- Consumer preference for healthier eating is driving growing demand for permanent crops in developed and emerging markets.
- Their extended productive lifecycles can be tailored to individual investment horizons while achieving higher sustainability standards demanded by investors.
- Direct operation management models favor cost reduction, productivity, and marketing to enhance potential income, diversification, and inflation protection benefits.
The defining features of permanent crops
Permanent crop investments are characterized by farmland and biological assets such as perennial trees, vines, and shrubs, which produce multi-year harvests and represent a major subset of agricultural investment. As of September 30, 2020, permanent crops comprised 39% of the NCREIF Farmland Index, a total of $4.9 billion in institutional investment.1
Permanent crops are higher-value crops quite distinct from annual crop farmland, which produces commodity crops planted and harvested each year. Investments in permanent crops encompass a wide range of fruits and nuts across a variety of geographic locations. But there are several common themes that emerge across investments in permanent crops: fundamentals of global demand, alignment of permanent crop operations with sustainability standards, and the impact of adding permanent crops to an institutional portfolio.
In the United States, the major perennial permanent crops targeted by institutional investors include tree nuts (almonds, hazelnuts, pecans, pistachios, and walnuts), wine grapes, cranberries, apples, citrus, and blueberries. Institutional investment in U.S. permanent crops that’s reported into the NCREIF Farmland Index is concentrated in the Pacific West and Pacific Northwest, but also includes permanent crop properties in the Lakes States and Southeast regions.
The U.S. permanent crop investable universe is estimated at over $71 billion
Source: HNRG Research as of May 2018, HNRG analysis using USDA data.
Fundamentals of demand are well supported
Permanent crop demand is supported by multiple major trends shaping global food markets: consumer preferences for products that are linked to health and wellness and growing demand for higher quality, fresh foods in developed and emerging markets. Two trends in this area include a rise in healthy snacking and a move toward the consumption of fewer processed foods. For example, in the United States, fresh fruit consumption has now outpaced processed fruit and juice consumption.2 Tree nuts, a source of plant-based protein, have moved from serving as a minor ingredient for flavor and texture to more prominent primary ingredients and directly consumed foods as part of a nutritious, healthy diet.
“Permanent crops are well aligned with growing incomes in emerging markets.”
Permanent crops, particularly fruits and tree nuts, are well aligned with growing incomes in emerging markets and increased consumption of fresh food and plant-based proteins globally. Many permanent crops are primarily consumed as fresh, whole fruit or provide a source of plant-based protein (tree nuts).
Offering flexibility to meet sustainability standards
Large-scale permanent crop properties are well positioned to adapt to an operating and marketing environment that increasingly requires agricultural producers to meet and certify higher standards of sustainability and operate with a smaller carbon footprint.
These irrigated, long-term crops represent major capital investments, and the high value of the resulting orchards and vineyards justifies the use of advanced agricultural technology that can boost the efficient use of inputs such as fertilizer and water and enhance the sustainability of property management. The deployment of technologies from remote sensing to precision irrigation and fertilizer application will be increasingly important in stewarding scarce water resources and adapting to climate change shifts in temperature and precipitation patterns.
NCREIF Farmland Index properties by crop type (US$ billions)
Source: NCREIF Farmland Property Index, as of September 30, 2020.
Points of entry offer varied strategic options
The extended productive lifecycle of permanent crops offers investors several strategic options when targeting investments, since the prime productive lifespan of the major permanent crops varies from 15 to 40+ years. On the shorter end of the spectrum are high-density apples, where innovation in new varieties leads to shorter tree life expectations, while at the longer end, pistachio trees can produce competitive returns for four decades. The optimal permanent crop lifecycle is a function of both biological (crop yield over time) and market considerations (crop varietal demand and prices).
Investors can access permanent crop properties at different stages in their lifecycle (mature properties, greenfield developments, and rehabilitation of older properties), based on their risk/return preferences and goals.
