Agri Fund - Global Investment Review

 

In recent years, agriculture land has attracted billions in private investments and a growing interest from professional investors globally including powerhouses like Black Rock, Morgan Stanley and Goldman Sachs, hedge fund gurus like George Soros, and retirement plan giants like TIAA-CREF. In the UK, City traders and investors bought more arable land than career farmers last year. The typical investment approach is made via private equity style vehicles. Canadian private equity firm AgCapita estimates that as of Q1 2009, more than $2 billion of private equity investments has already been raised for agriculture land investments globally. Expectations are for even larger amounts to be raised and deployed as investors seek to increase weightings to agriculture globally.

 

 

 

Closed Funds:

• Hancock Agricultural Investment Group: $900 million for US agriculture land
• Blackrock: raised $250 million for investment in UK agriculture land
• Macquarie Pastoral Fund: raised US$500 million for livestock investments in Australia
• Pergam Finance: raised $70 million for investment in agriculture in Latin America
• Landkom: raised $100 million for a farming operation in Ukraine
• Black Earth: raised $100 million for a farming operation in Russia
• Agcapita Farmland Investment Partnership: raised $18 million for investment in Canadian agriculture land
• Agrifirma: raised $20 million for investment in Brazilian farmland

Open Funds:

• Insight Agriculture Fund: target raise of $250 million for global agriculture investments
• Emergent Asset Management: target raise of $200 million for investment in Sub-Saharan Africa agriculture land2

Institutional Investors currently deploying capital or investigating deploying capital in agriculture and farmland investing:

      Credit Suisse

• UBS
• Schroders
• Barclays Capital
• Goldman Sachs
• Barings Brothers
• Oppenheimer
• Nomura
• Bank of Montreal    Scotia Bank
• Toronto Dominion
• Canadian Imperial Bank of Commerce
• Research Capital
• Canaccord Capital
• Dundee Securities
• ING
• Royal Bank of Canada

Sovereign Wealth Funds are also aggressively pursuing foreign agriculture land deals. The Gulf States of Qatar, Abu Dhabi and Saudi Arabia have already begun assembling deals to acquire large tracts of agriculture land in Eastern Europe, Africa and Asia at bargain prices. In Sudan alone, South Korea has signed deals for 690,000 Ha, the United Arab Emirates for 400,000 Ha and Egypt has secured a similar deal to grow wheat. It is not just Gulf States that are buying up land. China is unique amongst the world's largest economies in having experienced extreme famine and starvation over the last 50 years and is bringing food security to the top of the domestic political agenda. China announced a $5 billion plan to develop agricultural assets in Africa. In total, the International Food Policy Research Institute (IFPRI) estimates between 15 million and 20 million Ha of agriculture land have been subject to transactions or talks involving foreigner investors since 2006. Putting a conservative figure on the land's value, IFPRI calculates that these deals are worth $20-$30 billion.

 

 

The Sector

Growing world population, rising incomes in the developing world and the increasing use of biomass for industrial applications and biofuels will drive substantial growth in demand for agricultural crops. The world's population is growing by almost 80 million each year, which is approximately 150 more mouths to feed every minute (US Census Bureau, January 2009). High oil prices and the desire for energy independence have led to a strong pursuit for biofuels worldwide, and therefore energy crops such as rapeseed, sugar and corn are in high demand. The world's appetite is changing too. Improving diets in developing nations will also contribute towards a surge in prices. As global wealth increases, so does a desire for a better standard of living, which in turn affects eating habits. As per capita incomes rise in India, China and other emerging economies, millions of people will be increasing their calorie intake and will be adding meat, milk and eggs to their daily fare. That will have a positive impact on demand due to the considerable quantities of grain used to feed livestock.

On the supply side, climate change, fundamental limits to further cropland expansion and severe pressures on existing production, make keeping up with rising demand increasingly challenging. Land is scarce and will become scarcer. The amount of agricultural land on a worldwide basis per person is shrinking. In 1950, there were 0.5 hectares of arable land per person. Today, the number is only 0.25 hectares. Agricultural land is a diminishing resource, especially in more developed countries where cities are rapidly expanding. Every minute, in the US alone, two acres of farmland is being taken out of production and turned to other uses, mostly for development (American Farmland Trust, 2008). In addition, some 12.3m to 19.7m acres of agricultural land, out of a worldwide total of 3.7 billion, falls fallow each year as a result of deteriorating quality; expanding deserts and soil depletion (Bloomberg, February 2007.

Due to climate change related extreme weather events affecting yields, food production is becoming more volatile. Climate change effects could lead to a global decline in agriculture productivity of between 1% and 10% by 2030 (US National Oceanic and Atmospheric Administration, 2008). Rising temperatures and soil erosion are expected to restrain agricultural production growth in traditional producer countries e.g. US, Germany and France. 

