Flexible Cash Lease Arrangements - Part 3 of 5: Flexing on Crop Price

A flexible cash lease is a contractual arrangement between a landowner and operator in which the rent payment is determined after the crop has been harvested. Unlike a fixed cash lease, the rent amount with a flexible lease adjusts depending on final yield, commodity prices, cost of production, or some combination of all three. Flex lease arrangements offer opportunities for landowners to benefit should commodity prices rise or better than expected yields occur. Gains in commodity prices and increasing yields in recent years have increased the popularity of flex leases among landowners. Flex leases that allow the sharing of market and/or production risk with landowners are popular with some producers.

Base Rent

Many flex lease contracts will specify a base rent amount that can be used either as a minimum, per acre annual rent, or a rent value that adjusts depending on final crop price. Landowners should use caution in setting a base rent value. Landowners may be justified in setting a minimum base rent that is slightly below current market value because this allows landowners the opportunity to share with operators, some of the downside risk should yields or prices disappoint. Landowners may also want to consider a base rent (whether minimum or not) that is similar to cash rent amounts from two or three years ago – prior to the increase in crop prices that occurred in 2011 and 2012. (Readers interested in reported cash rental rates for South Dakota agricultural land should view the publication South Dakota Agricultural Land Market Trends 1991-2014.)

Base Rent Flexed by Price Ratios

In this arrangement, landowners and operators agree to flex rent based on a ratio of crop prices. This arrangement allows landowners the opportunity to share with the tenant the risks associated with crop price variability. However, both parties must agree on a base rent and a base crop price if this method is used. The procedure to calculate annual cash rent is as follows:

• Base Rent multiplied by (current year crop price/base crop price) = Current Year Rent

Assume a corn lease contract specifying a base rent of $180 per acre, a base corn price of $2.80 per bushel, and assume that the average price per bushel following harvest is $2.50. The annual rent paid is then $160.71 per acre ($180 x 2.50/2.80).

In addition to both parties agreeing on base rent and base commodity price, a mechanism for calculating an average grain price must be determined. Some contracts stipulate that the current year crop price is the average of daily closing prices quoted by a local commercial grain buyer for a period of time beginning at harvest and including several postharvest months (e.g. October through December).

Base Rent Flexed by Price and Fixed Crop Quantity

This type of flex lease results in a rental payment that is determined by a specific crop quantity set before the contract is signed and an average crop price to be determined at harvest. This arrangement allows annual rent to flex by crop price changes. Consider the example of a soybean producer whose contract specifies that annual rent is determined by multiplying a yield of 20 bushels by the average price per bushel. For an average soybean price of $9.00, the annual rent paid to the landowner is $180 per acre (20 x $9.00). Again, a method for determining an average price must be selected.

Base Rent Flexed by Non-typical Prices

Another alternative is to agree on a fixed base rent that applies only when prices fluctuate within a stated range; should prices move outside this range, up or down, the rent flexes from the base. Consider for example a contract for cropland to be planted to spring wheat. The landowner and producer might agree on a base rent of $165 per acre provided average wheat price remains between $5.50 and $5.75 per bushel. Should the average price fall outside this range, the contract could specify that the rent increases or decreases by some stated amount, say $5, for each $0.25 change in price. Thus, if the average wheat price postharvest was $6.00 per bushel, annual rent would equal $170 per acre. Should average wheat price fall to $5.00 per bushel, rent would be $155 per acre.

Minimum Base Rent with Upward Price Flex

If a minimum base rent is used, setting the amount below the current market level allows the landowner an opportunity to share downside risk with the operator. A minimum base rent with an upward flex on price also allows the landowner to share the revenue that accompanies higher prices. Suppose a minimum base rent is set at $150 per acre, but according to the contract, rent increases $5 per $0.10 increase in average corn price above $3.00 per bushel. If average corn price postharvest is $3.50, rent increases to $175. Should harvest corn price average $4.00, rent is now $200 per acre. When average corn price falls below $3.00 however, rent remains at $150.

Flexible leases that flex only on crop price increase the risk for operators. Should unfavorable growing conditions significantly affect crop production, the resulting decrease in supply may result in higher crop prices and higher flex rent amounts. In this scenario, a producer with poor yields (but high prices) might owe a rent payment much larger than the amount from a typical fixed cash lease.

There are many different ways for flexing rent, including yield, price, cost, or some combination of each. All of these are accompanied by some degree of risk and landowners and producers are encouraged to carefully consider each type before making a final decision. As flex leases specify a rent payment amount determined after the contract is signed, these arrangements require that both parties fully agree to, and understand completely, the exact mechanisms for calculating payment.

References:

• Edwards, W. 2014. Flexible Farm Lease Agreements. Ag Decision Maker. Iowa State University Extension, Ames, IA.
• North Central Farm Management Extension Committee. 2011. Fixed and Flexible Cash Rental Arrangements for Your Farm.

- See more at: http://igrow.org/agronomy/corn/flexible-cash-lease-arrangements-flexing-on-crop-price/#sthash.ZprO6qRt.dpuf

This article was written collaboratively by Kim Dillivan and Jack Davis.