By Wendong Zhang and Albulena Basha
The Iowa and Midwest farmland markets have seen tremendous momentum over the past 18 months. Both the Iowa Land Value Survey and the Chicago Federal Reserve Bank’s AgLetter show that average farmland values in Iowa rose 30% last year to the highest nominal values since the 1940s (Zhang 2021; Oppedahl 2022). At the same time, concerns about the sustainability of high land prices and possible changes in interest rates were the second- and third-most frequently mentioned negative factors in the 2021 Iowa Land Value Survey. In late March, the Federal Reserve Bank is expected to impose the first interest rate hike in three years, which will likely be the start of six-to-seven interest rate hikes over the next two years. This article examines the potential impacts of the future interest rate hikes on the farmland market.
Put simply, land value is the net present value of all discounted future income flows. With certain assumptions imposed, one could think of land value being net income divided by interest (discount) rate. In other words, interest rates inversely correlate with farmland values. At lower interest rates, demand for farm loans increases due to lower interest payments, signaling lower returns on competing assets such as bonds, thereby leading to a higher demand for land. The steep cuts in the federal funds rates in March 2020 resulted in historically low interest rates since the pandemic, which boosted not only farmland values but also residential housing prices across the nation. The Chicago and Kansas City Feds report that Illinois, Indiana, Nebraska, and Kansas land values rose 18%, 22%, 31%, and 25%, respectively, over the past year (Scott and Kreitman 2022). The CoreLogic US Home Price Index also shows a 19.1% increase for US national home prices (Boesel 2022), which was the highest 12-month growth in the US home index since 1976. The consistency across these real estate classes reveal the significance and power of interest rates.
The Federal Reserve is slated to raise its benchmark interest rate—the federal funds rate—by 0.25% in late March to curb inflation, which is running at a 40-year high rate of 7.9%. The Federal Reserve’s so-called dot plot, in which US central bankers reveal their projections of the future interest rate path, shows that officials expect to raise the federal funds rate three-to-four times in 2022 and three times in 2023, based on median projections (Foster 2022). This means that the farmland and operating loan rates could increase by 1.5%–2% by the end of 2023, which would be a 30%–40% increase compared to current farm mortgage rates. Figure 1 shows the evolution of federal funds effective rate and the inflation rate proxied by consumer price index since 1977.
Source: St. Louis Fed FRED data.
In a 2021 Agricultural Finance Review article (see Basha, Zhang, and Hart 2021), we develop an autoregressive distributed lag model and provide the first quantification of the impacts changes in interest rates since 2015 had on farmland values. Our model confirms the inverse relation between interest rate changes and farmland values. In particular, it shows that one hike in federal funds rate could leave a cumulative effect of near-20% loss in I-states farmland values. More importantly, it shows that changes in federal funds rates have long-lasting impacts on farmland values, as it takes multiple years, at least a decade, for the farmland market to capitalize the effects fully.
Our model focuses on the federal funds rate, which is unique in that it is the only interest rate officially set by the Federal Reserve. Thus, it is the major policy lever used by the Federal Reserve to steer the economy. During the 2015–2018 calendar years, the Federal Reserve undertook a series of small interest rate hikes. However, it recently changed course and started lowering interest rates with a drastic 1.5% cut in March 2020 to combat uncertainty due to the COVID-19 pandemic. The same-color bars spanning across multiple years in figure 2 show that the effect of one monetary policy move takes multiple years to be fully capitalized in the land market. The long time horizon is because many of the farmland or farm operating loans are negotiated at most semi-annually, and the lagged effect of prior interest rate movements might offset the effect of new policy proposals. That said, the collective sustained interest rate increases from 2015 to 2018 contributed an over-1.5% decline in farmland values for 2018, a 3.3% decline for 2019, and a projected 4% decline in 2020. The modest interest rate reversal in 2019 is not sufficient to offset these effects, but the larger cut in the interest rate in March 2020 has fully offset the 2015–2018 hikes.
Note: The legend shows the policy years during which the Federal Reserve made changes in the benchmark federal funds rates. The 2022 and 2023 projections assume three and four hikes based on the Federal Reserve Dot Plot.