- Permanent crops can be accessed through mature permanent cropland properties in their peak production years that should produce strong income from the point of acquisition, but these assets tend to be fully valued and competitive to purchase
- Greenfield developments may include planting a new permanent crop on former annual cropland or changing from one permanent crop type or variety to another. Planting a new permanent crop typically requires an extended pre-productive period during which investors forego cash returns (called the J-curve). Typically, permanent crops take three to seven years, depending on the crop type, to reach commercial production and provide positive cash flow
- A third approach could involve partial or complete redevelopment to redesign the property’s planting and irrigation infrastructure, with block-by-block development based on age profile and market conditions
The last two approaches provide an opportunity for patient capital that understands and is willing to accept the J-curve period in anticipation of future cash flows.
Management strategies favor direct operation
The dominant management model for institutional investors in permanent crops is direct operation of the properties, which contrasts with investments in annual row crops that are predominately managed as leased properties. As of September 30, 2020, 80% of all NCREIF Farmland Index permanent farmland properties by value were directly operated, with 20% leased.3 In contrast, annual crop properties in the NCREIF Farmland Index are nearly exclusively leased investments rather than directly operated.
The fact that a large share of the total investment value of permanent crop investments resides in the biological assets provides a strong rationale for an operating model that focuses on the preservation and optimization of those assets over a longer time horizon than a multi-year lease arrangement. The longer-term nature of permanent crop farming underpins the financial rationale for capital investment in associated infrastructure, deployment of advanced technology, and integrated marketing programs.
A directly operated investment strategy makes sense for a greenfield project as it allows for state-of-the-art orchard/vineyard and irrigation design to support sustainable management practices. It also allows for site and crop type selection based on optimal soils, water, and climate without needing to consider the constraints of the available tenant pool. And controlling costs in permanent crop operations is critical to offsetting the inherent price and yield volatility associated with permanent crop investing. Here, applying improved technology can simultaneously help achieve cost-efficiency and enhance sustainability.
For example, permanent crops are irrigated crops, and water optimization is important to maximizing crop production and preserving value. Water management plans are built on systems that are flexible, potentially including ground and surface water sources, with recharge and storage, to produce high yields with less water at lower cost. Under a direct operation management strategy, decisions on technology and capital expenditures can be more quickly evaluated and implemented.
“Successful permanent crop investment includes optimal property management.”
Direct permanent crop operating strategies can yield benefits beyond the production process. For example, large-scale farm management organizations directly operating their properties are well positioned to establish long-term relationships with processors and marketers to capture enhanced pricing based on their ability to deliver large, dependable volumes of product at a consistent premium quality.
Return characteristics of permanent crops
Permanent crops generally provide higher returns than row crops, but with some additional volatility tied to the inherent price and yield risk associated with direct operation.
Between 1995 to 2019, annual (row) cropland investments provided annual returns of 10.3% at an average standard deviation of 5.1% (Sharpe ratio 1.57).4 Average annual permanent cropland returns of 12.7% were higher than row crops, with an accompanying increase in annual average standard deviation of 9.9% (Sharpe ratio 1.05). The relatively higher volatility for permanent crops as measured by these NCREIF indexes reflects the fact that 80% of these investments are directly operated, compared to the row crops, which are leased investments.
U.S. historical return and standard deviation, 1995–2019
Sources: Data for Timberland refer to the NCREIF Timberland Index as of 12/31/19. Data for Farmland refer to the NCREIF Farmland Index as of 12/31/19. Data for Commercial Real Estate refer to the NCREIF Property Index as of 12/31/19. Data for Small Cap Equities refer to the Ibbotson series IA SBBI U.S. Small Stock TR USD as of 12/31/19. Data for Non U.S. Equities refer to the MSCI/EAFE International Equities Index as of 12/31/19. Data for Corporate Bonds refer to the Ibbotson series IA SBBI U.S. LT Corp TR USD as of 12/31/19. Data for U.S. Treasury Bills refer to the Ibbotson series IA SBBI U.S. 30 Day Tbill TR USD as of 12/31/19. Data for the CPI refer to the U.S. Bureau of Labor Statistics as of 12/31/19. The S&P 500 series is from Standard & Poor’s Financial Services LLC as of 12/31/19. Data for U.S. Private Equity refers to the Cambridge Associates Private Equity Index as of 12/31/19. Data for U.S. Forest Products refer to the S&P Composite 1500 Paper and Forest Products series as of 12/31/2019.
