In Australia, suburbia runs on house prices rather than land prices. The weekend talk around the Webber BBQs resplendent with their shrimp often ends up in the challenge of paying the mortgage. You know, the massive sacrifice taken on by tha family to secure the picket fence because, in time, the house price goes up to make it all worth it.
And so it has been in the 27 years I have lived in the great southern land. I am one of the lucky ones. Our house in the Blue Mountains west of Sydney has nearly trebled in value. It was an epic investment with risk and hefty monthly repayments, but we now have a tangible asset.
The pandemic stopped much of the BBQ chatter. Shooting the breeze went virtual, and we had to cook the seafood on our own. Such sacrifice—my lordy, we will struggle when the Great Simplification starts—and then we had inflation.
I am old enough to remember the highest-ever UK interest rate of 17% in November 1979. I was a naive freshman at the time with no thought of house or land prices. My wife remembers, though. She was the proud owner of a mortgage in Australia during the 1980s when interest rates were in the teens. Back then, the borrowings were modest, and the repayments were manageable. Today you must add a zero to the borrowed amount, which changes the game.
At the end of 2021, the interest rates in Australia rose far enough for the average mortgage repayment to grow by $1,000 a month before 2022 clicked 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 scares the pants off the average John Doe. 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. Land prices are changing too.
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
Should we choose to sell our suburban house, the market will set the price for the dwelling. A potential buyer wants a place to live, the house. The price reflects what people in the market are prepared to pay for that utility.
Our house sits on a little over a third of an acre (1,528 m2), only the buyer is not that concerned about the land beyond how it frames the house and if it is in the right location.
A farm used to be similar.
The price of a farm reflected its capacity to grow food and make a profit. Buyers of farms were interested in the business. Only to have a successful farm business, you need land, typically a few thousand hectares in the dry southern land. So rural real estate is about buying land, not the business running on it.
Today, that disconnect that sustainably FED has been discussing for a while is acute. The value of the land has become far more significant than its potential to grow food.
Why is this?
Intrinsic value or utility setting land price
The value of land was 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.
Moreover, 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 from the wet years and still suffer from droughts. Scale is what makes money from livestock.
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 land 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—land price from $1,000 to $14,000 per hectare—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 and quite another to have price hikes on staples like bread, eggs and dairy. Fisticuffs in the aisles over toilet paper might be fisticuffs, but food can incite riots.
Land prices set for the scarcity of agricultural land rather than intrinsic production value is a global phenomenon because countries with high food demand and deep pockets pay close attention to food security.
They have to.
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. Even for DINKY couples, average wages cannot service seven-figure loans no matter how frugal the household.
Interest rate pain just rubs in this reality.
Decoupling land’s intrinsic and utility value means the same happens in land prices in rural areas. Beyond the sovereignty issue, rising 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.
Consolidation of farms.
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. Intensive agriculture is necessary for feeding everyone well, but it tempts landowners and their land managers to push the land hard. Intensive farming relies on inputs and moves away from natural capital. Both are the opposite of sustainability.
Fewer rural residents.
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 agriculture, 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. It turns out that rural land is a social issue.
Land prices are a worry.
All this change in land price is in motion. The market, tweaked by regulation and government intervention, will continue to operate through supply and demand to set land prices.
It is what it is, a decoupling of values.
That is what markets do. They develop and evolve as the people who make trades in them decide on what is valuable today and what could be more valuable tomorrow. It’s a game.
The land has always been valuable. People desire it and have gone to war to acquire it. And so it will be valued in markets.
The problem is that we should value the land’s ability to grow food and sustain ecosystem services. Global food security is essential to the stability required for the complex capital system to function.
Making land more valuable than the food it produces is not the only threat to our economic system, but it’s a huge one.
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 additional wool growth 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.