LEASING LAND WORKSHOP David Armstrong AK Consultants 19 July 2010

Issues to discuss Leasing options/definitions Objectives, tenant and landowner Risks and rewards The lease agreement The financial value Other issues Golden Rules

Leasing or share farming Difference – who takes the risks Production and market risks Lease – tenant usually carries the risks Share-farming; risks are shared Leasing, for a paddock or property; short or long term. General principles apply.

Objectives Landowner and tenant – may not be “in sync” Landowner - Income - Resources maintained or improved Tenant – Profit - Growing his business - Increasing scale

So, why lease land? In 2008/09 69% of Tasmanian Farms had EVAO < $150,000 So, lease to gain economies of scale. Owner of a small operation can not justify modern, efficient and large scale equipment. Lessee can justify newer and more productive equipment.

Tractor overhead costs Example, 130 HP FWA tractor, 2007 costs Overhead costs include interest, depreciation, insurance, shedding, registration Hours use/yearOverhead cost, $/hour 250 hours (2.9% of a year, 5 hrs/week) $75/hr. 500 hrs (5.7%, 10 hrs/week) $39/hr 1,000 hrs (33 hrs/week, 30 weeks) $20/hr 1,800 hrs (38 hrs/week 48 weeks) $12/hr

Other benefits of scale More efficient, reliable and safer equipment is justified. Larger businesses - better negotiating power. More worthwhile investing in training and research. More attractive to contracting companies. So, a tenant may bring something of higher value to land that the landowner cannot.

Risks for the land owner RiskMitigation Tenant degrades land (soil) or pasture Agreement – cropping intensity - Fertiliser applications Tenant does not maintain infrastructure Agreement – details maintenance - Check initial condition - Document condition (photos etc) - Owner to maintain - Be realistic Tenant does not payAgree on payment procedure and late penalty Tenant over-staysAgreement – penalty for late exit Tenant cannot afford lease feeOwner to be sympathetic?

Risks for the land owner RiskMitigation Tenant does not meet owner’s expectations Expectations to be documented Tenant does not meet agreement Agreement to have dispute resolution procedure Owner to check references Owner may want to sellBe aware of the constraint. First offer to tenant. Tenant over-staysAgreement – penalty for late exit Dispute with tenantCommunicate early. Have resolution procedure.

Benefits for the land owner Potential benefitsEnsuring the benefit Rental incomeAgreement – payment procedures - Penalties for late payment Releases owner from work Releases owner from production and market risks Opportunity to do other things; e.g. earn income elsewhere. Retains benefit of appreciating land value

Risks for the tenant RiskMitigation Crops do not performCheck land beforehand Check water security Bonus or increase/reduction clause in the lease agreement Budget conservatively Markets fall income reducedTie lease fee to market; or bonus? Budget conservatively Insufficient capacity to handle the larger area Make sure resources adequate Inability to meet agreementCommunicate early Dispute with ownerCommunicate directly and early Negotiate a solution

Benefits for the tenant Potential benefitsEnsuring the benefit Increased scale with economies Apply skills etc to larger area Increase scale without financial risks of land purchase Business growth without purchasing land. Improved profitabilityMake sure you have a good agreement with the landowner, & communicate

The Lease Agreement Must have a written agreement. Define the area & exclusions What else is included; particularly water Duration, options or rights for renewal. Is renewal a right for the tenant; what conditions Rolling leases. Premature departure by the tenant; replacement with another tenant?

The Lease Agreement Agreed departure date. Penalty for late departure Delay could preclude future cropping opportunity Commencement date; Autumn is often a good time. Payment; amount, timing, procedure. Annual fee adjustment, cpi

The Lease Agreement Repair and maintenance issues Agreement – maintain present condition record what that is at start Soil fertility – agreed fertiliser. Tenant to provide evidence, or Owner applies. Apply extra to hay/silage paddocks. Consider sale of hay/silage from the property. End of lease – same pasture area Weed control – specify weed species Fences, yards, buildings, roads etc.

The Lease Agreement Cropping paddocks. Specify cropping intensity Paddock to be sown down at end of lease Access to water Who has priority of limited Capital improvements – clarify ownership Conflict resolution – establish a procedure Other payments – rates, licences insurance etc

Valuing the lease Percentage of land value Percentage of Gross Margin Percentage of Gross Income Check the market; real estate agents.

Valuing the lease Percentage of land value Historically, 4-6% for grazing 6-8% for cropping These values now too high Perhaps double what is realistic

Valuing the lease Percentage of Gross Margin 25-33% of GM. Level depends on risk. The remainder is required for: Contribution to overhead costs, including R&M Contribution to interest Return for the Tenant’s time and effort Return for taking the risks Examples: Sheep, GM ~$25/dse, lease 33%, $7-8/dse Potatoes, GM $4,000/ha, lease 25%, $400/ac.

Valuing the lease Percentage of Gross Income 16-22% of Gross More common in US for cropping land, 20% Justifiably lower here because tenant has more maintenance obligations.

Value of water Should water be valued separately? I suggest not. The cost of land and water should not be more than 25-33% of the GM.

Leasing livestock Sometimes considered. Value is the interest cost, and for the risk. Requires continuation of breeding strategy.

Leasing equipment I generally advise against including equipment in a farming lease: potential for disputes over maintenance. Who is responsible for maintenance? Objectives inconsistent.

Leasing a centre pivot A Pivot is fixture. Who is responsible for repair and maintenance? I suggest the tenant. Responsibility for negligence?

Leasing cost for a centre pivot What are the annual costs? If asset purchase ($6,000/ha capital, 6 7%), $1,258/ha. Interest & depreciation over 15 years, $925/ha.

Share farming Shares risks and rewards. Assume a Joint Venture approach: Owner gets a lease fee for the land. Share farmer engaged as contractor. Share farmer paid for management. The JV shares cash costs. Proceeds shared equally. Risks are shared equally.

Share farming Joint Venture Pays Owner for land Pays SF for managing Pays for materials Pays SF work Profits divided equally

Golden Rules Benefits are not without risks. The potential for economies of scale. Tenant may allow land to be used for higher value purposes. Responsibility and costs borne by beneficiary. Know and trust each other. Ensure documentary evidence.