Individual permanent crop type returns can be less correlated with each other than returns among major row crop types. With different geographic sources of supply and demand and regional weather patterns and market conditions, return performance for individual permanent crop properties each year can vary considerably. In this way, a well-balanced portfolio of permanent crop properties, diversified by crop type and geography, can mitigate some sources of volatility.
Another important performance feature of permanent crop investment is the high proportion of total return represented by annual cash flow. Between 1994 to 2019, permanent crops in the NCREIF Farmland Index delivered an average total return of 12.7%, of which the cash yield of 10.3% accounted for 81.0%, while capital appreciation represented on average only 19.0% of total return.5 Even in years where property values eased, strong current income supported positive total returns in each of the last 25 years except 2001.
Permanent crops have historically provided strong income
U.S. NCREIF permanent cropland index returns by component (%)
Source: NCREIF Farmland Property Index All Managers permanent cropland returns, 1994–2019. The NCREIF Farmland Property indexes comprise domestic (United States) farmland investment properties held in an institutional investment environment.
A well-balanced permanent crop portfolio can help manage the market and production variability of different permanent crops and regions. In the chart, the magnitude and return performance ranking of returns by crop changed each year, with the top-performing permanent crops consistently delivering higher returns than annual leased row crop investments.
Diversification by crop type can optimize returns
NCREIF property level annual total return by crop type
Permanent crop investments provide an opportunity to potentially benefit from demand for high-value nutritious foods such as fruit and nut crops that continues to expand in emerging and developed markets. These investments provide investors with the opportunity to invest in health and wellness themes while contributing to sustainability goals—successful permanent crop investment includes optimal property management since cost reduction, productivity, and marketing are key to long-term performance.
Within institutional portfolios, permanent crop investments can provide income, diversification, and inflation protection. In our view, the combination of current income, low correlation to other assets, and the opportunity to provide these benefits sustainably, make these assets a strong fit for long-term investors.
1 NCREIF Farmland Property Index, as of September 30, 2020. 2 USDA Economic Research Service Food Availability (Per Capita) Data System, November 18, 2020. 3 NCREIF Farmland Property Index, as of September 30, 2020. 4 Sharpe ratio 1995—2019 uses risk-free rate of 2.3%, the average 30-day Treasury bill rate. 5 NCREIF Farmland Property Index, 1994—2019.
Data for timberland refers to the NCREIF Timberland Index, as of December 31, 2019. Data for farmland refers to the NCREIF Farmland Property Index, as of December 31, 2019. Data for commercial real estate refers to the NCREIF Property Index, as of December 31, 2019. Data for small cap equities refers to the Ibbotson series IA SBBI U.S. Small Stock TR USD, as of December 31, 2019. Data for non-U.S. equities refers to the MSCI/EAFE International Equities Index, as of December 31, 2019. Data for corporate bonds refers to the Ibbotson series IA SBBI U.S. LT Corp TR USD, as of December 31, 2019. Data for U.S. Treasury bills refers to the Ibbotson series IA SBBI U.S. 30 Day Tbill TR USD, as of December 31, 2019. Data for the CPI refers to the U.S. Bureau of Labor Statistics, as of December 31, 2019. The S&P 500 series is from Standard & Poor’s Financial Services LLC, as of December 31, 2018. Data for U.S. private equity refers to the Cambridge Associates Private Equity Index, as of December 31, 2018. Data for U.S. forest products refers to the S&P Composite 1500 Paper and Forest Products, series as of December 31, 2019.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
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