fundamentals of income translating a confusing mass of facts into a summary of the agricultural...

Fundamentals of IncomeFundamentals of Income

Translating a confusing mass of facts

into a summary of the agricultural

property potential focuses on its ability

to return a stable income.

6-1

ObjectivesObjectives

The process of income capitalization

Estimating net operating income

Estimating and interpreting capitalization rates

Estimating a potential sale price from income

characteristics

6-2

Objectives (cont.)Objectives (cont.)

Pros and cons of cash lease income analysisPitfalls of share lease and owner-operator

income analysisBasics of government payments to agriculture Income capitalization break down for non-income

driven motives6-3

From Income to Selling Price

From Income to Selling Price

Frequently buyers focus on income potential Some want to add to their stock of land Some are replacing land Some want to balance their investment portfolio Buyers tend to focus on economic rent What income can an owner anticipate

6-4

Group Discussion 6-1Group Discussion 6-1

6-5

Income CapitalizationIncome Capitalization

Translates estimated income into potential sale price Involves judgements and assumptions Reconciling physical Reconciling economic Reconciling legal Reconciling social elements

6-6

Income Capitalization (cont.)


V = I / R V is value I is property income R is overall capitalization rate Relies on annual income (I) Anticipated rate of return (R) times selling price (V)

6-7

Individual Activity 6-1Individual Activity 6-1

6-8



Formula implies facts about property

Suited to estimating for unimproved land

Value is inversely related to capitalization rate

When the rate goes up value falls

6-9


6-10

IncomeIncome

Income in capitalization is a special income estimate Net operating income (NOI) Match property capabilities with expected outcome Simulate the income the buyer can anticipate Capabilities of the land Capabilities of people

6-11

Income (cont.)Income (cont.)

Three different tenure systems Owner-operator system - owner incurs all expenses Cash lease - farmer or rancher incurs production

expenses Share lease - landlord participates in production The best should opt to own their land Next best should opt for cash lease

6-12


Less capable should take a share lease Least productive should work for an operator Land quality affects leasing arrangement May insist on cash lease for inferior property Various tenure arrangements in local markets Identify the prevailing arrangements

6-13


6-14


Cash lease income estimation identifies gross potential income (GPI)

Avoid subjective judgements Use a multiple year average Previous years may not reflect future cash lease amount provides stating point Deduct all property related expenses

6-15


6-16

Individual Activity 6-2 (cont.)


6-17

RateRate

Finding proper rate to apply is critical Analyze recent sales of similar properties Large differences indicates analysis failed Some income may have escaped analysis Estimate requires informed judgement Analyst should use indicated prices with caution

6-18


6-19

Rate (cont.)Rate (cont.)

Small changes in lower rate has greater effect Historically, agricultural property rate is 4 - 6% Range land usually registers lower Less than 1% in areas of non-agricultural use Abnormally high rates indicates an imbalance Rate is a useful estimate of probable selling price

6-20

Sale PriceSale Price

Sale price is NOI divided by capitalization rate (R) A logic approach Operating expense ratio (OER) Percentage of GPI that will cover expenses Evaluate the property income characteristics A great OER variance indicates difference in subject

property6-21

Non-Irrigated Crop LandNon-Irrigated Crop Land

6-22

Non-Irrigated Crop Land (cont.)


6-23



6-24

Irrigated Crop LandIrrigated Crop Land

Revenue must cover maintaining the system Recover owner’s investment Often the farmer covers maintenance Irrigation systems wear out Costs must be recaptured over lifetime Capitalization rate should exceed unimproved land

rate6-25

Irrigated Crop Land (cont.)Irrigated Crop Land (cont.)

6-26


6-27


6-28

Share LeaseShare Lease

Much more complicated Cannot just identify a cash payment Assume a typical crop rotation for the land Identify inputs needed for the crop and prices Must be aware of government payments Must translate knowledge into capitalization regimen

6-29

Government Payments to Agriculture


Since 1930’s government has paid farmers

Congress adopts controlling features of payments

Can affect level of income a farm produces

Estimate of benefits can vary widely

Specialized courses are available

6-30

WarningWarning

6-31



Administered by Farm Service Agency (FSA) of USDA Involves several basic parameters Established crop base Target price Loan rate Direct payment and a counter cyclical payment

6-32

Government Payments to Agriculture (cont.)


Crop base - crop specific acres in program Program yields - determined in the farm bill Target price - Amount for covered commodity Loan rate - Amount per unit CCC will loan Direct payments - payments regardless of production or

price Counter cyclical payments - Increases / decreases with

market prices6-33

Calculating Government Program

Calculating Government Program

Calculating Government ProgramPayments

78 acre corn base at 175 bushels per acre

78 acre soybean base at 60 bushels per acre

Corn Soybeans

2003 2004-07 2003 2004-07

1 target price 2.60 2.63 5.80 5.80

2 loan rate 1.98 1.95 5.00 5.00

3 direct payment 0.28 0.28 0.44 0.44

4 counter cyclical 0.34 __________ __________ __________

6-34

Calculating Government Program (cont..)

