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September 6, 2007

Ag economists give tips for renegotiating lease arrangements

WEST LAFAYETTE, Ind. - Increased demand for corn and soybeans, increased commodity prices, and increased variability and risks create a complicated situation for landowners and tenants trying to reach a fair lease agreement, say Purdue University experts.

It is important to look at each case individually because of the variety of factors at play in this new economic environment, said Purdue Extension specialist Craig Dobbins.

"It's difficult to make blanket statements about what rents ought to be," he said.

Luc Valentin, Alan Miller and Dobbins, all Purdue Extension ag economists, sat down and worked through information for parties involved in rethinking and renegotiating lease arrangements.

Valentin broke down the different types of lease arrangements by landowner and tenant from least risky to most risky.

From a landowner's perspective, a cash rent agreement has no risks, but the landowner also should expect the lowest return from the agreement. On the other end of the spectrum is the share lease agreement with a tenant, where the risk for the landowner is higher so the expected return also should be higher. A flexible cash lease presents some middle ground. Depending on how it is set up, this type of lease typically provides the owner a base payment level and a bonus in good crop years.

For the tenant, a flexible cash lease provides a situation in which the base rent is not as high in a year of low prices or yields. But when revenues are larger because of higher than expected yields and prices, the tenant would pay a higher rent, Valentin said.

From the tenant perspective, cash rent agreements are the riskiest because a tenant has to pay the same rent every year, regardless of yield and price levels. With a share rent, the risks - and the returns - are split with the landlord. The share rent is the least risky agreement, but also the one with the lowest expected return.

Landowners and tenants also must determine the appropriate rent amount. Dobbins offered a few rules of thumb that may be helpful in reaching an agreement.

"Think about the relationship of rents to land value," Dobbins said. "Given the current environment, 3 percent to 4 percent of the current land value is a reasonable area for rents to be in.

"It also helps to think about farm productivity measured by long-term corn yields. Rent set at .95 cents to $1.10 per bushel is a reasonable ball park to be in based on the last five to six years of corn yields."

Not only are rents going up, but the cost of production also is increasing.

"As we look ahead to 2008, the forecast for cost of production will increase significantly," Miller said. "We're looking at a 15 percent or more increase in the cost of growing corn or soybeans, and they need to keep that in mind when making calculations."

When considering acceptable rental agreements, tenants should budget their costs to include an amount for machinery and labor, Dobbins said.

Miller also emphasized the importance for tenants to be proactive in managing their relationship with the landowner.

"Talk to the landowner about what is happening in the market, what you are thinking about doing and how this would affect them," he said. "Ask the landowner their ideas and show interest in coming to an agreement where both parties are happy."

Writer: Julie Douglas, (765) 496-1050, douglajk@purdue.edu

Sources: Luc Valentin, (765) 494-0468, lvalent@purdue.edu

Craig Dobbins, (765) 494-9041, cdobbins@purdue.edu

Alan Miller, (765) 494-4203, millerwa@purdue.edu

Ag Communications: (765) 494-2722;
Beth Forbes, forbes@purdue.edu
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