Figure 2 also reveals the dynamic path when the monetary policy changes will be most noticeable. The peak impact of the 2020 cut will reveal itself in 2022 and the uplift on the land market due to the 2020 cut will overwhelm the remaining impact of the 2015–2018 hikes. In other words, without the proposed interest rate hikes, the 2020 cut will dominate the net effect for the foreseeable future, leading to a net positive interest rate environment beginning in 2022.
Similarly, in figure 2, the downward-pointing brown and gray bars show the effects of the proposed interest rate hikes in the next two years. The peak effects of these projected federal funds rate increases will be felt most in 2024 and 2025. The magnitude of the 2020 rate cut is so substantial that its effect will still be dominant for calendar year 2022 and likely the first half of 2023. In other words, the proposed interest rate hikes will exert downward pressures on the farmland market; however, the hikes are not substantial enough to fully offset the influence of the March 2020 cuts, and the farmland market likely will not feel the downward pressure from higher interest rates until late 2023.
This is in part consistent with projections of how 2022 farmland values and residential home prices will go. Agricultural professionals and producers generally expect to continue seeing an increase in their local farmland values, probably around 10% in the core Corn Belt area. Cash rents show a 10%–20% increase compared to 18 months ago as well.
In a prior analysis, we compare the downturn from 2013–2018 with the 1980s and 1920s farm crises (see Zhang and Tidgren 2018). While the staggering inflation is a cause for concern, the replay of a farm crisis or a near-term burst of the “farmland bubble” seems unlikely due to the current very low interest rate environment, the slow and modest moves indicated by the Federal Reserve as opposed to substantial and surprise hikes, less reliance on adjustable-rate mortgages, and the substantially higher commodity prices despite rising input costs. Furthermore, the agricultural sector in general is not as leveraged as 82% of Iowa farmland is fully paid for (Zhang, Plastina, and Sawadgo 2018). With higher inflation and dramatic market volatility in stock and energy markets, farmland is a growing interest among investors considering it as part of an investment portfolio.
In sum, our analysis shows that the effects of the interest rate changes vary due to timing and magnitude. The current projected interest rate hikes will exert downward pressures on the land market; however, it probably is not sufficient to offset the supporting role of the 2020 rate cut this year. The net effects of all interest rate changes since 2015 will become negative for farmland values in late 2023 and onward. The federal funds rates have been lower than 3% for almost 15 years, which is a critical factor to watch when examining future farmland and other real estate values.
References
Basha, A., W. Zhang, and C. Hart. 2021. “The Impacts of Interest Rate Changes on US Midwest Farmland Values.” Agricultural Finance Review 81(5). doi: 10.1108/AFR-11-2020-0163.
Boesel, M. 2022. “Home Price Increases Reach New High in the New Year.” CoreLogic.
Foster, S. 2022. “The Federal Reserve’s Dot Plot Explained – and What it Says about Interest Rates.” Bankrate.
Oppedahl, D. 2022. AgLetter: February 2022. Federal Reserve Bank of Chicago.
Scott, F., and T. Kreitman. 2022. “Rise in Farm Real Estate Values Accelerates.” Federal Reserve Bank of Kansas City.
Zhang, W. 2021. “2021 Iowa State University Land Value Survey: Overview.” Working paper 21-WP 629. Center for Agricultural and Rural Development, Iowa State University.
Zhang, W., and K. Tidgren. 2018. “The Current Farm Downturn vs. the 1920s and 1980s Farm Crises: An Economic and Regulatory Comparison.” Agricultural Finance Review 78(4). doi: 10.1108/AFR-08-2017-0075.
Zhang, W., A. Plastina, and W. Sawadgo. 2018. “Iowa Farmland Ownership and Tenure Survey 1982–2017: A Thirty-five Year Perspective.” Working paper 18-WP 580. Center for Agricultural and Rural Development, Iowa State University.
Suggested citation:
Zhang, W. and A. Basha. 2022. "Will the Soaring Farmland Market Drop When the Federal Reserve Raises Interest Rates?" Agricultural Policy Review, Winter 2022. Center for Agricultural and Rural Development, Iowa State University. Available at www.card.iastate.edu/ag_policy_review/article/?a=138.