Calculating Government Program (cont..)




Corn Soybeans

2003 2004-07 2003 2004-07

5 Direct payment:

6 Adjusted DP 0.238 __________ __________ __________

7 Base acres 78.00 78.00 78.00 78.00

8 FSA Y ield 175.00 175.00 60.00 60.00

9 Payment $ 3,248.70 $ __________ $ __________ $ __________

10 Per acre $ 41.65 $ __________ $ __________ $ __________

6-35

Calculating Government Program (cont.)





Corn Soybeans

2003 2004-07 2003 2004-07

11 Counter cyclical payment:

12 Adjusted CCP 0.289 __________ __________ __________

13 Base acres 78.00 78.00 78.00 78.00

14 FSA Y ield 175.00 175.00 60.00 60.00

15 Payment $ 3,944.85 $ __________ $ __________ $ __________

16 Per acre $ 50.58 $ __________ $ __________ $ __________

6-36






Corn Soybeans

2003 2004-07 2003 2004-07

17 Income estimate

18 Loan amount $ 27,027.00 $ __________ $ __________ $ __________

19 Direct payment 3,248.70 __________ __________ __________

20 Counter cyclical pmt. $ 3,944.85 $ __________ $ __________ $ __________

21 Total Income $ 34,220.55 $ __________ $ __________ $ __________

22 Rent at 50 % $ 17,110.28 $ __________ $ __________ $ __________

6-37






Corn Soybeans

2003 2004-07 2003 2004-07

23 Total income per acre $ 438.73 $ __________ $ __________ $ __________

Assumes: prices are such that counter cyclical payments are triggered

base acres are planted to program crops

actual yields are equal to FSA yields

FSA adjusted yield is equal to historical FSA yield

market price Is less than the loan rate

6-38


6-39



Process is complicated Many variables can influence the bottom line Government programs can substantially increase

income Counter cyclical payment depends on market price Counter cyclical payment can fall below zero

6-40



Case 1 Market price less than loan rate Corn

Target price 2.60

minus loan rate 1.98

equals eligible difference 0.62

minus direct payment 0.28

equals maximum counter cyclical payment 0.34

6-41



Case 2 Market price greater than loan rate but less than target price Target price 2.60

minus market price 2.10equals eligible difference 0.50minus direct payment 0.28equals maximum counter cyclical payment 0.22

6-42



Case 3 Market price greater than loan rate and greater than target price Target price 2.60

minus market price 2.75equals eligible difference -0.15minus direct payment 0.28equals maximum counter cyclical payment 0.00

6-43

Grazing LeaseGrazing Lease

Rangeland tenure arrangements vary

Units vary

Per acre cost

Per animal unit cost

Amount of digestible nutrients an animal requires

6-44


6-45



6-46

Grazing LeaseGrazing Lease

When recreation income vastly exceeds productivity Buyers have other motives Wish to preserve the natural state When cost per animal unit soars Aesthetic quality outweighs productive capability Must learn to deal with non-agricultural buyers

6-47

Module 6 - ReviewModule 6 - Review

Understand the process of income capitalization

Converts expected income to value V= NOI / R Sale price inversely related to capitalization rate

6-48


Understand how to estimate net operating income

Cash lease Share lease Owner-operator NOI is estimate of economic rent

6-49


How to estimate and interpret capitalization rates

R = I / V Estimates from sales of similar properties Abnormal rates may signal change in the market trends

6-50


How to estimate a potential sale price from income characteristics

V = NOI / RAll sources of income must be consideredProperty related expenses only should be deducted

6-51


The pros and cons of cash lease and owner-operator income analysis Cash lease estimates require few subjective judgements

Data comes from market Knowledge of crops, commodity pricing, or exemptions not required Easy to calculate and explain 6-52


The pitfalls of share lease and owner-operator income analysesShare lease is often most prevalentMust forecast crop yields, crop and input prices,

input costsRequires much more knowledgeEntails subjective judgements 6-53


The basics of government payments to agriculture Consist of direct payments and counter cyclical payments May also include a CCC non-resource loan Do not depend on planting the base crop Payments can depend on target price and level of market 6-54


How income capitalization breaks down when buyers have non-income driven motives for owning land

Capitalization rates are very low Grazing land is sometimes priced by animal unit Extremely low capitalization rates are unstable

6-55

Self-Assessment QuestionsSelf-Assessment Questions

Income capitalizationA net operating income of $1,500,000 and

a selling price of $27,272,700Cash lease, share lease, and owner-

operator residual are

6-56


A NOI stands forTo effectively estimate an income approach

capitalized value, an analyst mustAll of the following are legitimate expenses to

be deducted in an income capitalization estimate of property value except for

6-57


Abnormally low capitalization rates indicate

that

Direct payment, counter cyclical payments,

and target prices are

6-58

fundamentals of income translating a confusing mass of facts into a summary of the agricultural...

Documents

income cont

income capitalization

income characteristics6

income potentialsome

stable income

special income estimatenet

economic rentwhat income

capitalization ratewhen