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Farmland Valuations - The Valuator - Agricultural Valuations

The Impact of Changed Land Use on Farmland Values and Farmland Valuations

An interesting read from Capeland Farming Properties.  We have given you an extract below but if you wish to read the full report, please follow the link – www.capeland.co.za

Abstract

The main agri-trends in North America, Europe and Australia are being followed closely in various regions of South Africa.

One such trend is on land-use changes; the fact that some investors purchase farmland in South Africa to not farm – for the sake of investment only. Research that was done in 2011 in the south-eastern Nama Karoo confirmed that purchasers do indeed buy farmland at significant prices primarily as investments, although not on a grand scale. The research was done on a quantitative and qualitative level – seminars and questionnaires (quantitative), and personal interviews (qualitative). It was confirmed that in this part of the Nama Karoo, like in many other parts in South Africa, there is indeed a trend of new investors purchasing land for its sheer beauty and natural magnificence, something that they believe will increase in value and which is a sound investment for the future.

The question was also asked: How might this impact on value of farmland in this region and how will property valuers interpret this changed land use? And, how should farmland be valued or valuated in future if this trend prevails and expand? The research confirmed that investors buy farmland not for primary agricultural production on a commercial and profitable sale, but for other secondary reason, which result in land prices almost double the average –which is not a unique South African trend. Pure investment is a primary driver in the decision making process and is based on a view that the future capital growth is enough to justify the investment. It was also shown that the typical investor is around 50 years old, financially extremely well off, and mostly professional. As potential non- commercial farmers , they are also not necessarily applauded by current commercial farmers. It finally became evident that traditional ways of farmland valuation will not suffice in future if this trend in changed land use prevails and that new approaches to farmland valuations should be considered.

 

1 INTRODUCTION AND PROBLEM STATEMENT

It almost goes without saying that farmland gets bought for farming. Why else would we call it “farmland”? Several issues about the very nature of farmland were recently researched in a part of the Nama Karoo, because it is true in other parts of the world and of South Africa that a new generation of investors, are purchasing farmland not primarily for commercial farming, or not to develop either – as a matter of fact not to do anything in particular on it. In doing so they believe that their investment decision will perform as good as other investments like gold, money markets and traded shares.
Should a trend like this become common practice and should it become true that substantial portions and hectares of land get taken out of the agriculture realm one could start asking some further questions:
1) What could be the possible impact on a specific farms value and what could be the impact of the value of such farmland on farmland value in general?
2) How would such farmland be valuated in future by professional valuers?
3) How should financing institutions respond to a development like this?

The value of farmland, and also the valuation of farmland, is not a simple matter. The valuation of farms is fast becoming a very complex process of understanding a whole new range of value elements, land use changes, amenity values, and deeply personal growing convictions amongst a new generation of landowners about the value, attributes and meaning of land in general, and farmland specifically.
In the past and to the present day the valuation of farms was and is based primarily on the production value of farmland and the commercial return that can be extracted from the farm with optimised farming activity, and the resultant market value. This situation highlights and accentuates several problematic areas like the valuation of a farm where that farm is used only for personal enjoyment and not for agricultural production reasons, or establishing the value of a farm, which is not farmed or improved or utilised for farming, or even formally defining the value attributes that landowners confer on farmland as well as the incorporation thereof into current valuation methodologies.
According to Reed and Kleynhans (2009: 324) agricultural land valuations are becoming increasingly challenging due to changes in land characteristics classification and land-use options. The more classic, and now almost traditional approach to valuations is based on market value and comparative sales, but also substantiated by the productivity of farms, a feature, which is financially measurable and directly related to the property’s income-generating capacity; a confirmation of a farms standing with other comparable farms.
To further accentuate the value of agricultural land the recent worldwide recession from 2008 to 2010 dispersed a lot of wealth in a general sense because of a sharp, albeit temporary, decline in residential and commercial real estate values and a stock market meltdown (Painter, 2011: 396). However, Painter’s research, mainly in the northern hemisphere, indicated that farmland seems fenced from this to a certain extent (Painter, 2011: 396).

It seems necessary to establish whether this truth applies to farmers and farmland in South Africa.
In some areas of South Africa, it looks like farming has already reached the stage where the price of land is more than what may be farmed within the capacity of the land (Kleynhans & Opperman, 2005: 497) – a common phenomenon in an agricultural environment.

