After nearly 20 years of rising farmland prices, the Chicago and St Louis Federal Reserve arms reported the first drop in farmland prices during the first quarter of 2014. There are some key fundamental reasons why this is a lasting change and not a short-term aberration.

But to understand the recent drop, you first have to understand why prices had been rising so dramatically. This chart from Iowa State University shows over a 6X increase in Iowa farmland prices during the past 10 years. This increase has been driven by some macroeconomic forces that had increased the price of corn and soybean during the last ten years.

Corn has been in a strong and steady up cycle until late 2013. The chart from insidefutures.com shows the dramatic 5-fold increase in the price of corn from 2005 through 2012. Corn prices during this time were increasing for three primary reasons; Biofuels use, China demand and weather.

Biofuels Use – During the 1990s and early 2000s, Methanol use in the U.S. and other countries was increasing dramatically. New plants were being built for both electrical energy production and as an additive in gasoline. This alternative use of corn led to a steady increase in corn prices.

China Demand – During the past 15 years, China has emerged as one of the fastest growing and largest economies in the world. This growth has created an ever-expanding population of middle class Chinese with more expensive tastes, in particular, a taste for more protein products. To raise livestock for protein, you need a lot of corn to feed livestock – driving up demand and prices.

Weather – The spike in corn and soybean prices in 2012 was largely an aberration around the drought in much of the U.S. While it was short-term in nature it drove commodity prices up and also fueled higher farmland prices.

While these factors have been long-term drivers of both commodity prices and farmland, there is evidence that the trends are reversing and could lead to a dramatic drop in both corn and farmland prices.

Looking Ahead
First, biofuel use is still increasing but at a much slower rate than it rose during the 1990s and 2000s. What’s more, the fastest growing biofuel inputs are no longer corn and soybeans, but rather, non-food stock sources such as palm oil.

Second, China has spent the last 5 years learning how to grow corn using Western techniques. They have been buying both new and used U.S. farm equipment and growing crops much more efficiently. The result has been record China corn harvests the last two years. Additionally, South America is emerging as a very big player in the world corn market and is increasing its exports to China. Consequently, demand for U.S. corn and soybean exports to China has slowed.

Lastly, weather has moderated back to more normal levels and the trend to record harvest levels resumed in 2013 to 13.9 billion bushels of corn produced.

So, what does this all mean? While corn prices rose from the $2 per bushel range in 2005 to over $7 per bushel in 2013, prices have dropped back into a range around $5.00 per bushel more recently. Where will the new price settle out longer term? My educated guess would be in a band between $4.00 and $5.00 per bushel.

If you bought farmland in the $4,000 to $5,000 per acre range several years ago, then the new range for corn is fine and you will likely make money on your investment. However, if you bought farmland more recently at rates that have ranged from $8,000 to even $13,000 per acre, well, the economics don’t work at $5.00 corn.

We are likely to see more failures among farmers paying higher rents (associated with higher farmland prices) and the farmland owners who have borrowed heavily to continually buy more land. It won’t likely invoke the “Farm Aid” levels of failure we saw in the 1980s, but these leveraged farmland speculators are going be in trouble in the new era of $4.00 to $5.00 a bushel corn.