Asset Allocation with Farm Land

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jamokaj
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Asset Allocation with Farm Land

Post by jamokaj » Wed Oct 04, 2017 8:05 am

Hi folks -

Great web site - lots of useful information.

I have a question regarding farm land real estate in the context of overall asset allocation. I own approx $4M in farm land (corn, soy beans) which is rented out annually for cash rent. This cash rent provides a return of roughly 2-3%. This farmland represents 2/3rds of by investment portfolio.

I also have approx $2M in other investable assets, 75% in tax except, 25% in taxable accounts.
These non farm assets are in vanguard 3 fund portfolios split 55% stock, 45% bond. I would like the overall asset allocation of all my investments to be 55% stock and 45% bond. My question is should the farmland be treated like stock or bonds (or other) when considering overall asset allocation.

Thanks for your thoughts.

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ruralavalon
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Re: Asset Allocation with Farm Land

Post by ruralavalon » Wed Oct 04, 2017 2:12 pm

Welcome to the forum :) .
jamokaj wrote:
Wed Oct 04, 2017 8:05 am
Hi folks -

Great web site - lots of useful information.

I have a question regarding farm land real estate in the context of overall asset allocation. I own approx $4M in farm land (corn, soy beans) which is rented out annually for cash rent. This cash rent provides a return of roughly 2-3%. This farmland represents 2/3rds of by investment portfolio.

I also have approx $2M in other investable assets, 75% in tax except, 25% in taxable accounts.
These non farm assets are in vanguard 3 fund portfolios split 55% stock, 45% bond. I would like the overall asset allocation of all my investments to be 55% stock and 45% bond. My question is should the farmland be treated like stock or bonds (or other) when considering overall asset allocation.

Thanks for your thoughts.
Real estate, including farm land, is "other".

Although it produces income, it is not a fixed rate or amount, so it's not like a bond.

I don't believe value of farm land is highly correlated to the stock market, so it's not like a stock.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

CnC
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Re: Asset Allocation with Farm Land

Post by CnC » Wed Oct 04, 2017 2:25 pm

While it is cash rent, it should still be classified as "income" in your portfolio.

Meaning the $100,000 you make a year off of the farm ground should be treated like income. Meaning that for retirement purposes your $250,000 a year required expenses should be treated as $150,000.

All that being said farm ground much like my pension would make me consider being a bit more agressive with my AA than I would without it.


The problem is, if you consider your farm ground as a "bond" which you could it would pretty well destroy any type of asset allocation you could come up with because even if you put 100% of everything else in stocks you would still be at 66% bond and 33% stock.

This defeats the purpose of conservative asset allocation because you can not sell portions of your ground when the stock market dips the same way you would sell a bond.


A bit more logical question is why do you want a 55/45 asset allocation?

Wormhauler
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Re: Asset Allocation with Farm Land

Post by Wormhauler » Wed Oct 18, 2017 7:38 am

Interesting that I had this thought as I just purchased another piece of farm ground. What should a good balance be? Would a good financial adviser be able to help?

kenoryan
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Re: Asset Allocation with Farm Land

Post by kenoryan » Wed Oct 18, 2017 9:37 pm

Why can’t you sell part of your land when you need money? I know it’s not as liquid as selling bonds and stocks but hey I can carve off a hundred acres from my farmland anytime. There’s people ready to buy if the price is right.

Bastiat
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Re: Asset Allocation with Farm Land

Post by Bastiat » Wed Oct 18, 2017 9:56 pm

Why 55/45 asset allocation? How far from retirement are you?

That's more conservative than my portfolio will likely be in retirement.

I agree with the notion that the farm income allows you to be a little more aggressive in your allocation.

64415
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Re: Asset Allocation with Farm Land

Post by 64415 » Thu Oct 19, 2017 8:48 am

I treat my farmland as “other”. With respect to investable assets I am now approximately 50:50 farmland vs liquid investable assets. The liquid asses are currently 75:25 equity: fixed income. I am working toward paying of the small debt (less than 10%) I carry on the farms by building up funds in a munincipal bond fund. Once the debt is payed off I will glide toward 100% equities. I feel like the farms allow me to take more risk for the sake of my heirs and charities.

