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Contracts can determine how much you pay for land

With commodity and specialty crop prices high and optimism for 2008 also high, landowners are looking to get a piece of those profits by turning to different types of land rental contracts that buck traditions.

Many growers act as both a tenant and a landlord in a given year. Crop rotation schedules often require potato growers to work with neighbors to restore soil tilth and reduce pest and disease pressure in their fields.

The “rent” for a piece of farmland can be paid in various ways, either with part of the crop or cash, but there should always be a contract that outlines and anticipates any problem areas so the agreement is equitable, said Ben Eborn, Extension educator in Teton City, Idaho.

“By equitable, we mean fair for both the landlord and tenant,” he said. “They can be written or oral. I highly recommend the written form, but the oral one is legal.”

The goal is for both parties to make money and be happy with the contract.

Crop Share

In Eborn’s area, the most common type of agreement is the crop share type, where the landowner and tenant split the final crop. That split is usually determined by tradition, from agreements that go back to a grower’s father or grandfather. The tenant in a crop share agreement doesn’t have to pay any cash up front for the land, but the end production is split between the two. The landowner may be more involved in the production aspects, but not necessarily so.

The advantages of a crop share are:

-Both parties benefit from new technologies – increase yields or quality and increase profit for both.
-Risk of both yield and price is shared.
-Proving material participation is easier.
-Tenant’s operating costs are reduced.
-Management of production and marketing is shared.

“That could also be a disadvantage if you don’t like how the tenant is managing the land,” Eborn said.

There are disadvantages to the crop share agreement, too:

-More recordkeeping for tenant and landlord involvement.
-The other party can have a say in how the crop is marketed.
-Greater need for communication because decisions are joint.
-Both parties have to agree on what expenses to share.
-Government programs can be more complex and payments have to be agreed upon by both parties.

Fixed Cash Lease

The fixed cash lease is the simplest lease, which could be why it’s getting popular, Eborn said. This type of lease program is a cash payment for the use of land, with the rate determined by the demand for land in the area.

The advantages to the fixed cash lease are:

-Simple and easy.
-No management decisions for the landowner.
-Guaranteed fixed income for the landowner.

The disadvantages to a fixed cash lease are greater for the tenant than they are for the landowner, such as:

-The tenant bears all the cost and all the risk.
-Land value can be difficult to determine.
-There’s less incentive for the landlord to make improvements or invest in new technology.

This contract also can take time to determine the value of the land, because land only has value for its income potential, Eborn said. The formula for finding the value (V) is V=P/i, where P is the income per acre and i is the interest rate. So for a field that has an income per acre of $100 and an interest rate of 6 percent, the value of the land is $1,667.

There are other factors that can be considered besides land value, including machinery, management costs and family labor. Management costs are typically figured at 5 percent of gross return or as a fixed percent plus a percentage. Figuring in the management costs is common in the Midwest to cover costs that exceed the unpaid labor or family labor that is usually figured at market rate.

But with rotational crops, the income for the crops will vary and the landowner and tenant have to agree on an average for the cash rate or adjust the value for higher-income potato crops and lower-income grains.

Machinery, such as irrigation equipment and wells, can affect the rate in an area that requires more water. There can be a flat rental rate for the equipment and the land or the tenant can pay the depreciation on the equipment plus the land rent, Eborn said.

“Don’t use your accountant’s depreciation value,” said Paul Peterson, Extension agricultural economist with the University of Idaho. “He’s giving you the tax rate depreciation, not the management or useful-life depreciation.”

Flexible Cash Lease

A flexible lease is a way for landowners to get some of the profits growers are finally seeing, Eborn said. Flexible leases are made up of an initial cash payment, plus an adjustable rate based on yield or commodity price. This lease is advantageous for landowners because it offers only upside and no downside. Tenants also pay less up front, but carry more risk because the flexible portion of the lease only goes up – it doesn’t adjust payments if a grower under-produces or has a crop failure.

“I think these are going to be more common out West if commodity prices remain high,” Eborn said. “I think there is some incentive for landlords to negotiate with some of these leases.”

So if a grower paid a fixed rate of $125 an acre with an expected yield of 110 bushels, but actually produces 120 bushels, his payment would be $125 X (120/110), or $136 per acre.

On a price-based flexible lease with the same fixed rate of $125 and an expected price of $4 per bushel, but during the season the price is $4.50 a bushel, then the lease payment would be $125 X (4.50/4.00), or $140 per acre.

It’s also possible to have a yield and price flexible lease, which combines the two. For the same farmer, he would pay $125 X (120/110) X (4.50/4.00), or $153 per acre.

The lease can be negotiated before the season to account for higher risk items. For potatoes, the cash discount might be higher because of the higher risk.

Originally posted Tuesday, Feb. 26, 2008

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