The mainstream Australian media is warming up its audiences to the reality that interest rates will rise far enough for the average mortgage repayment to grow by $1,000 a month before 2022 clicks over.
To put that into context, the Australian Bureau of Statistics in August 2021 has the average weekly earnings for all employees in Australia at $1,305 (or $67,860 per year).
$1,000 extra a month is a staggering reality that will scare the pants off the average John Doe.
Suddenly, buying the house with the picket fence costs another $15,000 a year before tax. There will be mortgage defaults. There has to be.
But it is not just house prices in cities and the finance to purchase them that is sailing away into the blue yonder.
Here is a rural perspective
Land prices continue to soar, but this phenomenon is not an indication of improving profitability or resilience in the agricultural sector. It reflects a genuine decoupling of the agricultural real estate business from the agricultural production business. And it will precipitate a necessary structural adjustment that has the potential to be very destabilising to both businesses.Pete Mailler, grain and cattle farmer, northern NSW, Australia
At sustainably FED, we have been talking about this disconnect for a while.
Intrinsic value or utility
The value of land used to be about what you could do with it.
For example, land suitable for crops, let’s say growing wheat that yields around 2 t/ha and sells for $300/t, is worth more than rangeland that can’t be used for cropping but can carry 8 DSE/ha and might have a gross margin of around $250/ha running cattle.
Wheat makes more money than cattle, so the land that can grow wheat is more valuable.
Plus, to make the cattle gross margin, there is a minimum number of cattle in the herd and a minimum land area needed to raise them, at least 150 ha in the wetter parts of eastern Australia.
What’s more, wheat might make a lot of money in the good years. Combining an above-average yield with a spike in the price per ton and buying the arable farm makes perfect sense.
The wheat prices have fluctuated over the last 20 years with steep falls and sudden rises that reflect global demand and supply volatility. A good crop in 2007 or again in 2022 is a massive earner for grain growers.
While the grain growers dream, the animal producers trudge along without the bumper years. They benefit from more reliable returns but don’t get the windfalls.
Historically these production factors mattered when agricultural land was valued.
Then something more substantial came along.
The median price per hectare of Australian farmland increased by 13% in 2020, the seventh consecutive year of growth, bringing the 20-year compound annual growth rate (CAGR) to 7.6%.
Although notoriously bumpy, the average stock market return is about the same. The S&P 500 returns with dividends included had a CAGR of 5.7% over the same period.
Land is a good investment again.
Image source: Australian Farmland Values 2020 New South Wales, Rural Bank
The 2020 13% year on year price growth is a heady hike. Analysts point to a combination of reasons for the price growth: high commodity prices, historically low interest rates, good seasonal conditions, and intense competition for prime farmland as farmers seek to expand their operations.
It’s a spike.
The steady capital growth over decades is different, and it’s not because the land makes more money than it did. Indeed, profit margins are tighter than ever because input costs have risen sharply.
Agricultural land price gains are about scarcity and capital markets flush with cash looking for a return.
Agricultural land is in demand because investors and governments worldwide have realised that good farming land is about to become a critical resource. Access to land is a vital part of any forward-thinking food security strategy. This is partly about the absolute supply of food for urban populations and partly about the ability to buffer supplies of foodstuffs to avoid market volatility and panic buying.
It is one thing to have a shortage of toilet rolls, quite another to have price hikes on staples like bread, eggs and dairy.
Land for intrinsic value is a global phenomenon because there are countries with high food demand and very deep pockets paying close attention to food security.
In 2019 there were 66 million sheep in Australia, roughly 2.6 sheep for every person.
What sustainably FED suggests…
Housing affordability in Australia is already a critical social challenge. The urban dream of a house, yard, and white picket fence is now a myth. Average wages, even for DINKY couples, cannot service seven-figure loans no matter how frugal the household.
The decoupling of intrinsic and utility values means the same is happening in rural land. Prices are impacting succession planning for family farms and putting up a massive barrier to new entrants to farming.
At least two things follow.
The first is the trend for the consolidation of farms. Larger farms can raise the capital to get bigger by buying up their smaller neighbours. Banks and lenders are good with this because they are investing in the land asset that on its own generates a competitive return. The farmer gains from economies of scale.
This is the inevitable trend to intensification that is great for yield but not for collective over-reliance on inputs and the move away from natural capital, both the opposite of sustainability.
The second is the need for more rural residents. One of the few ways to wean ourselves off energy subsidies but still grow enough food is to build farms with closed-loop nutrient exchange through systems like regenerative ag, restoration and organic production. All fancy words to describe more people to supply the energy to run the production system—people and horses, livestock and cover crops to replace at least some of the fossil energy inputs.
And these people currently live in the cities because, despite the high cost of living, it is where the supply of services from education to health and entertainment is most reliable.
All this is in motion. The market, tweaked by regulation and government intervention, will continue to operate through supply and demand to set the price of land.
It is what it is, a decoupling of values.
By the way…
In Australia one DSE, the shorthand for Dry Sheep Equivalent, is the feed energy required to maintain a 45 kilogram live weight Merino wether with zero weight change, no wool growth additional to that included in maintenance, and walking 7 km/day. 1 DSE has an energy requirement of approximately 8.7 MJ ME/day, and all other livestock are benchmarked against this value. Typically, a yearling steer is 8 DSE.