The two thoughts I have on how farmland positions should impact the management of an equity:bond portfolio are as follows. First, if I was going to hold bonds I would be comfortable stretching out the term given the inherent inflation protection of farmland. Granted, farmland won’t perfectly hedge against your own personal “ basket of goods” being subject to any future inflationary pressures, but it will certainly afford some degree of protection. Additionally, farmland performs poorest in deflationary environments, so having for instance Vanguard intermediate term muni fund in taxable, or 10 year treasuries in a qualified account would be prudent in my opinion. Second, I believe it would be reasonable to keep international equity exposure to 20% or less, and not the commonly recommended 30-50 %, given the fact you are selling commodities every year that are sold in dollars and will benefit greatly in the form of increased international demand from any depreciation of the dollar.

Personally, I don’t feel comfortable avoiding international equities and I allocate 40 % of my equities to international with a strong .4/.4 small and value tilt. I am committed to this allocation for the long term.

dbr
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Re: Asset Allocation with Farm Land

Post by dbr » Thu Oct 19, 2017 8:58 am

It is a research problem to see how individual investors like most of us should configure a portfolio to include assets such a real estate, land, even gold in a portfolio. The one point of agreement is that alternative assets are certainly not stocks or bonds and should not be treated as if they were.

It is an fair observation that if the asset is income producing it could just be accounted for as an income stream the same as pension, annuities, and Social Security. When you do that you consider your stock and bond assets in the light of how much risk you have need, ability, and willingness to take to support your remaining income needs. At that point the argument can be ambiguous as depending on circumstances the extra income may enable more risk in investing but also may reduce the need for risk in investing. A problem with such as income stream being lumped with other income streams is that income from rents or operating land or real estate as a business is still not the same thing as an annuity, may be more at risk, certainly can be more changeable, can be manipulated, and can be liquidated and turned into stock and bond assets.

Short answer: Use the scheme of need/ability/willingness to find your stock/bond allocation taking other assets and situation into account. If someone has a more systematic way to address this it would be interesting to hear about it.

alex_686
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Re: Asset Allocation with Farm Land

Post by alex_686 » Thu Oct 19, 2017 9:08 am

dbr wrote:
Thu Oct 19, 2017 8:58 am
It is a research problem to see how individual investors like most of us should configure a portfolio to include assets such a real estate, land, even gold in a portfolio. The one point of agreement is that alternative assets are certainly not stocks or bonds and should not be treated as if they were.
I agree with Dbr's points.

To extend a bit, historically real estate has delivered about the same level of risk and return as BBB bonds. I am not sure where you would slot your farm land. REITs have a lower correlation to real estate than you might think. So while farm land might occupy the same risk / return space of bonds and REITs they are not strictly speaking substitutes.

I might advocate a slight over-weighting of equities in your portfolio if it fits your risk profile.

dbr
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Re: Asset Allocation with Farm Land

Post by dbr » Thu Oct 19, 2017 9:17 am

I suspect it is a rare financial advisor who has any insight at all as to how a major land or real estate owner might invest as well in stocks and bonds. If anyone has experience with such a thing it would be good to hear it.

Here is one article that discusses how MPT might incorporate real estate. Note that in MPT it is necessary to not have diversifiable risk as when you do the risk of the undiversified component is too wild to compare and correlate with the other assets. That is what makes advising for someone with a couple of apartment houses or a farm so far as what they should do with stocks and bonds: http://www.realmarkits.com/derivatives/7.0portfolio.php

Yukon
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Re: Asset Allocation with Farm Land

Post by Yukon » Fri Oct 20, 2017 5:34 am

Similar scenario here and I believe Roger Gibson's book Asset Allocation praised The Talmud's ancient asset allocation strategy "Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve." I treat farm land as "bond like" so shifting away from Talmud's recommendation.... my current IPS goal is 25% land:50%stock:25% bond. Actively trying to balance towards those goals without having to sell land which is currently too high of a %. I've been meaning to re-read Gibson's take (I read it 10-15 years ago) as to why I think my goal is smarter than Talmud's 33:33:33. I'm also a fan of Bernstein's liability matching portfolio theory and struggle with how such a substantial amount of land fits into quitting the game.
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Castanea_d.
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Re: Asset Allocation with Farm Land

Post by Castanea_d. » Fri Oct 20, 2017 11:12 am

We have half of the "old home place" back in the southern Appalachians: 150-plus acres with about 20 acres of it under cultivation/pasturage and the rest in forest. No habitable structures. It produces no income (I "rent" it to the neighbor, a long time family friend and farmer, who keeps up the fences and looks after the place in return for use of that 20 acres down by the creek). But there is all that timber, much of it high-quality hardwood, untouched for around seventy or eighty years.

