Inflation, interest rates, and recession risk: farmland’s resilience in the face of uncertainty

What drives farmland investment performance?

The financial performance of farmland and agricultural investments is driven by both market-specific factors and developments in the global macroeconomic environment. The recent dramatic changes in the U.S. economy, including rising inflation and interest rates, are already affecting farmland operations and income. The financial performance of farmland and agricultural investments has shown incredible resilience during previous recessions and periods of economic turbulence. This resilience will be tested as headwinds build, with economic growth slowing and the risk of a near-term recession on the rise.

Farm products registered price gains as inflation rates rose

Demand for goods and services rebounded quickly following the pandemic-induced recession in early 2020, aided by a series of monetary and fiscal measures undertaken to inject liquidity into the system and ultimately support the economy. The juxtaposition of rapidly rising demand and pandemic-induced supply chain constraints led to surging inflation beginning in early 2021. Within agriculture specifically, U.S. farmland markets responded quickly to the changes in the inflationary environment. The rapid recovery in demand for farm products placed strong upward pressure on prices for agricultural crops after the short-lived declines seen during the pandemic-induced recession. Farm product prices posted double-digit percentage gains in both 2020/2021 and 2021/2022 marketing years, more than offsetting the initial 11% drop in the price level seen during March–April 2020. Several factors contributed to the enhanced demand prospects for major U.S. agricultural products, including consumers’ increasing interest in healthier diets that boosted domestic fruit and tree nut consumption, reopening local economies that reinvigorated fuel consumption and lifted the outlook for ethanal, and by extension corn, and strong export demand.

Agricultural production costs pushed up due to high inflation rates

Increasing inflationary pressures in major input cost categories have had a direct impact on farm operations, and most farm-related cost categories have shown increases for over two years. From the trough seen during the first months of the pandemic in 2020 to the peak levels of 2022, major input costs, including fuel and energy, machinery, chemicals, and fertilizers, surged, with increases ranging from 30% for machinery to 120% for natural gas costs. 

Due to differing cost structures, the impact of higher inflation on operating costs varied by crop type, and while surging prices for fertilizer and other chemical inputs accounted for most of the rising operating costs of major U.S. row crops in percentage terms, the dollar impact of these increases varied. Specifically, the effects of the dramatic rise in fertilizer and chemical costs were significant for corn, soybeans, and wheat, with a respective 92%, 71%, and 84% of the per-acre operating cost increases attributed to higher fertilizer costs from 2020/2021 to 2022/2023. However, this masks the disparity of the impact between different crops; U.S. corn farmers are forecast to pay $81/acre more for fertilizers in 2022/2023 relative to the average fertilizer costs of 2020/2021. In comparison, U.S. soybean and wheat growers are forecast to pay $40/acre and $29/acre more for fertilizers and other chemicals over the same period. Per-acre cost impact also influenced farmers’ planting decisions: In 2022, U.S. farmers planted 4.6 million fewer acres of corn relative to a year ago despite high corn prices, while soybean acreage gained a quarter million acres due to the relatively smaller impact from rising fertilizer costs. Overall, combined planted acres of corn, soybeans, and wheat declined by 5.4 million acres in 2022 compared with 2021, illustrating the direct impact that rapidly rising costs had on farmers’ planting decisions.

Farm profits rise as revenue growth outpaced cost hikes in 2022

For over two years, agricultural product prices have largely kept pace with increasing input costs, measured by the correlation between monthly price indexes of farm products and major input cost categories, including energy, chemical inputs, machinery, and transportation. This positive correlation statistically demonstrates crop prices’ capability to keep pace with rising input costs and has allowed farmers to at least partially offset rampant increases in input costs, providing operators and investors some relief within an inflationary environment. This capability was demonstrated through the expected increase in farm profits forecast by the USDA in the face of rapidly rising input costs during 2021 to 2022, with net farm income forecast to increase 5.2% ($7.3 billion) year over year.

The evolution of the relationship between interest rates, agricultural investment returns, and farmland values

Interest rates are another macroeconomic factor affecting agricultural investments. U.S. interest rates have experienced several hikes in 2022, with additional increases expected heading into 2023. Meanwhile, U.S. farmland values have increased significantly in the past two years. According to the USDA’s annual surveys, average U.S. farmland values increased by 7.0% and 12.4% in 2021 and 2022. Despite this strong appreciation in farmland values, investors have become more cautious as the U.S. Federal Reserve (Fed) continues to raise interest rates in an attempt to control persistently elevated inflation. Looking back, the appreciation in farmland values has been supported by the relatively low interest-rate environment witnessed since the Great Financial Crisis (GFC) and by strong farmland returns. Looking forward, expectations for crop prices, and the pace and duration of further interest-rate increases, are expected to be key determinants of farmland values.

Land values have increased steadily, while interest rates have trended lower and been more volatile

U.S. farmland values, represented by average U.S. farm real estate values as calculated in the USDA’s annual surveys, have shown incredible growth and resilience for more than five decades.¹ U.S. farmland values have expanded at an average annual rate of 5.8% since 1970, only declining seven times on a year-over-year basis. When market conditions are robust and positive—supported by rising crop prices, demand, and other sources of income—U.S. farmland has appreciated at an average rate of 7.8% per year. On the other hand, farmland values have also displayed relatively modest declines during periods of weaker market fundamentals (as indicated by the shaded areas in the chart below). During these periods, land values only retreated at an average annual rate of 5.1% per year.

Interest rates have a complex relationship with farmland appreciation

In general, an increase in interest rates may create downward pressure on asset prices. This negative relationship is illustrated by the negative correlation (-0.7) between U.S. average farmland values and the federal fund rates seen from 1970 to 2022. However, the relationship between interest rates and farmland values is more complex and differs from that of other traditional financial asset classes, including stocks and bonds. Changes in farmland values tend to lag interest-rate changes and are more heavily influenced by broader agricultural market factors such as rising per capita income and the supply-and-demand balance. Therefore, the recent surge in interest rates alone is highly unlikely to result in imminent farmland value depreciation as current values appear to be in line with returns and interest rates.

The historically dynamic correlation between farmland value and interest rates

The overall negative long-term correlation between farmland value and interest rates masks a more dynamic pattern. When viewed on a rolling 10-year basis, farmland values exhibited a positive correlation with interest rates as they trended slowly higher from the 1970s through mid-1990s. This rolling 10-year correlation turned largely negative beginning in the mid-1990s, as interest rates eased steadily lower through 2017. As the Fed attempted to normalize interest rates and began raising rates again in 2017, farmland values continued to rise on positive agriculture market fundamentals and the correlation once again turned positive.

Farmland returns are a key driver of farmland value

Like other asset classes, farmland derives its value as a function of discounted future returns. Expected future farmland returns can be calculated by the estimated future income generated from the underlying land. For leased farmland, which is a prevalent management type for annual row cropland used by institutional investors, cash rents can be used as a proxy for future income. Higher cash rents typically lead to higher farmland values, and data from the state of Illinois (one of the more active and mature U.S. farmland markets) shows the exceptionally strong positive correlation (0.98) between farmland values and cash rents. Between 1970 and 2022, the average farmland value in Illinois increased at an average rate of 5.7% per year, while a