This translates into an untenable reality that it becomes impossible for a farmer to pay back the cost of the land within a limited period of time, in addition to making a profit from farming. Yet the demand for land is not diminishing and more and more potential buyers vie for less and less land that is offered for sale. Demand exceeds supply and prices remain bullish.
In spite of all this the valuation of agricultural land was and still is restricted to commercial or production value; the value that is linked to the production potential of a farm combined with the relevance and nature of supporting infrastructure on that land. Painter (2011: 397) reasons and proves to a certain extent that investment in agricultural land, under certain predetermined circumstances, can indeed be compared to investment in gold or gold shares.

 
1.1 Research Approach

How was the research done?

The inevitability of both a quantitative and a qualitative research approach was evident from the outset. It was unavoidable to embark on the very demanding route of providing information to prospective respondents through some seminars in the towns of Steytlerville and Willowmore combined with the process of completion of questionnaires probing about whom the investors are, what the main motivators for their financial decisions were, and why they were paying for the land what they paid? In addition the responses had to be clarified and further explained by a series of personal interviews with as many of the subjects as possible.
The results were an astounding confirmation of postulations and hypotheses, and early on it was clear that South Africa is indeed following similar trends in North America, Europe and Australia.

 
2 LITERATURE EVALUATION

Kleynhans and Opperman (2005: 507) confirmed that, amongst other attributes, aesthetically attractive natural landscapes are associated with land price increases, and although difficult to really get a grip on, valuers will have to study the influence of aesthetic beauty and natural or environmental heritage, on the value of farmland.

It is the opinion of Adams and Mundy (1991: 48) that the public believe that natural habitat farms, under certain circumstances, have significantly higher and better use than certain commercial-economic alternatives. This may pose problems for valuers since the challenge remains, as is the case with this research, how to qualify, and even quantify this non-commercial-based value. As a general rule this research set out to show that the income capitalisation method of valuation, as well as other economic based valuation methods is not applicable to natural or non-producing farmland either.
The assessment of landscape and aesthetic appeal is becoming a highly scientific process where different models of valuation based on psychophysical and surrogate elements are blended together and materialised into valuation techniques that make use of additional statistical skills to determine the mathematical relationships that exist between landscape components and the scenic preferences of observers (Arriaza, Ca–as, J. F., Ca–as, J. A., Ruiz, Gonz‡lez, & Barea, 2005: 1). Landscape or visual appeal is one of the most salient components of what is valued outside the commercial domain, together with natural habitat and scenic beauty.
It is not surprising that Doye and Brorsen’s (2011: 16) research confirms that landscape features and natural habitat are becoming increasingly important for buyers of undeveloped farmland. This accords with a similar research, which found that farmland amenities or public goods are non-exclusive; i.e. accessible and to be enjoyed by all; and also non-rival; i.e. the one persons enjoyment does not diminish another persons gratification (Irwin, Nickerson & Libby, 2003: 21; Libby & Irwin, 2003: 1) hence more value. Since farmland value, inclusive of amenity value, dwarfs other asset values in agriculture production, the understanding of insight in the formation of farmland prices should command high research priority (Ervin & Mill, 1985: 938). Research should go on far beyond what was confirmed in this study.
The possibility that city-based wealth find investment opportunities in the platteland is neither farfetched nor impossible to comprehend. Most, if not all of the wealth in some areas, invested in farmland, where natural beauty is an overwhelming motive for investment, come from cities and bigger centres where wealth could be accumulated rapidly over short periods of time.
In South Africa the trend that the deep platteland is economically dwindling and becoming under pressure, may not be true entirely or it may not be the full picture of the status quo. In reality it is possible that it is only cash that is being spent elsewhere – in bigger centres. Although life is still rewarding in these areas, money is basically exported to the cities and services are imported at a premium, hence the relative impoverished situation. The scarcity of farmland, especially in the deep rural areas, is possibly becoming one of the major reasons for the sharp and sustained increases in farm prices and a growing concern for government.