As compared to farmland, it is easier to get some money from it when needed without selling the land; just have some trees harvested from a portion of the land. My mother and father did this once when they needed a sum of money in the 1970's; they had about thirty acres of what is now my sister's half of the land cut for timber. Since it came to me and my wife by inheritance, we have not needed to do such a thing. But (again) it does not provide a current income stream, and we have to pay the property taxes (about $2500/year). And a forest fire could come along, or a disease could strike down a major portion of the forest -- as the chestnut blight did on this land.

In terms of asset allocation and investment, I simply ignore it. We are blessed with enough in financial assets so that we don't really need it. When I think of it at all in these terms, it makes up for our complete lack of home equity (we live in a rental apartment), and it provides some inflation/currency risk protection. There are still stories in the family about a relative who sold his land elsewhere in the county in 1863 for Confederate dollars...

Mostly, it is worthwhile just for visiting it (it is very pretty. Quiet. Peaceful. Walking around in one's own forest, which you have known since childhood, is a Good Thing) and it gives us an "escape" to talk about when work and other daily things are going badly -- the thought that we could walk away from everything here and put a double-wide up the hill from the creek has been quite helpful at times. We might retire there, but realistically it is awfully far up the "holler" for elderly people.

I am quite interested in what others have said in this thread, and hope there will be more comments and ideas.

[Edited to add: I love Yukon's post, and especially the Talmudic asset allocation. I had not heard that before.]

not4me
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Re: Asset Allocation with Farm Land

Post by not4me » Fri Oct 20, 2017 1:20 pm

64415 wrote:
Thu Oct 19, 2017 8:48 am
I treat my farmland as “other”. With respect to investable assets I am now approximately 50:50 farmland vs liquid investable assets. The liquid asses are currently 75:25 equity: fixed income. I am working toward paying of the small debt (less than 10%) I carry on the farms by building up funds in a munincipal bond fund. Once the debt is payed off I will glide toward 100% equities. I feel like the farms allow me to take more risk for the sake of my heirs and charities.

The two thoughts I have on how farmland positions should impact the management of an equity:bond portfolio are as follows. First, if I was going to hold bonds I would be comfortable stretching out the term given the inherent inflation protection of farmland. Granted, farmland won’t perfectly hedge against your own personal “ basket of goods” being subject to any future inflationary pressures, but it will certainly afford some degree of protection. Additionally, farmland performs poorest in deflationary environments, so having for instance Vanguard intermediate term muni fund in taxable, or 10 year treasuries in a qualified account would be prudent in my opinion. Second, I believe it would be reasonable to keep international equity exposure to 20% or less, and not the commonly recommended 30-50 %, given the fact you are selling commodities every year that are sold in dollars and will benefit greatly in the form of increased international demand from any depreciation of the dollar.

Personally, I don’t feel comfortable avoiding international equities and I allocate 40 % of my equities to international with a strong .4/.4 small and value tilt. I am committed to this allocation for the long term.
Good thoughts & I think you have some good reasoning for your situation. I would personally not pay much, if any, attention to broader studies on real estate or even farmland. Real estate is by nature local & there is wide variation even within "farmland". In addition to what you have mentioned, I think how farmland influences the rest of your AA should depend some on your cash flow situation. That is, someone who has their cash flow needs met without any contribution from farmland may have a different view than someone who needed more income. Here again, farmland isn't all the same. If you either farm it yourself or are on crop shares, you have a difference from someone with cash rent. The cash rent is less directly/immediately affected by bad crop years, commodity prices, etc. This is particularly true inn the case of long term leases. So, your 100% equity idea might need to be tweaked to shift some risk to more income producing assets.

Because you have a tailored approach, have you documented your reasoning for your beneficiaries? I'd be curious as to how specific & long term that is.

not4me
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Re: Asset Allocation with Farm Land

Post by not4me » Fri Oct 20, 2017 1:37 pm

Castanea_d. wrote:
Fri Oct 20, 2017 11:12 am

a forest fire could come along, or a disease could strike down a major portion of the forest -- as the chestnut blight did on this land.

