Timber Lake Topic, February 29, 2021
Read the full article from the Money Matters Insert of the Feb 28, 2021 issue of the Timber Lake Topic here.
Is it important to keep your rental rates in line with the market? Do rental rates affect the value of your land when you’re ready to sell?
When a piece of land is put on the market and a farmer, rancher, or an investor calls, the first question they will ask is “What is the current rental rate?” They want to know what kind of return they can get on their investment if they were to purchase the property.
In its simplest form, the return on investment, not accounting for taxes, is calculated by dividing the income by the purchase price.
Let’s take an example. Say you have a full section of cropland that you want to sell for $1000/acre. Your current cash rent rate is $30/acre, making your rental income $19,200 per year. Divide $19,200 by $640,000 and the return is 3%. That’s not a bad return but may be lower than what a prospective buyer is looking for.
Say the buyer is looking for a 4% return. At a purchase price of $640,000, they would need to receive a rental income of $25,600 per year (or $40/acre) in order to be comfortable making the purchase. That’s a 30% jump in cash rent. A buyer typically buys based on what they know they can get today, not what the future potential may be.
Looking at this example another way, in order for the buyer to be assured of their 4% return, they may only be willing to offer $480,000. That is the purchase price that will achieve the 4% return at the current cash rent rate. That’s $160,000 less for the seller. Do you see how rental rates can affect the selling price?
Every buyer’s goals are different and not all buyers are looking for the same return. I’m certainly not suggesting that all landowners should raise their rents. There is value in a tenant being a good steward of the land. However, if you are currently leasing out your land and considering the possibility of selling it in the next few years, you may want to think about how your lease rate figures into the selling price and the type of return it may provide to a prospective buyer.
