AgDM newsletter article, June 2005
By Mike Duffy, extension economist, 515-294-6160, firstname.lastname@example.org
Recent increases in Iowa farmland values and the turbulence in the stock market have resurrected a perennial question. Which is a better investment - the stock market or farmland?
Iowa farmland values have risen over the past four years and recent estimates suggest that this increase is continuing. Based on the Iowa State Land Value Survey, the 2004 estimated farmland value was $2,629 per acre, a record high. This was an increase in Iowa land values of 15.6 percent over the 2003 estimate. Since 1990, the estimated average value of Iowa land has more than doubled going from $1,214 to $2,629 per acre.
On the other hand, the stock market, as measured by the Dow Jones Industrial (DJI) average, last year closed higher for the second time in four years with an increase of 3 percent. Even though the DJI lost more than a quarter of its value (27.4 percent) between 1999 and 2002, its overall record has been positive over the past 13 years. Stock values rose from 2,633in 1990 to 10,783 in 2004, an increase of nearly 300 percent in spite of the declines in recent years.
Are the changes in the stock market, low interest rates, 1,031 exchanges, and increases in land values causing people to shift to land investments? Does purchasing land make sense economically, in the short term and the long term?
To determine which option provides the better investment, this paper compares and contrasts the various returns over the past 50 years. It also discusses some of the important factors to consider over the next few years.
The returns to land or stocks are composed of two parts. The first is capital gains or the increase in value. Obviously, this also could be a capital loss if values decrease. The second component is yearly returns.
Another consideration for investors is that land has an unavoidable annual ownership cost not associated with stocks. Average property taxes have now been subtracted from the rent value in our calculations and this adds to our understanding compared to previous versions of this comparison.
The data used for this analysis comes from three sources. The Iowa Land Value Survey, FM 1712 (AgDM File C2-70) and Cash Rental Rates for Iowa, FM 1851 (AgDM File C2-10) come from Iowa State University surveys. The average land tax per acre comes from the USDA, Economic Research Service. And, the Dow Jones Industrial averages and yearly dividends come from the Dow Jones Web site, www.djindexes.com/jsp/industrialAverages.
The annual percentage changes since 1950 in the DJI and Iowa land values reflect considerable yearly variation in both investments. For land, the average percentage change is 5 percent with a standard deviation of 11 percent. Percentage changes for land range from a negative 30 percent to a positive 32 percent. The Dow Jones Industrial shows an average percentage change of 9 percent with a standard deviation of 16 percent. The yearly percentage change in the DJI ranges from a negative 28 percent to a positive 44 percent.
Land rent after taxes has averaged 5.8 percent of land value since 1950. The Dow Jones Industrial dividend has averaged 3.8 percent of the DJI closing level over the same time period. A few assumptions are necessary to determine which provides the better investment. It is assumed $1,000 is invested in each alternative at the beginning of the period discussed. The amount of land or stock purchased will depend on the existing value. For example, if land was $500 then you could buy 2 acres with the initial investment.
Another assumption is that all of the rent or the dividend earned in any year will be reinvested in the land or the stock market. This will increase the number of units held. To continue the example above, if the after-tax rent was $27.50 per acre then the amount of rent earned was $55 (2 acres times $27.50). The $55 would be reinvested in land at the end of the year. Suppose the land values had increased to $550 over the year, then at the end of the second period there would be 2.1 acres, the original 2 acres plus the .1 acres that could be purchased with the $55 in rent.
Land taxes are the only ownership cost considered for land. There is no ownership cost assumed for stocks. No transactions costs or other costs are considered in this analysis.
Figure 1 shows the return to $1,000 invested in 1950. At that time, $1,000 would have purchased 4.59 acres or 4.25 shares of the DJI. Using the assumptions above, an investor at the end of 2004 would have 98.65 acres worth approximately $259,344 or they would have 33.21 shares of the Dow Jones Industrial, worth approximately 358,132. In other words, the value of the DJI investment would be 28 percent higher than the stock investment.
Figure 2 shows what would happen if the $1,000 investment in land or the DJI had been made in 1970. At that time $1,000 would purchase 2.4 acres or 1.2 shares in the DJI. By 2004 the land investment would have been worth $48,582, while the DJI investment would have been worth $44,433. A land purchase in 1970 would have approximately 8 percent greater value relative to a land investement.
Figure 3 presents the results of a $1,000 investment had it been made in 1980, near the earlier peak in Iowa land values. In 1980, the $1,000 investment in land would have purchased only .48 acres of land or 1.04 shares of the DJI. By 2004, the land investment would have been worth $5,891 while the DJI investment would have been worth $24,488. This means the DJI investment would be worth nearly four times the land investment.
Figure 4 shows a comparison of the returns based on the year of the initial investment and the difference between the investment in Iowa farmland and the Dow Jones Industrial as a percent of the value of the Dow Jones. A negative percentage indicates that the Dow Jones had a greater return and conversely, a positive percentage indicates that land had the greater turn. For example, if the investment was made in 1962, land would be worth approximately 60 percent more than an investment in the Dow Jones. On the other hand, an investment in land in the early 1980s would be worth about 80 percent less than an investment in the Dow Jones.
Figure 4 shows that the timing of the investment makes a difference in which appears to be a better investment. Land would have been a better investment if the investment was made in the late 1950s through the late 1960s. Similarly, starting in 1995, an investment in land has once again produced higher returns than the Dow Jones.
This raises several interesting questions, including whether or not land is a “good” investment and which is the “better” investment. Much of the difference in returns can be attributed to taxes. If the taxes are not removed from the land rents, a $1,000 land investment in 1950 would have outperformed the stock market at the end of 2004. Taxes have a large long-term effect on land returns, and the tax climate must be considered in making the investment decision. It should be noted that no costs have been removed from the DJI returns in our study.
It also is important to remember that the majority of farmland purchasers are already farming. Since 1989, the ISU Land Value Survey has asked the respondents who was the primary purchaser of farmland that year. In 1990 and 1991, existing farmers represented more than 80 percent of the purchasers. This number dropped to 56 percent in 2004. This is important because for the most part farmers do not buy land strictly as an investment. They buy land for a variety of reasons and the expected return is only one of many factors.
The proportion of purchasers classified as investors by the ISU land survey respondents has risen considerably over the past several years. In 1989, investors represented only 12 percent of the purchasers, but in 2004 they represented 38 percent of the purchasers. Many of the purchases over the past few years have been for a variety of nonagricultural uses, including summer homes, hunting camps, and other recreational purposes.
Investors also may purchase farmland to diversify their financial portfolios.
Given what has happened to the stock market, the lessons learned in the land
market during the 1970s and 1980s should not be forgotten; that is, what
goes up also can go down and there is no such thing as a market that will