In terms of asset allocation and investment, I simply ignore it.
I'm not an expert in this & so mention it only as a skeletal idea. It might be worthwhile to you to have a professional appraisal done on this land for the purpose of establishing a value of the timber. This would need to be somewhat specialized & its usefulness may depend on how long you've had it & your plans for the future. The reason is that I believe the timber is actually a capital asset & it qualifies for a step-up basis if inherited. So, if timber is harvested, you could pay only capital gains tax on the increase in value while you've had it. That may carry with it the need for more specific forestry management plans....I'm not sure. Both federal & state may have resources to help you in this regard & in some cases thinning actually helps the health of the forest. If all that is true, then if a forest fire wiped you out, you might have a capital loss & so the appraisal might be insurance if nothing else.

Since it is currently non-income producing, I think ignoring it works itself out in terms of AA.

I too look forward to more perspectives.

ThrustVectoring
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Re: Asset Allocation with Farm Land

Post by ThrustVectoring » Fri Oct 20, 2017 2:07 pm

This is probably more straightforward than people are making it out. Stocks and bonds are just junior and senior portions of the capitalization of a business. There's pricing for the senior portion of a business - the cost of taking on debt to finance the business. For real estate, this is mortgage rates. If you were to use a mortgage to buy your real estate, you'd be taking on $X of debt at a Y% interest rate, while putting in $Z of your own money as a down payment. Since you own your property outright, the overall capital structure is the same, except you're giving yourself a mortgage. So you have $Z worth of what's essentially equity and $X worth of what's essentially a bond. The equity is comparable to what you'd find in a publicly traded REIT, the bond is comparable to what you'd find in a mortgage-backed security.

tl;dr - look at mortgage underwriting standards for buying farmland like you have. The amount the bank is willing to finance is the bond portion of your holdings. The remaining is the stock portion. If it's 80% like I suspect it is, that means your $4MM of farmland is something like $800k of undiversified REIT holdings and $3.2MM of undiversified mortgage-backed securities.

dbr
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Re: Asset Allocation with Farm Land

Post by dbr » Fri Oct 20, 2017 5:52 pm

ThrustVectoring wrote:
Fri Oct 20, 2017 2:07 pm
This is probably more straightforward than people are making it out. Stocks and bonds are just junior and senior portions of the capitalization of a business. There's pricing for the senior portion of a business - the cost of taking on debt to finance the business. For real estate, this is mortgage rates. If you were to use a mortgage to buy your real estate, you'd be taking on $X of debt at a Y% interest rate, while putting in $Z of your own money as a down payment. Since you own your property outright, the overall capital structure is the same, except you're giving yourself a mortgage. So you have $Z worth of what's essentially equity and $X worth of what's essentially a bond. The equity is comparable to what you'd find in a publicly traded REIT, the bond is comparable to what you'd find in a mortgage-backed security.

tl;dr - look at mortgage underwriting standards for buying farmland like you have. The amount the bank is willing to finance is the bond portion of your holdings. The remaining is the stock portion. If it's 80% like I suspect it is, that means your $4MM of farmland is something like $800k of undiversified REIT holdings and $3.2MM of undiversified mortgage-backed securities.
So the problem is to assess that investment assed to a portfolio of stocks and bonds which means you need to know the expected return and the expected variability of the return as well as the correlation of return with the returns of your stocks and bonds. If we take the leap that a REIT and an MBS are possible surrogates that might be an entre to the problem. You have a creative but maybe not unuseful suggestion here. The one bothersome issue is the condition of being "undiversified." It is very difficult to know how to combine undiversified risk with an investing point of view that says first we get rid of undiversified risk.

SGM
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Re: Asset Allocation with Farm Land

Post by SGM » Sat Oct 21, 2017 4:05 pm

We have farmland that produces income. I consider all real estate as an income stream minus any real estate taxes and maintenance. Some income is more efficient and trouble free than others. Farm rental and deer leases require very little work on our part. It is neither a bond or a stock.

Less income is required from the portfolio due to the various income streams. My withdrawal rate is lower than it would be if I did not have farmland.

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ruralavalon
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Re: Asset Allocation with Farm Land

Post by ruralavalon » Sat Oct 21, 2017 6:00 pm

SGM wrote:
Sat Oct 21, 2017 4:05 pm
We have farmland that produces income. I consider all real estate as an income stream minus any real estate taxes and maintenance. Some income is more efficient and trouble free than others. Farm rental and deer leases require very little work on our part. It is neither a bond or a stock.

