1. Leasing Game Intro to Flex Leases Henderson County January 12, 2011 Greg Halich 859-257-8841Greg.Halich@uky.eduhttp://www.ca.uky.edu/agecon/index.php?p=169 Dept. Agricultural Economics University of Kentucky December, 2010.

2. Agricultural Economics The Leasing Game (#1) Tenant Farmers: Each have capacity to farm up to 1000 acres each. Tenant Farmers: Each have capacity to farm up to 1000 acres each. → Bid on lease land. → Goal is to maximize net profit. Landowners (Me): Have land to rent out to farmers. Will tell you how much at the start of each game. Landowners (Me): Have land to rent out to farmers. Will tell you how much at the start of each game. → My goal to maximize my cash rents.

3. Expected Costs Inputs: Corn (150 bu)Soybeans (45.5 bu) Seed$76$45 Nitrogen$74$0 P, K, and Lime$66$50 Pesticides$30$20 Total Inputs$246$115 Machinery and Labor$116$82 Other: Drying Grain$19$0 Crop Insurance$15 Misc.$20 Land RentVariable Operating Interest$12$7 Total Other$61$37 Total Costs$428 + Land Rent$238 + Land Rent

4. Summary Revenues/Costs Yield and Price:CornSoybeans Expected Yield (rotation)15045.5 Future's Price Fall 2011$3.50$7.50 Grain Revenue$525$341 Direct Gov’t Payment$20 Total Revenue$545$361 Total Costs (Less Land Rent)$428$238 Gross Return$117$123

5. Agricultural Economics Time to Bid Make an offer to rent my land.

6. Agricultural Economics Results-Leasing Game (#1) What was the winning strategy? Where would rents end up if we repeated?

7. Agricultural Economics Increased Production Capacity (#2) Tenant Farmers: Have capacity to farm up to 1250 acres each. Tenant Farmers: Have capacity to farm up to 1250 acres each. Landowner(s): Have same acreage. Landowner(s): Have same acreage.

8. Agricultural Economics Time to Bid Make an offer to rent my land.

9. Agricultural Economics Results-Leasing Game (#2) What was the winning strategy? Where would rents end up if we repeated?

10. Agricultural Economics Increased Commodity Prices (#3) Tenant Farmers: Still have capacity to farm up to 1250 acres each. Tenant Farmers: Still have capacity to farm up to 1250 acres each. Landowner(s): Have same acreage. Landowner(s): Have same acreage. Commodity prices increase. Commodity prices increase.

11. Agricultural Economics Summary Revenues/Costs Yield and Price:CornSoybeans Expected Yield (rotation)15045.5 Future's Price Fall 2011$5.25$11.85 Grain Revenue$788$539 Direct Gov’t Payment$20 Total Revenue$808$559 Total Costs (Less Land Rent)$428$238 Gross Return$380$321

12. Agricultural Economics Time to Bid Make an offer to rent my land.

13. Agricultural Economics Results-Leasing Game (#3) What was the winning strategy? Where would rents end up if we repeated?

14. Agricultural Economics Uncertainty of Net Revenue What if we are uncertain about net revenue (price and/or yield)?  What affect will this have on rents for a long-term lease?  Who will end up getting most of new leases?

15. Agricultural Economics The Leasing Game Application Today  Was it easier to predict net revenue when corn was at $2.50/bu or today?  What happened in the past if corn fell from $2.50 to $1.50?  What happens today if you base cash rent bidding decision on $5.00 corn and it falls to $3.00?

16. Agricultural Economics Nuclear Scenario $ 6.50 Soybeans (elevator) $ 3.00 Corn (elevator) $.30-N; $.30-P; $.30-K Gross Return Corn Gross Return Soybeans Gross Return Rotation 125 bu corn $31$50$40 150 bu corn $91$87$89 175 bu corn $151$122$136 Note: Subtract land rent to get Net Return.

17. Agricultural Economics Risk Management Options 1) Flexible Cash Leases 2) ACRE Program

18. Agricultural Economics ACRE Program FSA Program:  Give up portion of direct payment.  Get downside revenue protection.  Revenue guarantee can only go up/down 10% per year.

19. Agricultural Economics ACRE Price Guarantees Worst-Case Scenario ( Assumes Avg. State Yield) CornSoybeans 2011-2012 $4.37 $10.45 2012-2013$3.93 $9.41 2013-2014$3.54 $8.46

20. Agricultural Economics 20 What is a Flex Lease?  Lease rate will vary from year to year.  Based on price and/or yield.  Usually has a base rate (floor) that the lease cannot go below.

21. Agricultural Economics 21 More Specifically:  Landowner shares price/yield risk.  Limits profit potential when revenue high.  Limits loses when revenue low.

22. Agricultural Economics 22 Why Consider a Flex Lease? 1)Negotiating tool with landowners. 2)Potentially protect you if prices fall.

23. Example: Cash and Flex Lease Expected Price of $5.00/bu Final Corn Price Cash Lease Rate Flex Lease Rate $4.00$200$175 $5.00$200$225 $6.00$200$275

24. Agricultural Economics 24 Options for Flex Leases Important Point:  These are only examples (although common ones).  Need to tailor Flex Leases to your needs/requirements as well as the landowner.  Infinite ways to write Flex Leases.

