Rural property – the next investment frontier?

Property has long formed the backbone of many investment portfolios; it’s an asset class that’s tangible, one that is familiar. Many investors have done particularly well with exposure to residential property, which over recent years has experienced stellar capital growth. As with other asset classes, diversification is important.

In this article DomaCom examines the case for investing in rural (agricultural) property and presents ways investors can access this exciting property sector.

Feed the world

“We not only need to grow an extra one billion tonnes of cereals a year by 2050… but do so from a diminishing resource base of land and water in many of the world’s regions, and in an environment increasingly threatened by global warming and climate change.”
Jacques Diouf, Director General, Food and Agriculture Organization of the United Nations (FAO)

The world’s population is growing and so too is the need for agricultural production. As illustrated in table one, it’s estimated that the world’s population will increase by 2,376 million by 2050, from 2015 figures. Asia and Africa will account for most of that growth; with significant urbanisation and economic growth fuelling a growing middle class, these regions face the loss of arable agricultural land at the same time that the growing population is increasing consumption, particularly of meat, dairy and grains.

However, it’s not just food that will be in demand – agriculture also provides feed for livestock and the raw material for biofuel. The demand for each is growing and, given population projections, will continue to do so.

As illustrated in figure one, the availability of arable land is declining; it is under pressure due to urbanisation, land degradation and climate change which will, in turn, reduce the ability for growing population centres to cater for their agricultural needs.

According to Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES), the demand for Australian agricultural products is predicted to increase by 77 per cent by 2050, an increase of 1.3 per cent per year[1]. This will, in turn, increase the value of Australian agricultural land.

A secular change

Due to global population growth and an expanding middle class with increasing per-capita incomes, the quantity and quality of food demanded worldwide is likely to remain solid in the years ahead. Australia’s perception as a clean and green source of food has seen increased demand for dairy, meat, fish and grains. We’ve witnessed baby formula being swept from supermarket and pharmacy shelves to be sent to China, Japan importing Australian grown Wagyu beef and the availability of Australian wine around the globe.

Importantly, agriculture is relatively impervious to economic cycles. People need to eat, they need to feed livestock and they need fuel.

Investing in Australian rural property provides a number of benefits to investors:

• Diversification benefits – real assets, such as rural property, generally have low correlation to traditional asset classes and are less impacted by economic slowdowns
• Hedge against inflation – because food prices are closely linked to inflationary trends, owners of rural property are likely to possess a hedge against inflation
• Scale– Australia’s size and population lends itself to large scale farming, which typically delivers more produce at a lower cost
• Low geopolitical risk– Australia has respect for property rights, transparent trade policies, and government support in relation to Australian agriculture and trade
• Isolation – as an island continent, Australia has been less impacted by disease and pests that have plagued other nations; our stringent quarantine laws aim to keep it that way
• Research and development (R&D)– according to FarmInvest Australia, $1.5 billion is invested annually in agricultural and rural R&D, which has driven a 2.8% p.a. productivity growth over the past three decades.
• Proximity to Asia– as illustrated in Table one, Asia is the most populated continent and is predicted to remain so; it is also expected to be home to the majority of the world’s middle class. Australia’s proximity to Asia has it well positioned to be a significant supplier of agricultural products to this expanding market.

Importantly, there is a solid investment case for rural property. Research by the Rural Bank[2] found that in all states, the median price of agricultural land has trended higher over the past decade, with average annual growth exceeding 3% in most states. As inflation has run at 2.8% over the same period, this indicates real growth in farmland values.

Table two illustrates the growth in farmland value on a state-by-state basis; over 20 years the median price in most states recorded average annual growth above 5.5%. According to the Rural Bank, taking a long-term view of the performance of Australian farmland values is appropriate given the cyclical weather and market conditions that characterise farming in Australia. Add to that, many Australian farmers consider farming to be a long-term career and lifestyle, often with the livelihood of the next generation in mind, so a long-term view is appropriate.

As with any investment, there are risks associated with rural property. These include:

• Climatic issues such as drought or storm activity
• Pests and disease
• Natural disasters such as fire or floods
• Volatility in the price of agricultural products.

The capital requirement gap

A study by ANZ Bank[3] found that while Australia has a globally competitive position in agricultural production, the industry needs an additional $A160 billion to fill the capital gap to maintain its position.

The research found that if Australia is to maintain its current share of exports by 2025, it will need an additional $A109 billion in capital. A moderate growth in Australia’s market share could cause this figure to increase substantially – and that’s just to retain the existing position. To increase market share will require substantially more capital.