Many regions across the globe already suffer from water shortages. 63% of the combined population of BRIC countries is already living under water stress. Demand for water is projected to increase by 70-90% by 2050 and water scarcity could be responsible for yield losses in the range of 1.7-12% in major cereal producing regions by 2050. The debate has already started concerning “Water, the New Oil”.

Demand for agricultural commodities is outpacing supply. Grain consumption has exceeded production for 7 out of the last 8 years. Global grain stockpiles have been in relentless decline bottoming out at 68 days of total supply in 2008. This was accompanied by a year on year rise in soft commodity prices over the period. This trend has resumed (post the 2008 correction) in spite of a reduction in demand as a result of the global financial crisis.

The gap between demand and supply is widening. Even today, 1 billion people go to bed hungry. The business of feeding the world is therefore growing bigger. The strong demand for food is pushing this sector to become a major investment theme. Countries producing and exporting crops on a large scale to meet growing demand will enjoy favourable returns. With limited land and water resources, this will drive up prices of agricultural commodities and strongly positions agricultural land for long-term appreciation.
 

 

 

Commodity  Prices, Land  Availability and  Land Values

As with all assets, agricultural land values are dictated by the relationship between supply and demand. The global financial crisis has shown that other market factors such as credit availability and negative consumer sentiment can also have an effect in the short term. Over the long term, however, supply and demand fundamentals will dictate trends.

On the demand side, agricultural land values are primarily driven by the profitability of agricultural activity. Tenant farmers will be prepared to pay higher rents on land if the financial incentive to do so exists and investors will be prepared to pay a higher price for land as yield ratios improve.

The profitability of an agricultural enterprise is driven by the relationship between input prices such as fertilizers, pesticides, herbicides and fuel (all of which influence yield per unit of land area) and the output value of the crops. Thus, agricultural commodity prices play a significant role in dictating land value. It is this relationship between agricultural commodities and agricultural land values, which in great part explains the evident gains in agricultural land values in recent years, particularly during 2007 and 2008 when commodities soared reaching unprecedented highs.

On the supply side, if there is a high level of availability of agricultural land in a particular market, then prices will likely be lower compared to a market with more limited availability.

“Land is scarce and will become scarcer as the world has to double food output to satisfy increased demand by 2050. With limited land and water resources, this will automatically lead to increased valuations of productive land.” Joachim von Braun, Director General at the International Food Policy Research Institute, 2009

 

Trends in UK  Agricultural Land and Food Prices from Q3 2004 to Q2 2009

 

Long Term Relationship Between Rental Income and Agricultural Land Prices
 

David Ricardo, one of the most influential classical economists, is responsible for developing theories of rent, wages, and profits. His definition of rent applies equally to the profits that are generated from farming activity by a landowner or the sum paid by a tenant farmer for the use of the agricultural land (as these are paid to the landowner by the tenant from the surplus cash flow, or profit, remaining after production). This means that there is also a direct relationship between rental rates paid by tenant farmers and land values. This relationship does not necessarily hold, at least to the same extent, in the case of less developed land markets.

 

Trends in agricultural land prices and rental rates in Japan between 1955 and 2000

 

Source: Tokyo University of Agriculture and Technology and Newcastle University (UK), Published in Agricultural Economics, 2008
 

The above Figure also illustrates that land values can trend away from rental income in densely populated regions such as Japan. This is because agricultural land prices can also experience upward price pressure from development speculators thus driving prices beyond pure agricultural value. For example, in Britain, the average value of an acre of arable land in the South East of England in 2008 was £8,214, whereas the average value of an acre of residential building land was £3,300,000. This price differential can encourage the market to pay prices over and above the level dictated by agricultural earnings in more densely populated regions.

Despite this apparently simple relationship between farm rents, agricultural land availability and agricultural land values, predicting the future is a lot more complex than it seems because agricultural commodity prices are also set by supply and demand. Therefore, assessing the future outlook for agricultural land values relies on a clear understanding of trends in agricultural commodity prices. This presents its own challenges.

 

 

 

Agriculture Sector Drivers

The world’s population is expected to reach around 7.67 billion by 2020 and 9.2 billion by 2050 from the current 6.5 billion. Economic growth in BRIC countries and Asia has given rise to increasing demand for protein. High oil prices and the desire for energy independence have led to a strong pursuit for bio fuels worldwide. Simultaneously productive land is diminishing due to urbanization, soil erosion, salinisation and other forms of land degradation. In 1950, there were 0.5 hectares of arable land per person, today it is closer to 0.25 hectares. Grain reserves are low with stock to last for 68 days compared to 111 days in 2000.

