Rupert Nabarro and Eileen French
The financial institutions moved into agriculture in the 1970s when the 25-year post-war agricultural boom was nearly over. They had money to spend, they looked at the long-term record of income and capital growth for prime arable land, and bought at low yields. High levels of inflation were a critical factor in persuading the institutions of the advantages of investment in land and in crops whose prices were set by the European community. Reports from the Northfield Committee suggested that in the late 1970s some institutions envisaged placing up to 2% of their total funds in agricultural land.
Financial institutions chose to purchase let land, and their activities overwhelmed this sector of the market. Over 50,000 acres of land were purchased by the funds each year from 1975 to 1982: they were acquiring 8% to 10% of all land sold in the UK.
The properties purchased were either sale and leaseback transactions or traditional estates. The sale and leaseback properties were largely well-run, modern farm units in the best land grades, while the traditional estates gave the institutions opportunities to reap rewards from reorganisation and capital injection.
About two-thirds of the larger financial institutions became involved to some extent in owning let land. Some large insurance companies limited their interest to a single estate; others built up portfolios of 30 to 40 farms. Most funds considered that agriculture needed specialist management, so direct ownership was limited. Property unit trusts invested in farms on behalf of the smaller investors. A few funds became owners of vacant possession land in the late 1970s, farming these properties direct. By 1983 institutional land holdings totalled 830,000 acres, 3% of the area of crops and grass in Britain. Of this, insurance companies held 51%, pension funds 38% and PUTs 11%.
In the 1970s most people assumed that rising farm incomes from crops would be reflected in rising farm rents. This assumption was not borne out by experience, however, and current forecasts for agricultural production and prices are gloomy. In addition, the present situation is highly political, and the future pattern of rents and values will be directly affected by decisions made in Westminster and Brussels. The voice of the landlord will not feature strongly in the discussion of such policies.
How are the financial institutions reacting? The simple answer is that they are sitting tight, keeping a look-out for a sale if this means a good deal. So the total ownership of agricultural land by the institutions is now falling. Sixteen whole properties were sold in 1986 — 13,000 acres — and a further 7,400 acres were disposed of in part-sales. Thus the Savills/IPD figures for 1986 show a net disinvestment of 20,000 acres among 43 of the largest institutions owning farmland, a reduction of 4% of their total holdings. These institutions made only eight purchases of land in 1986 — 750 acres altogether — but all were tidying-up operations on existing holdings.
The number of farms sold in 1986 was well up on the previous year when many institutions had tested the market and then withdrawn their land. The higher number of sales in 1986 hides the fact that very few farms are being sold tenanted. Virtually all sales are “special”: sales to sitting tenants or sale of vacant land after a deal has been struck between landlord and tenant. Furthermore, the majority of sales were made by PUTs, many of whom are effectively forced sellers. But for most funds market activity has dried up: none of them is willing to buy at present prices. Sitting tight is the best option that can be adopted.
The critical indicator now is the level of current rent reviews. Can any increases in rent be achieved? Of the 106 farms in the Savills/IPD survey which had rent reviews in 1986, half did show rent increases, although these were far below the levels of previous years. An average rise of 4.3% in 1986 contrasts poorly with the 17.4% achieved in 1983 and 11.6% in 1985. For a further 46% of farms in the sample there was either no increase at the 1986 review, or fund managers had delayed serving review notices: 3% of farms had had their rents reduced.
Farm rental values offer us a comment on prospects as seen by valuers. At the end of 1986 Grade 1 land in England was alone in having an average rental value in excess of current rents, and valuers were expecting rent reductions of 3.5% for other land grades. The situation has improved in the first six months of this year, with rents holding up at review.
In these circumstances it is not surprising that farmland was severely down-valued in 1986. Although valuers have very little market evidence on which to work, the average fall in capital values was 19.6%. This was the third successive year of falling capital values, which are now back to the 1978 level. Since 1980 they have fallen by 31.5%: reductions have occurred across the board and are hardly influenced by tenure, size, region, or land grade. But this fall in capital value over six years is still smaller than the massive 1974 decline of 37.7%.
Current net yield on let land stood at 5.3% at December 1986. In 1979 yields were 2.2%; they have progressively lengthened to 3.1% in 1983; 3.3% in 1984, and 4.2% at the end of 1985. There is widespread agreement among investment managers that this movement has further to go. Certainly the yield on let land does not look generous by comparison with an income yield on equities of 4.1%, or on gilts of 10.5% at December 1986.
A low, if rising, income return and negative capital growth means falling total return. Again the differences in performance by type of farm are small. Higher-quality land has done marginally better than the rest, but the market is largely untested and the total returns equation is heavily influenced by valuations placed on property. Since 1976 all land grades show a negative return in real terms. Strong growth between 1976 and 1980 was followed by stability between 1981 and 1984 and then the falls of the last few years.
The future of the let land market is almost impossible to judge at the moment. It is currently in a state of adjustment to the overrosy expectations of a few years ago and the weight of money that flooded in behind them. Sales are few and institutions (except for PUTs) are not forced sellers. Average yields are still below those on retail property. Further falls in capital values may be expected in the short term and market professionals suggest that a realistic current price may be based on a 7% to 7.5% return.
In theory a bottom exists to the market, because funds like owning farms. There is no shortage of tenants and farms occasionally show spectacular capital gains — minerals are discovered or a tenancy falls in. At some time in the future the CAP will be settled and order might then return to the European agricultural market. The institutions own some of the best and in the UK and will therefore benefit from any rise in crop prices and rents. In such circumstances institutions will undoubtedly return to the market — although initially they will be merely absorbing the holdings of their disillusioned colleagues.
But no one is brave enough to say when this turn-round will occur. For the next 12 months all eyes will be firmly fixed on rents and whether they move upwards or downwards. What is clear is that the immediate prospect of further falls in capital value will limit trading activity.
