| Updated August, 2008 |  |
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File C2-21 |
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Flexible Farm Lease Agreements
William Edwards, extension economist, 515-294-6161, wedwards@iastate.edu and Ann Johanns, extension program specialist, 641-732-5574, aholste@iastate.edu
| The interactive spreadsheet (xls) to analyze flexible farm lease agreements is presented the xls file that you can access by clicking here or on the icon above. |
| For more explanation of Flexible Farm Lease Agreements, listen to the presentation available here. |
Fluctuating markets and uncertain yields make it difficult to arrive at a fair cash rental rate in advance of each crop year. To address this problem, some owners and tenants use flexible lease agreements in which the rent is not determined until after the crop is harvested. The final rental rate is based on actual prices and/or yields attained each year. A recent survey showed that flexible leases accounted for nearly 12 percent of all cash leases in Iowa.
Flexible leases have the following advantages:
- The actual rent paid adjusts automatically as yields or prices fluctuate.
- Risks are shared between the owner and the tenant, as are profit opportunities.
- Owners are paid in cash--they do not have to be involved in decisions about crop inputs or grain marketing.
Share of Gross Revenue
The most common type of flexible lease calls for the owner to receive cash rent equal to a specified share of the gross value of the crop. The value of the crop is determined by multiplying the actual harvested yield by the market price available, usually at harvest time. Under this type of lease both price and yield risks are shared between tenant and owner, in the same proportion as the gross revenue. In this respect, it is similar to a crop share lease.
Most of the flexible leases in Iowa specify that the rent will be equal to anywhere from 35 to 45 percent of the gross revenue. The share received for very productive land should be higher than for less productive land. The table below shows the average cash rent paid for corn and soybean land in Iowa during the past 10 years as a percent of the estimated crop gross revenue each year, not including USDA direct and counter cyclical payments or crop insurance proceeds.
Base Rent plus Bonus
Another type of flexible lease formula specifies a base or minimum rent, plus the owner receives a share of the gross revenue in excess of a certain base value.
The base rent may be the amount that was being paid several years ago, before the recent increases in grain prices (see Table 1).
The base value for gross revenue can be the amount that would be received under typical yield and price conditions corresponding to the base rent (see Table 1). It can also be equal to the tenant’s cost of production per acre, including the base rent if any.
The bonus may vary from one-third to one-half of the amount over the base revenue. Both parties must agree on how to calculate gross revenue, and whether a gross revenue below the base level will cause the actual rent to be less than the base rent value. If the base rent also is specified as the minimum rent, it should probably be set lower than a typical fixed cash rent for the same land; otherwise, the landowner does not share in any of the downside risk.
Sharing Risk
Owners and tenants should consider carefully the type and degree of risk they want to assume. Taking on risk means greater losses when prices or yields are low, but can result in larger profits in better years. Owners who wish to receive a fixed income from their farm investments may have to accept a lower long-term rent than those who are willing to share risk. Tenants with substantial financial obligations should consider adopting other means of reducing risk, as well, such as purchasing crop revenue insurance.
Leases that base the rent on price only or yield only may actually increase the tenant’s risk in some years. This is because prices may be high when yields are low, or prices may be low when yields are high. Thus, adjusting the rent based on only one factor does not always reflect the actual profits received in that year. Adjusting the rent for changes in both price and yield ensures that the actual rent will be closely tied to the tenant’s income each year.
Determining Yield
It is important to agree ahead of time on the procedure for determining the factors that will be used to calculate the final rent. These factors should be based on information that is available to both parties. Actual yields can be determined by:
- weight tickets, if all the crop is sold or put into commercial storage
- combine yield monitors or weigh wagons
- storage bin capacity
When crops stored on the farm are ultimately sold, any variation from the estimated yield can be used to adjust the rent paid for that crop. Estimated yields should be corrected to a standard moisture level, for example, 15 percent moisture for corn.
Using actual farm yields to calculate the rent may cause the lease to be considered a “share” lease by the Farm Service Agency (FSA), as explained later. Using the county average yield as estimated by USDA will avoid this problem. However, county average yields are not generally announced until March each year.
Determining Price
The price used to calculate the final rent payment can be the cash price at a local elevator or processor on a specified date, or an average of nearby prices on several dates. Prices on dates near or before the time the final rent is paid should be used even though the crop may actually be sold later. If the landowner is providing storage facilities, later prices may be used. Forward contract prices available before harvest can be included, too.
An alternative to using a local price is to use a futures contract price minus a normal basis value for the location of the farm. If the price chosen is lower than the USDA county loan rate for that commodity, the loan rate can be used instead. This would represent the tenant’s potential selling price including loan deficiency payments or gains from USDA marketing loans.
Other options include using the posted county prices calculated by FSA each day, or the monthly average cash prices reported by the National Agricultural Statistics Service (NASS) Iowa branch.
Other Issues
Some tenants and landlords may want to avoid the possibility of a very high or very low rent in a given year by setting a maximum and/or minimum rent. This keeps the actual rent paid each year within a desirable range.
Many leases ask for a portion of the rent to be paid in advance, possibly by March 1. Under a flexible lease, the advance payment may be for a fixed amount while the final payment depends on actual prices and yields.
The flexible lease formula to be followed should be tested by using several different price and yield possibilities so as to illustrate the range of potential cash rents. Regardless of what type of agreement is adopted, it should be described in writing (with an example) and made a part of the written lease contract. The following page can be used as a lease supplement to specify flexible lease terms.
Government Payments
The Farm Service Agency (FSA) specifies that under a lease arrangement in which yield risk is shared between the tenant and the landowner, any direct payments and counter cyclical payments for which the farm may qualify must be shared in the same proportion as the risk. This is similar to the sharing of payments under a crop share lease. In such cases, these payments should not be included in the gross revenue estimates used to determine the amount of rent due, such as in examples 1 and 2 in this publication.
Tenants and landlords who agree on a flexible cash lease should provide a copy of it to their county FSA office, and request approval for the proposed sharing of the direct and counter cyclical payments. Flexible leases in which the rent is based on the actual market price and a fixed yield, or a yield such as the county average yield each year, do not require a division of USDA payments.
Other Resources
ISU Extension publication FM 1538 or Ag Decision Maker File C2-12 contains a standard farm lease form. ISU Extension publication FM 1801 or Ag Decision Maker File C2-20 contains information on how to determine a fair cash rent.
An interactive spreadsheet to analyze flexible farm lease agreements is available on the Ag Decision Maker Web site at: www.extension.iastate.edu/agdm/wholefarm/xls/c2-21flexiblerentanalysis.xls.
The Flexible Lease Worksheet is presented in the accompanying "pdf" file that you can access by clicking here or on the icon above.