Demand

World Population Growth

World population is projected to grow from 6.5 billion in 2005 to nearly 9.2 billion by 2050. Increase will occur in urban areas of developing countries by about 3 billion inhabitants. To meet demand, global food production must increase by 50%. Migration to urban areas causes abandonment of land farmed. Even today, 1 billion go to bed hungry.

Global Population Growth Forecast

Source, UN Population statistics, Aug 08; Source OECD

Changing Dietary Habits

Dietary changes are correlated to urbanisation and increase in GDP. People are consuming more calories and demand for protein is placing an additional strain on the supply chain. Conversion rates for 1kg of meat requires 8-9kg of grain for beef, 5-6kg of grain for pork and 2-3kg of grain for poultry.
 

Per capita consumption  in developing countries 1980 -2003

Source, FAO, UN 2007

 

Increasing Demand for Bio Fuels

Demand for bio fuels has more than doubled in the last 5 years to 77bn litres. This is expected to hit 127bn litres by 2017 according to the UN's Food and Agriculture Organisation. Current mandates commit millions of hectares of agriculture land to bio fuel feedstock production over the next 10 years.

 

 

SupplyWorld Consumption & Inventory

Historically inventory to usage ratio of below 25% increases volatility. In 2008, when commodities prices reached their peak, despite a record harvest for maize (up 11%) and wheat (up 15.24%) compared to 2007, average global grain stocks reached 18.7% of annual global utilization, equivalent to 68 days worth of global supply, well below the long-term average.

World consumption & stocks 2003 -2017

Source: US Department of Agriculture Foreign Agricultural service, 2008

 

Declining Yield Improvements

The Green Revolution in the 1970's improved yields dramatically. Technological advances are slowing causing yields to stagnate in developed countries. Government intervention may increase regulation on herbicide, pesticide and fertilizer use; further decreasing yield improvements.

Source, FAO, UN 2009

 

Diminishing Supply of Productive Land

 

Since the mid-90s the rate of population growth has exceeded the rate of crop land growth to an ever-increasing extent. Over the period 1961-2000 the world's population grew by 113.9%, while the total amount of arable farmland globally only increased by 10.2%. The arable land area per person was 0.42 hectares in 1961 compared to 0.21 in 2007.

Trends in Per Capita availability between 1961 and 2006

Source, FAO, UN, 2009; United Nations Population Division, 2006

 

The per capita amount of arable land has halved during the past 50 years.

Source, UN Population Division, 20

 

 

Romanian Agriculture Sector

Romania is fundamentally an agricultural country with a very high proportion of the economy engaged in this sector. Agriculture's importance within the economy remains disproportionately higher than its importance for Western Europe as a percentage of GDP.

.

 

Agriculture (including fisheries and forestry) was responsible for employing approximately 40% of the country's workforce in 1998 which has fallen to 2.9 million people or 32.2% of the workforce in 2005. The trend is continuing. The rural economy generally lacks diversification and is dependent upon natural resources consequently it is largely dependent upon agriculture. Due to the subsistence farm structure of the country rural household incomes are low at €2839 (including government support) per month in 2006.  Of this income 77% was derived from payment in kind transactions. Rural households have very limited access if any to credit markets.

Farm Structure and the Market for Agricultural Land

The Fund aims to develop a large, well-managed and diversified portfolio in Romanian agricultural land. A professionally managed agricultural land portfolio will achieve diversification through targeting different geographical regions through a range of rotation cereal crops such as wheat, winter wheat, corn, soya, barley and diverse soil types and operators to decrease the non-systematic risk of the investment portfolio. To protect the interests of shareholders it was determined that such an operation should be established within a regulatory framework which permits the company to own land without restriction and that legally enforceable protection from the local and changeable political manoeuvrings often associated with emerging economies. Through the collective experience of our sponsors and advisors it was determined that such an operation should be centred on the newly acceded states of the European Union. Assessing these countries we found that Romania met a number of fundamental requirements and the current farm structure in the country is conducive to ensuring that a scalable operation could be established within a reasonable timescale.

Romania has been chosen for three fundamental reasons which, when taken in the round – provide a unique set of value adding circumstances:

• A regulatory and legal framework within the European Union
• Common Agricultural Policy: the Single Farm Payment Scheme provides the backbone to European Agriculture and ultimately underpins the land market – thereby further reducing risk.
• Undervalued land: by whichever measure is taken land in Romania remains undervalued when compared to any    other European Union country.

 

The current structure of the farming sector in Romania is the result of the Government's land distribution and restitution policies implemented after post 1989. The First was the Land Fund Act of 1991 which established and limited the restitution and ownership distribution processes, second was the Land Leasing Act of 1994 (amended 1998) which regulates the relations between lessors and lessees. This act is perceived to be relatively restrictive (Leasing was prohibited under the communist regime) piece of legislation and has limited the scope for the development of a large scale land lease market. The third law passed was the Land Transactions Act of 1998 which effectively opened the market potential for land transactions removing the states pre-emptive right to purchase land from individual owners and which now provides the legislative framework for all land exchanges.

