Aerial view of a generic farm in Indiana, USA. Corn and soybean crops growing. JennaWagner/iStock/GettyImagesPlus

Rent calculator helps zero in on profitable farms

Here is a different way to look at whether you should keep renting farms with narrow margins.

By Howard Doster

I’ve not written on rent for farmland since expected earnings dropped, and my tenant continued to pay too much rent. He still is, but I decided to write this, anyway.

In the Sept. 2018 issue of Farm Futures, ”Some farms not worth keeping” (p. 12), a tenant-farmer wrote he was tempted to not rent 10% of his farms for next year because he couldn’t get the rent any lower.  When the author replied, “Do an analysis to consider the impact of your fixed costs,” I wondered what he would say next. I was disappointed. Why? As I decide what rent to bid, I don’t consider total costs per acre. I don’t even use fixed costs in my rent decision. 

True, to stay in business in the long run, a tenant has to more than cover fixed costs. True, traders in our market economy tend to bid toward what I will call an equilibrium rent where there is no excess profit for either party. But present landowners don’t have to pay their farm loans or even their real estate taxes out of next year’s rents.

And tenants, including mine, may be better off paying more than equilibrium rent vs. not renting another farm. I think this was generally the situation in 2018 and will be generally the situation in 2019.

Rent calculator works

Calculate your ‘Contribution Margin Budget.’ The contribution margin is, expected future revenue from sales and government payments minus variable costs. These include seed, fertilizer, chemicals, fuel, repairs, machine loss from use and operating interest for the farm in question. 

If the Contribution Margin is negative, don’t rent the farm, even at zero rent.  It’s that simple -- well, almost.

I just started using ‘machine loss from use’ in my calculations.  Until I get a better number, I’ll use $20 per acre.

Consider creating a contribution margin spreadsheet. Do your contribution margin budget for the farm in question, and for each of your other rentals, as if each were planted and harvested last. 

Why?  One of your farms will be planted and harvested last.  Agronomists say expected yield penalties are similar for most soils. 

Consider each farm’s merits

Rank your farms, starting with the lowest contribution margin. If it’s negative, don’t farm it. At today’s expected yields and prices, it’s sub-marginal for a corn/beans rotation. 

Then, maybe recalculate contribution margin for each of your remaining farms, using a slightly higher ‘last plant/harvest’ yield.  If the rent is more than the contribution margin, don’t rent it, either.   

Suppose your ‘last plant/harvest’ contribution margin is positive. Guess what your likely competition will bid. Subtract that amount from the positive contribution margin for the last plant/harvest acre. Do this for each alternative farm you could bid on.

Pick the alternative with the largest amount remaining after subtracting the competition rent. Then, bid $1 more than your competition bid. The remaining amount adds more returns to your fixed labor, management and machinery resources than any other alternative you’ve identified!

Let’s call the remaining amount of the contribution margin after subtracting the competition rent, ‘adjusted contribution margin.’

That’s more precise than accurate, but I hope you get the idea of what to consider bidding for your last plant/harvest acre. 

Doster is professor emeritus of the Purdue University Ag Economics department.

 

 

TAGS: Leasing
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