Sourcing capital is one of the most critical areas for Australian farmers to drive efficiency gains to increase scale and productivity. However, debt levels are already high and farmers have had difficulty accessing the alternative sources of funding required to fill the capital gap.

Who’s investing in rural property?

According to global research firm Prequin[4], agriculture has attracted greater levels of interest from institutional investors internationally in recent years, as they seek to diversify their portfolios and position themselves to take advantage of the secular trend of growing demand for food arising from global population growth and increased consumption. Although globally, pension funds have the highest allocation to agricultural investments, in Australia, just 0.3% of superannuation assets[5] are invested in agriculture.

This small allocation is despite the agricultural sector:

• representing approximately 12% of Australia’s GDP
• generating over A$145 billion annually
• generating A$32 billion in exports.

BDO’s report found that to ensure the industry is well placed to meet growing demand globally, Australian agriculture requires active investment at both a domestic and international level.

Importantly, farmers tend to reinvest retained earnings; the more profitable farmers are, the more reinvestment becomes available, and the more valuable the agricultural investment.

How can retail investors access rural property?

There are three ways Australian investors can access the agricultural growth story.

Listed companies

Buying shares in an agricultural company provides exposure to the performance of the capital assets, as well as success from innovation, market expansion and export success. However, a listed entity will generally move in line with the market, removing the benefits of diversification that investing directly in rural property can provide.

Managed funds

There are a small number of managed funds available to Australian investors, ranging from single property to multi-property investments. In many cases the farms are corporatized, the successes of the enterprises heavily dependent on the quality of the management teams in place to run each.

Fractional property investment

The sharemarket is fractionalised investing. By breaking a company into shares, it makes it possible for investors to buy a portion of a company for a relatively small outlay. Similarly, fractional rural property investment is an asset allocation solution for this asset class; it breaks a rural property down into affordable segments, and enables investors to buy a portion of a property. It also enables farmers to raise capital while retaining a significant portion of their landholding.

Fractionalisation provides financial advisers with an opportunity to easily invest a portion of their clients’ investment portfolio in rural property and take advantage of this emerging thematic. A liquidity facility allows investors to trade out when they are ready to do so, subject to the availability of a buyer.

Benefits to investors include:

• Fractional investment allows a limited amount of funds to be spread across multiple rural property assets, providing diversification from different geographic locations and agricultural usage
• It can be viewed as a socially responsible investment; investment in rural property can relieve farmers of bank debt and enable them to make capital investments that can ultimately improve productivity and in turn, reinvigorate rural communities
• In many cases, it enables co-investment with the farmer; and in any situation where the person driving the investment has skin in the game, they will work hard for positive outcomes
• Fractionalised property is an asset of a registered managed investment scheme and the property title is held by a registered custodian; this provides security to investors
• Each property asset is segregated into a sub-fund, so returns and costs pertinent to each property are kept separate and applicable to investors in that property only
• It offers advisers the potential for enhanced fees by including direct rural property investment in your asset allocation to clients.

Fractional investment also provides benefits to farmers:

• Selling a portion of equity enables expansion and investment, which in turn provides farm businesses with a mechanism to improve economies of scale
• Small to medium family run operations have been under strain from increasing debt, which in turn limits borrowing capacity to purchase more land and grow the business.

Importantly, fractional rural property investment provides an opportunity for financial advisers to add value to clients by providing exposure to a true growth asset, one that is generally uncorrelated with other growth assets. The world’s expanding population and subsequent increased demand for agricultural products will ensure that the value of quality farmland will continue to rise over the coming decades.

[1] Funding our Future – ANZ Bank
[2] Preqin Special Report: Agriculture September 2016
[3] Australian Superannuation Fund Investment in Agriculture 2014/15 – BDO
[4] ABARES, 2013, Food Demand to 2050: Opportunities for Australian Agriculture
[5] Australian Farmland Values Report 2015 – Rural Bank of Australia

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This article provides general information only and has been prepared without taking into account the objectives, financial situation or needs of individuals. The information contained in this article reflects, as of the date of publication, the views of DomaCom Australia Limited ABN: 33 153 951 770, AFSL 444365 (DomaCom) and sources believed by DomaCom to be reliable. We do not represent that this information is accurate and com­plete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither DomaCom, its related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article. Past performance is not a reliable indicator of future performance. Investing involves risk including loss of capital invested. ©2017 DomaCom Australia Limited.