As with all countries in the region, foreign ownership of agricultural land is controversial. Romania currently allows foreign ownership through foreign owned locally registered companies. This is less restrictive than the markets of other newly acceded states of the EU. Currently approximately 85% of agricultural land has been privatised. The main form of privatisation was restitution. However, from 2013 legislation will allow direct foreign ownership.
 
As illustrated in the Table below, restitution and distribution of land processes carried out established more than 3.9 million farm holdings, of which 1.6 million are less than 1 hectare, 1.1 million are less than 3 Ha, 290,000 are in the range of 10-20 Ha and 255 are more than 2,000 Ha (the latter  are cultivating 11% of the utilised agricultural area).
 

Source, Ministry of Agriculture & Development: National Rural Development programme 2007-2013; 20/12/2007

A consequence of the land restitutions is that many holdings are operated on a subsistence basis and which are not economically viable. These farms have significantly reduced the yield potential of the agricultural sector cancelling out the gains achieved by the commercial farming enterprises operating above 50 hectares. The small size of farms inhibits the ability to gain credit for farm inputs thereby further reducing actual yields.

Romania's agrarian transition has had to cope with the task of reversing the post 1945 land expropriations and of de-collectivising co-operatives, which had been the dominant farm structure since the 1950s. The reforms also had to eliminate the ingrained legal bias that had favoured co-operative and state owned farms since the adoption of the 1948 constitution. The process started in 1990 when members of the co-operatives received ownership rights to land parcels of 0.5ha. This part of land reform was not based on restitution principles as it gave ownership rights incrementally to the people who worked the land.

The Land Law passed in 1991 (Law 18/1991) laid the foundations for a dual land reform mechanism. It restored ownership rights to former owners, their heirs or successors whose land had been expropriated by the state after March 6, 1945 and it returned usage rights to individuals whose land had been managed for years by co-operatives and state-owned farms. The dual mechanism introduced by the 1991 Land Law is called Reconstitution of Land Ownership Rights as distinct from restitution which in conventional terms returns land to former land owners. In addition to the reconstitution of land the act introduced Constitution of Land Ownership Rights which was the distribution of land to landless farm employees who had worked the land for at least three years on a co-operative or state farm and to landless young families who undertook to start farming the land they gained under this process.

Romanian legislation set absolute limits on both the amount of reconstituted land and the amount of land in private ownership. According to the legislation a family could receive a maximum of 50ha by reconstitution or constitution and purchase up to a maximum of 200ha. Land in excess of 200ha operated by a family must be leased; it cannot be purchased. This land ownership limit does not apply to legal entities.

Following the commencement of the land reconstitution process private individuals had a ten year period to register claims for restitution of previously owned land expropriated by the Government. The procedure for registering claims ended on the 31st December 2007, after which it is not possible to register claims for restitution, although it may be possible to register a civil claim with the courts. This procedure is prohibitively expensive for most of the remaining potential claimants.

 

Agricultural holdings by legal status & size 200212

 

Source, General Census on Agriculture 2002 vol 1. NIS Bucharest 2004

The process of land restitution, reconstitution and constitution carried out since 2009 has led to excessive land fragmentation creating 4.23 million land holdings with an average size of 3.11 ha. The ownership structure shows 99.5% of all holdings representing 55.3% of the utilised agricultural area are in family holdings with an average size of 1.73 ha. The severe land fragmentation has been accompanied by a reduction in the living standards of the rural communities causing 76% of the total holdings (38.2% of area) producing for self consumption and only 2.3% of the holdings (31.2% of area) being market oriented.

The reduction in farm area utilised for market production has reduced the financial capability of the small family holdings causing further erosion of productivity of the land resource as these farms are not able to afford improving inputs such as fertilisers or irrigation. The management of farm holdings is highly dependent upon the educational level of the head of the holding, in the farm census of 2002 less than half of the head of the holdings had completed specialised higher level studies in the field of agriculture.

The land holding structure changed slightly by 2005 but not significantly part of the change is explained by the decrease in the Utilised Agricultural Area of 1,417,200 hectares.

Farm restructuring is an ongoing process as the current status is significantly hampering farm productivity and competitive capacity. The Common Agricultural Policy is geared towards agricultural holdings of a larger size than the average in Romania. Unless the Government acts the agriculture sector will not be able to fully benefit from the CAP reforms 2007-2013 and will diminish the possibilities to take advantage of the financial support available though the European Unions' EAFRD contributions. In addition, the current financial crisis increases the likelihood of private individuals and smaller farm operators having to sell their holdings.