Physicists are very clear about this: bubbles must burst. Eventually, the laws of gravity and surface pressure kick in – and there is no escape.
So how do you cope with a price bubble that never bursts, and just seems to get bigger?
That is the conundrum facing the UK’s agricultural land market. With the IPD index showing a 14.2% increase in prices in 2011, and agents reporting that prices have risen by as much as 217% over seven years since the market began to inflate in 2005, everything about it screams bubble. But there is no sign of this bubble bursting and, according to the experts, no reason to suppose it will.
What is going on?
All bubbles depend on steady demand dwarfing limited supply, and that is certainly true in the rural land market. Prices have risen largely because the amount of land for sale has been shrinking, while the number of potential buyers is still growing.
According to Smiths Gore, in 2011, total UK open market large-lot land sales amounted to just 127,000 acres – with about 25,000 more sold privately. Smiths Gore estimates that in the late 1980s, more than 300,000 acres were turned over each year – and it used to be even higher.
Strutt & Parker says that in the first quarter of this year, 44% less land entered the market than during the same period last year. As Savills points out, there were substantial regional variations – supply was down by 14% in the West Midlands and up by 42% in the East. However, the overall picture is clear: there is less on the market.
Meanwhile, the ranks of potential buyers has been swelled by rising farm incomes. Around two-thirds of buyers are farmers, mostly neighbours who have special reasons for wanting to buy. Mid-term reforms to the Common Agricultural Policy in 2004-5 helped to put money in their pockets, and land prices have grown sharply ever since.
Catherine Penman, head of research at Carter Jonas, agrees that the land market looks bloated. “It’s a price bubble that just gets bigger and bigger,” she says.
But, like everyone watching the land scene, she does not expect the bubble to burst. “We are less bullish on growth than some – predicting a tail off in price growth, with 2-5% increases this year, not 7%,” she says. “But the market is not going to fall off a cliff, even though its unviable and looks bubbly.”
What the experts say…
There are three reasons why experts do not expect this bubble to burst.
First, the supply of open market land will continue to shrink before it reaches a floor, below 130,000 acres a year. When it hits this floor, it will stay there because there is not much risk of a surge in supply.
A change in farmer behaviour is largely responsible for this drop in supply. As recently as 2006, farmers accounted for 60% of sales – today they buy heavily, but sell less often. Savills estimates they accounted for 40% of sales in 2011.
Mark McAndrew, partner at Strutt & Parker, says: “The market has been shrinking for years and it will continue to do so. Once land is absorbed into a large farm or estate it tends to stay there for generations. But the market won’t shrink to nothing – there is a minimum – and I think we’re getting close to that point.”
Jason Beedell, head of research at Smiths Gore, suggests the floor could be a lot lower than we think – although he hopes it is not. He says: “The market will continue to shrink and although there is no evidence to support the idea, we could be reaching the floor. We’re seeing three big farms a year traded in each English county – and that kind of churn has to be inevitable, it has to be the baseline.”
Beedell warns that a very small market leads to some peculiar pricing decisions: “In some places there are so few sales it’s almost impossible to price, and the evidence to support valuations is thin.”
Second, farmers are flushed with cash, dominating the ranks of buyers, accounting for just over 60% of all land purchased.
According to Strutt & Parker, there is a direct correlation between rising land prices and rising commodity prices. The agency says that average land prices have increased by 217% since 2005 – and wheat prices have risen by 235%. Only prime central London residential prices have risen so fast. While farmers are doing well they will pay top prices.
McAndrew says: “The big farmers are making money thanks to rising wheat and livestock prices – not flushed with cash but doing a lot better – and buying more land spreads their costs over a larger acreage. Larger farms mean more efficient use of machinery and staff, so margins are improved.”
Not only can they enjoy improved margins and capital growth, but they can also use extra land as collateral as they expand to take advantage of high commodity prices. “Land as an asset is worth so much that banks are very tolerant about lending to farmers,” says McAndrew.
Third, the low prospect of changes to a UK tax regime encourages investment in agricultural land. Dr Beedell says: “We know the government is looking at tax simplification, and inheritance tax and capital gains tax, and changes there would be a big threat to land prices. But they are largely a Conservative government and there are too many vested interests to make change likely.”
There are sharp objects around that could cause the bubble to deflate, if not to burst. Changes to the EU’s common agricultural policy could have unpredictable effects, while a slump in commodity prices – possible if Russia and the US have a series of good summers – would take the rocket fuel out of the land market. That would trigger a fall in the profitability of UK farming, which would undoubtedly hit land prices. But according to most commentators, the effect of these changes would be to slow the rate of growth, not send it into reverse.
Unspoken fear
Behind these concerns lies a largely unspoken fear that the relationship between the income-producing capacity of land and its capital value has become unsustainable (see below).
For now, though, the land price bubble continues to inflate. Richard Thomas, partner at South Coast specialist BTF Partnership, says: “The perception among buyers, especially among the farmers, is that the land price is peaking, yet there is no real evidence for that. It’s a market that is hard to understand – bubbles always burst, I suppose, and sometimes you look at a price and think ‘where’s that come from?’. Land brings out a yearning in people, and scarcity is a massive factor. Maybe this bubble will just continue floating?”
McAndrew adds: “We’re seeing increased demand, not increased supply, and while growth might be slower in the next five to 10 years, £10,000 an acre UK average isn’t far off, and £15,000 is visible.”
Meanwhile, Savills is predicting that the average value of farmland in the five years from 2012 will increase by 36%.
Those are eye-popping predictions, but there are thousands of farmers and investors who hope the bubble never bursts.
Time to sell
Debt, death and divorce have always had leading roles to play in prompting the trickle of land reaching the market.
According to Savills, the proportion of debt-related sales doubled to make up 13% of all deals in 2011 – the highest level since 2006. Today, profit-taking is almost as influential.
BTF Partnership’s Richard Thomas is selling a 500-acre block near Faversham in Kent on behalf of a large estate. “The tenant farmer retired and the landlord decided to sell,” he says. “I think there’s an element of taking advantage of bullish prices.”
Income
The capital value of most property assets is related to the income it can produce. Not so agricultural land.
Rents have since ceased to bear any relationship to the land’s value to buyers. In Herefordshire, for instance, good grazing land might command a rent of £80-£100 per acre – but the capital value is closer to £10,000 per acre, and rising.
In the South East, where rents can be around £200 per acre, land prices of £7,500 an acre mean low yields for investors. According to IPD and Smiths Gore, the average UK rental yield is around 1.6 %.
