An Economists View - Determining Agricultural Land Values
Land is just one of many factors of production in agriculture. Despite its critical importance and in the absence of efficient rental markets, the value of land, as with managerial labor, is often determined as a residual; subtract all other production costs from total revenue and what is left is the "rental value" for land. This annual value can then be projected into the future, discounted and summed to determine the value of agricultural land. This is essentially the capitalization of net income approach to determining agricultural land values. If rental markets are efficient in an economics sense, then an equivalent value for land can be determined by capitalizing "ground rent." In Massachusetts, sufficient rental data do not exist to offer a reliable means of determining agricultural land values.
The data requirements of the above approach are many. For each commodity, annual survey data on farm costs and returns would be required. While many farmers keep adequate records on their operating costs, the costs for capital (machinery, buildings, etc.) are more difficult to determine. Equipment rental values could be used, but again we are faced with thin markets for machinery and equipment rentals in Massachusetts. Typically rental rates for machinery and equipment are "built up" in costs of production studies using the capital stock values, depreciation rates, repairs, interest, opportunity costs, and taxes. In addition to valuing capital, the value of the operator's labor, including management, and the value of unpaid family labor further challenge the analyst's ability to establish accurate full costs of production.
Some History - What Massachusetts has done
Despite the data intensity of the procedure described above and the challenges that were faced, the proceeded in this manner for a number of years. Periodic data collection was conducted by surveying Massachusetts farmers and agricultural land values were set by capitalizing the net income by commodity that was determined from survey data. Those data collection efforts were not insignificant, requiring a survey be conducted, the data gathered, coded, cleaned and analyzed. The process required that requests for proposals be sent out and contracts established with analysts. The process would take the good part of a year to complete and were planned for about every five years. State budget problems and associated budget cuts resulted in curtailing these efforts. For several years to follow, results from previous years were updated using price and cost indexes for many commodities. As values changed little year to year for most commodities, there was little concern raised over the agricultural land values for those commodities. Given the importance of the cranberry industry, the FVAC focused on providing the best estimates possible for cranberry bogs and annual cranberry surveys were conducted.
What Massachusetts Does Now
When cranberry prices plummeted, it became apparent that changes were needed. Annual net income for cranberries went into the red, and it was clear that within a few years, the FVAC would face negative values for cranberry bogs. A request was sent out for proposals to study the farmland evaluation process. First Pioneer Credit conducted the study in 2001 and made recommendations to the FVAC. The approach that was adopted based on their recommendations facilitated the process and greatly reduced the amounts of data used and the associated costs. The current process relies on the Massachusetts Value of Agricultural Output as determined by the United States Department of Agriculture Economic Research Service (UADA/ERS). The process, in brief, is as follows:
- The Value of Agricultural Output for Massachusetts is collected from the USDA/ERS. These data are readily available on-line.
- The Value of Agricultural Output is adjusted (reduced) by the value for the costs of production (purchased inputs, capital, etc.), value of dwellings, and a management fee to determine the adjusted Net Farm Income for Massachusetts. (Note - a single Adjusted Net Farm Income is determined for all Massachusetts farms/commodities. Thus, all farms are assumed to face similar cost and return structures. All farm/commodities are assumed to be doing equally well/bad in a given year.)
- A 5-year average of the Adjusted Net Farm Incomes for the most recent 5 years is then determined. This process smoothes out the ups and downs of agricultural production and prices. It is also more in line with the thinking of most farmers. They are in the industry, typically, for the long-run and must look beyond the current period. By using a 5-year rolling average, we essentially say that farmers are predicting the future based on what they observed over the past five years.
- The 5-year Adjusted Net Farm Income is then capitalized to determine the Capitalized Adjusted Net Farm Income.
- The Capitalized Adjusted Net Farm Income is then allocated to different commodity groups based on shares of the Value of Agricultural Output determined from the Census of Agriculture. Previously, values from the 2002 Census of Agriculture were used. The 2007 Census values were made available recently and will be used for the coming fiscal year.
- Once the Capitalized Adjusted Net Farm Income has been allocated to the different commodity groups, the types and amounts of land on those types of farms are used to determine a base value for the land category "Woodland." "Woodland" is presumed to be the least valuable type of land for agriculture - it is assigned a productivity value of 1.
- Once the value for woodland is determined, the remaining land types are determined by multiply by the productivity factors. Productivity factors range from the low of 1 to a high of 20 for our most productive agricultural land, cropland harvested. For example (see Table 1), the value for woodland for the commodity group "Vegetables, Tobacco, Sod and Nursery" was estimated to be $24.29. The value for cropland harvested is then 20 times greater, $486 per acre.
The Current Approach - Pros and Cons
The current approach is consistent with the theory that farm land should be valued according to the capitalization of net farm income, an accepted methodology for valuing farmland. The approach that is currently used in Massachusetts also uses readily available data on Massachusetts agriculture from a credible source, the USDA. The process is straightforward and can be implemented year after year with a limited amount of time and expense. It meets the State objectives and requirements for the Chapter 61A program.
All commodities or farmland types are treated the same when developing estimates of Adjusted Net Farm Income and the problems of negative values for net farm income are not resolved. In recent years, Massachusetts Adjusted Net Farm Income has been negative and the resulting 5-year average has been negative. The process has led to negative farmland values. As a result, the FVAC adopted an approach of using the last positive farmland values prior to the negative estimates.
Editor's note: this article represents the opinions and conclusions of the author and not those of the Department of Revenue.
Dr. Daniel Lass is a professor at the University of Massachusetts Amherst in the Department of Resource Economics. He has served as designee to the Farmland Valuation Advisory Commission for many years.