25. Agricultural Economics 25 Options for Flex Leases 1)Price RatioPrice 2)Bushel EquivalentPrice 3)Revenue RatioPrice/Yield 4)Revenue PercentPrice/Yield 5)Revenue Base + %Price/Yield

26. Agricultural Economics 26 1) Price Ratio  Simplest Flex Lease.  Have a base rent and adjust for price increases.  If price increases by 25% than base rent increases by 25% (typical). Example: $200 base rent. $4.00 base corn price. If actual price is $5, then $5.00/$4.00 = 1.25 $200 x 1.25 = $250 rent for year $200 x 1.25 = $250 rent for year

27. Agricultural Economics 27 2) Bushel Equivalent  Price-based Flex Lease.  Landowner gets a set number of bushels as rent along with the final harvest-time price.  Thus final price determines the rent. Example: 50 bu base X $4.00 = $200 rent for year. 50 bu base X $5.00 = $250 rent for year 50 bu base X $5.00 = $250 rent for year

28. Agricultural Economics 28 3) Revenue Ratio  Just like the price ratio Flex Lease.  Have a base rent, a base revenue, and adjust for final revenue increase.  If revenue increases 20% from the base, then rent increases 20%. Example: $200 base rent. $700 revenue. If actual revenue is $840, then $840/$700 = 1.20 $200 x 1.20 = $240 rent for year $200 x 1.20 = $240 rent for year

29. Agricultural Economics 29 4) Revenue Percentage  Cash-lease version of a crop-share.  But usually with min. base rent.  No inputs contributed by landowner.  Can link yield to county average (or some % of the average) Example: Landowner gets 35% of revenue. 150 bushels X $4.50 X 35% = $236

30. Agricultural Economics 30 5) Revenue Base + Bonus  Base rent, base revenue, and % landowner gets above the base.  Sounds more complicated that it is. Example: $200 base rent; $700 base revenue; 50% of revenue above base. 150 bushels X $5.50 = $825 total revenue. $825-$700 = $125 revenue above base. $125 X 50% = $62.50 additional rent. $62.50 + $200 base = $262.50 total rent.

31. Base Plus Bonus Flex Lease Flex Lease Information: Cash Rent (for comparison)$200 Base Land Rent$150 Can final rent go below base rent?No CornSoybeans Total Costs (including base land rent)$600$400 Base Gross Revenue$600$400 Rent - % of Gross Revenue above base50% Bonus Land Rent$75$48 Flex Rent (Base + Bonus)$225$198 Flex Rent (rotation)$211 Increase from Cash Lease6%

32. Example: Base + Bonus Flex Lease $200 Cash Lease Comparison 50% Bonus Revenue Corn Price Flex Lease Net w/Flex Lease Net w/Cash Lease $3.00 $150-$107-$157 $4.00 $150$18-$32 $5.00 $211$81$93 $6.00 $274$144$217 $7.00 $336$206$342 Soybean Price 2.2 x Corn Price.

33. Base Plus Bonus Flex Lease Flex Lease Information: Cash Rent (for comparison)$200 Base Land Rent$150 Can final rent go below base rent?No CornSoybeans Total Costs (including base land rent)$600$400 Base Gross Revenue$600$400 Rent - % of Gross Revenue above base40% Bonus Land Rent$60$38 Flex Rent (Base + Bonus)$210$188 Flex Rent (rotation)$199 Increase from Cash Lease-1%

34. Example: Base + Bonus Flex Lease $200 Cash Lease Comparison 40% Bonus Revenue Corn Price Flex Lease Net w/Flex Lease Net w/Cash Lease $3.00 $150-$107-$157 $4.00 $150$18-$32 $5.00 $199$94$93 $6.00 $249$168$217 $7.00 $299$243$342 Soybean Price 2.2 x Corn Price.

35. Revenue Percentage Flex Lease Flex Lease Information: Cash Rent$200 Minimum or Base Rent$150 Corn Soy- beans Land Rent - % of Gross Revenue35%40% Flex Rent$263$198 Flex Rent (rotation)$230 Increase from Cash Lease15%

36. Example: Revenue Percentage Flex Lease $200 Cash Lease Comparison 35%-Corn 40%-Soybeans Revenue Corn Price Flex Lease Net w/Flex Lease Net w/Cash Lease $3.00 $154-$110-$157 $4.00 $184-$16-$32 $5.00 $230$62$93 $6.00 $276$141$217 $7.00 $322$219$342 Soybean Price 2.2 x Corn Price.

37. Price Ratio Flex Lease Flex Lease Information: Cash Rent$200 Base Rent$200 Minimum Rent$150 Corn Soy- beans Price Ratio (current price / base price)1.00 Flex Rent (base rent x price ratio)$200 Flex Rent (rotation)$200 Increase from Cash Lease0%

38. Example: Price Ratio Flex Lease $200 Cash Lease Comparison Corn Price Flex Lease Net w/Flex Lease Net w/Cash Lease $3.00 $150-$107-$157 $4.00 $160$8-$32 $5.00 $200$93 $6.00 $240$177$217 $7.00 $280$262$342 Soybean Price 2.2 x Corn Price.

39. Agricultural Economics 39 Flex Lease Summary  Different flex leases have advantages and disadvantages.  Needs to be understandable to landlords.  Need to understand the risk-reward tradeoff.  Not for all landlords.

40. Agricultural Economics 40 Let’s Look at Your Examples  Switch over to Flex Decision-Aid

41. Agricultural Economics Questions?