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Rural land values set to soften, says bank

“All our valuation metrics imply rural land prices have shifted into the expensive zone,” ANZ Bank said yesterday in an economic commentary.

After 5 years of land prices going up, that implies a correction but not necessarily a slump, the bank’s economists said.

Unfortunately the focus is on rural as in farming, with little apparent factoring in of forestry’s influences. Mid-90s plantings increased forestry land dramatically, but some major landholders have recently decided to turn some forestry land back to farming.

The economists said dairy land prices had surged by 60% over 5 years, grazing & fattening land around 70% and horticultural land more than 50%, as good commodity prices & a low $NZ produced a strong revenue stream – heading a long list of reasons, including alternate & competing land uses, productivity growth, interest rates at 30-year lows and availability of finance.

Land price dynamics

The bank’s economists said:

land price cycles have tended to occur every 8-11 years
triggers to material land price corrections have tended to be major events, such as 1984-90 major economic reforms and the 1997 Asian crisis & low commodity prices
while nominal land prices have seldom declined, real land prices have
booms have tended to be short & sharp on the upside. In relation to previous booms, the current cycle is smaller in magnitude but longer in length
increases in real land prices have averaged just over 3% since 1956, marginally above real economic growth.

The economists used 3 frameworks to see if the market’s overvalued & due for a correction – p:e ratios, current earnings against sale price, and the ratio of land prices to nominal gdp.

Price:earnings ratio – theoretically, the value of rural land should be determined by the future income stream. High p:e ratios, say above long-run averages, imply a degree of overvaluation
Current earnings against sale price – suggests land prices have moved into overvalued territory and are at similar levels seen in the mid-70s, 80s & mid-90s, but the drivers have been different. A commodity boom occurred in 1973. Government policies underpinned the late 70s & early 80s. The mid 90s was driven by a combination of higher land prices, yet somber earnings growth. The current spike is more broadly based.
Land prices:nominal gdp – land as a scarce resource should broadly mirror growth within the economy as a whole. Moreover, New Zealand’s growth prospects remain heavily tied to rural prospects. According to this gauge, the ratio of rural land prices:gdp has ticked up beyond its long-run average and is broadly mirroring peaks reached in 1994-95.
Composite model – this also suggests a degree of over-valuation. The model includes all the theoretical drivers of land prices, including commodity prices, productivity, real economic growth (to proxy alternate land usage), scarcity & interest rates.

The ANZ economists said one-off external shocks had instigated previous price declines.

To justify land prices at current levels, or to justify a further rise, they said, would require combinations of:

Higher revenue prices – this could come through sustained higher international commodity prices or a lower $NZ. Some commentary suggested New Zealand agricultural commodity prices might have shifted to a higher plane, helped in part by added-value products.
Further productivity growth – productivity growth within the primary sector has more than doubled the national average of 1.5% for the past decade. The bank pointed to the emergence of “a more financially focused rural community, less interested in accepting below-average returns on their investment. In short, farming is now less about the lifestyle and more about the money.”
Science & technology – breakthroughs will come
Trade agreements – an impact from this source could be longer coming
High levels of farmer confidence – farmers changing farms or buying more land have traditionally been the largest component of the market. Farmers are unlikely to stop changing farms and continued low cash returns on capital will act as a persistent incentive to try to increase scale. Many have strong balance sheets and the borrowing power to finance the purchase. Economies of scale (efficiency) are underpinning prices, and there is a shortage of quality units on the market, with purchasers paying a premium for quality units.
Interest from other New Zealand investors, overseas buyers &/or the conservation lobby – New Zealand land remains relatively cheap & scarce and the overall long-term return on investment is very comparable to other alternatives. Many combinations of the above scenarios are possible. The current level of land prices implies some or all are already heavily factored in &/or there is an element of speculation in the current market. Alternatively, buyers are banking on the resilience of land to withstand a major future external economic shock.

The economists said previous rural land price booms had been followed by a period of consolidation & real price declines. They said that, in the absence of a major external event, consolidation should be expected.

“The combination of robust gdp growth (alternate land use) & continued productivity gains (earnings) will support medium-term prospects & lessen the degree of overvaluation in a gradual fashion as opposed to a king-hit.”

Website: ANZ Bank

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