Less income is required from the portfolio due to the various income streams. My withdrawal rate is lower than it would be if I did not have farmland.
In my opinion this (treating land an an income source, reducing the amount needed from the investing portfolio) is the more sensible easier to use approach, rather than trying to make land an asset allocation issue and trying to figure out what "other " means and how it could affect at stock/bond ratio.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

dbr
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Re: Asset Allocation with Farm Land

Post by dbr » Sat Oct 21, 2017 6:10 pm

ruralavalon wrote:
Sat Oct 21, 2017 6:00 pm
SGM wrote:
Sat Oct 21, 2017 4:05 pm
We have farmland that produces income. I consider all real estate as an income stream minus any real estate taxes and maintenance. Some income is more efficient and trouble free than others. Farm rental and deer leases require very little work on our part. It is neither a bond or a stock.

Less income is required from the portfolio due to the various income streams. My withdrawal rate is lower than it would be if I did not have farmland.
In my opinion this (treating land an an income source, reducing the amount needed from the investing portfolio) is the more sensible easier to use approach, rather than trying to make land an asset allocation issue and trying to figure out what "other " means and how it could affect at stock/bond ratio.
I think this is a feasible fallback that avoids some miss-thinking. One should still somehow keep in mind that there really is wealth in existence out there though and that while real estate is not a stock or a bond, income from real estate does not represent just an annuity or even just a paycheck.

Yukon
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Re: Asset Allocation with Farm Land

Post by Yukon » Sat Oct 21, 2017 7:31 pm

ruralavalon wrote:
Sat Oct 21, 2017 6:00 pm
SGM wrote:
Sat Oct 21, 2017 4:05 pm
We have farmland that produces income. I consider all real estate as an income stream minus any real estate taxes and maintenance. Some income is more efficient and trouble free than others. Farm rental and deer leases require very little work on our part. It is neither a bond or a stock.

Less income is required from the portfolio due to the various income streams. My withdrawal rate is lower than it would be if I did not have farmland.
In my opinion this (treating land an an income source, reducing the amount needed from the investing portfolio) is the more sensible easier to use approach, rather than trying to make land an asset allocation issue and trying to figure out what "other " means and how it could affect at stock/bond ratio.
Once retired, bonds, stocks, social security, pensions, farmland are ALL income sources and would certainly affect one's desired asset allocation. I think it gets more murky in how to think about these income sources when a person is in accumulation mode.
Don't Work Forever.

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ruralavalon
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Re: Asset Allocation with Farm Land

Post by ruralavalon » Sun Oct 22, 2017 9:53 am

Yukon wrote:
Sat Oct 21, 2017 7:31 pm
ruralavalon wrote:
Sat Oct 21, 2017 6:00 pm
SGM wrote:
Sat Oct 21, 2017 4:05 pm
We have farmland that produces income. I consider all real estate as an income stream minus any real estate taxes and maintenance. Some income is more efficient and trouble free than others. Farm rental and deer leases require very little work on our part. It is neither a bond or a stock.

Less income is required from the portfolio due to the various income streams. My withdrawal rate is lower than it would be if I did not have farmland.
In my opinion this (treating land an an income source, reducing the amount needed from the investing portfolio) is the more sensible easier to use approach, rather than trying to make land an asset allocation issue and trying to figure out what "other " means and how it could affect at stock/bond ratio.
Once retired, bonds, stocks, social security, pensions, farmland are ALL income sources and would certainly affect one's desired asset allocation. I think it gets more murky in how to think about these income sources when a person is in accumulation mode.
Also very murky in the case of farm land during both accumulation decumulation, because the income is variable not fixed. The income is determined by uncontrollable factors like rain, sunshine, temperature, and costs of fuel, seed, fertilizer, herbicides, and pesticides both at your location and at competing farms elsewhere in the world.

Even during the accumulation stage, for retirement planning purposes (estimating the size of "nest egg" needed to retire) it's still appropriate in my opinion to think of it as an income source.

I think that treating land as an income source (affecting how much you may need to draw from the investment portfolio) is more practical and easier than trying to treat land as an asset allocation issue, and trying to determine if it is like a bond or more like a stock for asset allocation purposes. Land is "other".
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

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