investors must (1) complete the Investor Questionnaire to establish that they are accredited investors, (2) execute the Subscription Agreement, and (3) execute the LLC Agreement. Yes, I.R.A. funds may be invested. One alternative is to open an I.R.A. account with Sterling Trust where Ceres Farms LLC is approved as a suitable asset for custody and then follow their instructions. Also, National Financial Services permits both qualified and non-qualified plan assets to be invested in Ceres Farms LLC.