 
2.1 Rural Market Changes Nationally and Internationally

In the last two or three decades there was a noticeable cognitive shift in the way people comprehend and respond to environmental surroundings (Adams & Mundy, 1991: 48). In some or another way these changes in habits and behaviour amongst populations deposit itself in noticeable changes in the economy and socio-economic realities; it has unmistakeable monetary value. Although some of these are driven or determined by the value of natural resources such as gold and gas and oil in the northern hemisphere, and an increasing awareness of the lands utility, aesthetic and emotional context and elements are also taking effect.
It may be concluded that farmland is the only classification of property that cannot be increased by area or availability, and it faces a diminishing future mainly due to industrialisation, urbanisation and changes in land use legislation. Mathews and Rex (2011: 41) record similar findings in North Carolina and all-over the USA, more specifically in Iowa, substantiated by the United States Department of Agriculture (USDA, 2011: online). Here it should be noted that farmland prices just recently increased more than inflation, for the first time in recent history.
Higher farmland values and the diminishing availability of farmland as such are causing a strong leaning and tendency towards the preservation of land almost across the globe and especially for the conservation of localised benefits like open space, environmental quality, and impediments to urban sprawl (Plantinga & Miller, 2001: 56; Shi, Phipps & Colyer, 1997: 90).
In spite of the fact that farmland historically has been valued for its capacity to provide food and raw materials, public concern and interest has shifted from food production to protecting and enhancing quality of life and quality of the countryside landscape (Henderson & Gloy, 2011: 18). If this is anything resembling a trend, it might add momentum to even higher land prices and adjusted land valuation methodologies in future.

 
2.2 Agricultural Land Valuation Principles

The traditional approach of commercial and production value as a basis for farmland valuation may create the impression that it is the only available valuation method – this research will attempt to confirm same.
As a professional land valuer, Gwartney (2012: online) speaks eloquently about the value of (farm) land:

Land, in an economic sense, is defined as the entire material universe outside of people themselves and the products of people. It includes all natural resources, materials, airwaves, as well as the ground. All air, soil, minerals and water is included in the definition of land. Everything that is freely supplied by nature, and not made by man, is categorized as land. Land holds a unique and pivotal position in social, political, environmental and economic theory. Land supports all life and stands at the center of human culture and institutions. All people, at all times, must make use of land. Land has no cost of production. It is nature’s gift to mankind, which enables life to continue and prosper. Land’s uniqueness stems from its fixed supply and immobility. Land cannot be manufactured or reproduced. Land is required directly or indirectly in the production of all goods and services. Land is our most basic resource and the source of all wealth (Gwartney, 2012: online).
This sums up a lot of value elements and additional values that need to be taken into consideration when attempting to establish or verify the value of a certain piece of land. People see value and look for value in unexpected ways, and are prepared to pay for it.
Various approaches to farmland valuation models currently utilised are all related to comparative farmland value and its inherent ability to produce and economic yield; Comparative Model employing Market Value, Commercial Value, Production Value, and the Growth Model acknowledging the Investment Value and Capital Gains Value of the land, and Option Value, or also described in literature as Personal Value or Hedonic-Aesthetic Value or Pleasure Value.

 

2.2.1 Highest and Best Use

Disagreement persists among traditional and contemporary thinkers, researchers, valuers and students over the meaning and execution of highest and best use (HBU) analysis in valuation of farmland (Wilson, 1995: 11). The discourse is also not something that will disappear immediately since it is the nature of the valuerÕs profession to not accept one single approach for all circumstances and situations, although valuers are sometimes inclined to default onto farmland valuations based on market or commercial value, and then validated by the comparative sales model.
Reed states that valuers, although information about amenity value and natural attributes might be available, do not make use of the information or are not equipped to translate the information into adjusted HBU interpretations:
Analyses of valuation reports as well as interviews with valuers and buyers indicated that valuers continued to emphasise mainly traditional agricultural characteristics associated with production in the valuation of farms bought for lifestyle purposes. They concentrated on measurable characteristics and valuation reports were dominated by attributes associated with the agricultural potential of farms. This avoidance of lifestyle attributes or vague descriptions left valuers in a vulnerable position, as they struggled to balance agricultural and market value based on market sales comparisons. Most comparable sales used were those of agriculturally productive farms and focused on value attributes such as the extent of permanent crops, number of arable hectares, topography and improvements such as irrigation infrastructure. Valuers concentrated on measurable characteristics that could be expressed in monetary terms (Rand per hectare) and assumed the typical buyers of these properties to be farmers (Reed, [n.d.]: 6).

 
3 RESEARCH RESULTS AND INTERPRETATION

During February 2010 a farm in the Steytlerville district of just more than 3000ha, not a very big farm, but sizeable, was sold for R3 863/ha. Landowners in the area will, and do confirm that there are no means or possibility of any type of farming or agricultural activity that can possibly repay this investment out of farming activities in this specific area.
The conclusive finding was that some investors (they cannot be called anything else) are prepared to pay as much as 150% more than the average price for good farmland in a specific area only to engage in farmstyle living and not lifestyle farming, as many people would describe it. Their primary motive, we found, is investment combined with preservation of the inherent natural beauty and scenic appeal of the area, and this notion is coloured with a hint of conservation undertones and ecological awareness.

The Impact of Changed Land Use on Farmland Values and Farmland Valuations