Understanding the Balance Between Land Value and Operations

Key Takeaways:
  • Knowing your farm’s value helps with financial planning, negotiations and long-term success.
  • Strategic estate planning can lower taxes and keep the farm in the family.
  • Land appreciation builds equity, making farmland a strong long-term investment.

 

Understanding the value of your farm is important for a variety of reasons, ranging from financial planning to strategic decision-making. Whether you are buying, selling, planning your estate or evaluating operational success, knowing what your farm is worth can provide critical insights.  

Why is Farm Valuation Important? 

  • Sale or purchase transactions: Whether you’re buying or selling, determining the value of the farm is the starting point for negotiations. Accurate valuation ensures a fair transaction and provides a foundation for financial planning. 
  • Assessing the underlying value of the land: Farms are unique businesses where the return on investment (ROI) often goes beyond cash flow. While farming may not generate immediate high returns, the appreciation in land value over time can be a game changer in terms of valuation. Unlike cash held in money markets, farmland historically appreciates in the long term, despite short-term fluctuations. 
  • Estate planning and taxes: Farm valuation plays a crucial role in estate planning, especially when considering strategies to reduce estate taxes. For example, transferring ownership into trusts or shared family ownership can create discounts that reduce taxable value. Ownership structures, such as joint ownership with family members or holding assets in an entity, can significantly impact valuation. Consider this: if a farm is owned by an entity where you hold only a minority stake, the lack of full control reduces the value of that stake. Restrictive transfer clauses and other factors in operating agreements can further lower the valuation. These strategies can help preserve family farms and prevent liquidation of assets to cover tax liabilities. 

ROI: Beyond Cash Flow 

For many farmers, understanding ROI is not just about net income but also about the appreciation of their most significant asset — the land. While annual returns from farming operations may seem modest, the equity buildup from land appreciation is substantial. In fact, farmland has consistently proven to be a low-risk investment with strong long-term returns. 

Farmers who underestimate their farm’s value – because they are considering only the operational side – risk leaving money on the table in negotiations with lenders. Demonstrating the equity buildup and appreciating land value can strengthen their position and lead to better financing terms. 

Additional Land Value Drivers 

  • Land comparisons: Tracking land value trends and comparable sales in your area can provide valuable insights. For instance, farmland values in 2020 and 2021 saw year-over-year increases of 10% to 12%, making it a highly attractive investment. 
  • Alternative uses: Non-agricultural uses, such as hunting leases, have become increasingly popular. Many professionals and investors from the coasts and big midwestern cities are willing to pay a premium for exclusive hunting rights, especially on land with natural features like trees and streams. 

Methods for Valuing a Farm 

Farm valuation typically employs two main approaches: the income approach and the asset approach. 

  • Income approach: This method focuses on cash flow and profitability. Farming operations often involve interrelated entities, such as an operational entity and a landholding entity. The operational entity might lease land from the landholding entity at a modest rental rate. While cash flow in these setups may appear low, the real value lies in the underlying land’s appreciation over time. 
  • Asset approach: The asset approach assumes liquidation of the farm’s assets to determine value. While this method may seem straightforward, it often overestimates value because most farm owners are not planning for liquidation. Farms are typically long-term investments with intergenerational goals, making the asset approach less relevant for ongoing operations. 

Factors Affecting Discounts 

Various factors can create discounts on the value of farmland, particularly in estate planning or minority ownership scenarios. While a value discount may sound like a bad thing, as if it is devaluing your land, it’s actually a very good thing when it comes to tax and estate planning because it lowers your tax liability. 

  • Restrictive transfer clauses: Operating agreements often limit the transfer of ownership to family members or specific individuals, reducing marketability and, consequently, value. 
  • Minority ownership: Minority stakes in a farm entity come with limited authority and control, leading to significant valuation discounts. Buyers are less willing to pay full value for shares they cannot easily manage or liquidate. 
  • Marketability discounts: Farmland is not as easily liquidated as other assets. This reduced marketability can result in discounts ranging from 15% to 35%. 

Another essential factor in creating valuation discounts on farmland is whether an owner has a successor designated in the event of the owner’s death. The successor could be a family member or an employee. If there is no identified successor – or if the owner’s heirs plan to liquidate the farm – it’s difficult to justify valuation discounts in the estate plan. If the discounts are critical to achieving tax savings, heirs or successors should plan to hold the land for a significant length of time. 

Strategic Planning for Estate & Taxes 

Effective estate planning involves taking proactive steps to minimize taxes while preserving the farm’s legacy. Here are some strategies: 

  • Utilizing trusts and family entities: Transferring farm assets into trusts or family-owned entities can reduce taxable value and simplify succession planning. This approach ensures that assets remain within the family and avoids forced liquidation due to tax liabilities. 
  • Maximizing tax savings: Tools like the 1031 exchange allow farmers to defer taxes by reinvesting proceeds from the sale of one property into another business property, such as farmland. This strategy is especially attractive for investors looking to park money in a low-risk asset with steady appreciation. 
  • Planning for succession: Identifying successors, whether family members or employees, is critical. As discussed earlier, a clear succession plan makes it easier to justify valuation discounts and ensures the farm’s continuity. 

The Bigger Picture 

Farm owners should focus on the total picture of their operation rather than just immediate cash flow. Understanding the value of equity buildup, appreciating assets and long-term goals can help farmers make more informed decisions. 

It’s really about understanding the value of building equity in the land. That’s so important for an ROI approach and management approach for a farm owner. You need to look at the total picture rather than what your checkbook looks like today. 

Strategic planning, whether for taxes, ROI or succession is essential for preserving and growing the value of a farm. By taking a proactive approach to valuation and understanding the important role that land value plays, farmers can better navigate challenges and capitalize on opportunities, ensuring their operations remain viable for future generations. 

If you would like to discuss your farm’s valuation, contact an Adams Brown advisor.