A Farmer’s Dilemma

A farmer based in Saskatchewan would like to purchase land to own and operate. Using traditional forms of financing in order to purchase the land, the farmer would be able to borrow against their available equity. Assuming a lender, such as Farm Credit Canada, requires a down payment of at least 25%, and a farmer has accumulated $500,000 in equity, they could borrow up to $1.5 million and purchase total land valued at $2.0 million.  If land costs $2,000/acre the farmer would be able to purchase a total of 1,000 acres.  Unfortunately, for many farmers, this may not be a large enough operation with which to make a comfortable living, and the farmer would need to find a solution to operate additional land to justify being a full time farmer.

In an attempt to operate additional land and scale up operations to a sufficient level, the farmer’s primary option is to rent or lease land from a landlord.  This approach may be accompanied with significant risks, including:

• The risk a rental or lease agreement is not renewed – at the end of the rental term the landlord may opt to rent the land to a new tenant, or the landlord may sell the land and the new owner may decide to operate it themselves or rent to a new tenant. In both situations the farmer loses the ability to operate the land;
• Capital expenditure risk – if a farmer has purchased significant equipment in order to properly operate the rental land, and subsequently loses the ability to rent this land, it could put the farmer under enormous financial strain, also the labour that was hired will now have to find work elsewhere.

Skyline Offers a Real Solution

Skyline offers an innovative form of financing to farmers seeking to scale up operations, but would prefer to not tenant farm and incur the risks associated with it. Skyline’s goal is to help farmers acquire land they otherwise could not and provide a real solution in helping to transition land from the current to the next generation. Let’s make the following assumptions:

In this example, based on the farmer’s available equity of $500,000, they could purchase up to 1,000 acres using traditional forms of financing, such as Farm Credit Canada:

Rather than having to rent the remaining 2,000 acres, and the farmer exposing themself to the risks associated with this, the remaining acres could be fully financed by Skyline and purchased by the farmer:
 

The “land value hedge” is simply a contract entered into between Skyline and the farmer which will fluctuate based on changes in land values in the province of Saskatchewan.  Essentially, this contract is a hedge for the farmer on changing land values. By entering into a “land value hedge” Skyline assumes a portion of the land value risk, which lowers the farmer’s credit risk and increases their ability to borrow money to purchase farmland. In the example above, Skyline would lend the farmer the additional $4 million necessary to purchase the 2,000 acres.  This gives the farmer the ability to own and control 3,000 acres of land rather than just 1,000 acres.  Skyline has no ownership or control over this land and simply plays the role of a financial institution similar to Farm Credit Canada, a credit union or a bank.  

It is important to stress that the land is 100% owned by the farmer and the appreciation of that land is 100% attributable to the farmer.  However, the farmer can choose to enter into a contract in order to hedge some of the future potential land appreciation, which will give them greater flexibility to borrow and increase their land ownership. By hedging some of their land ownership risk, which is similar to the way farmers’ hedge commodity price risk by forward selling a portion of their crops, Skyline is able to offer the farmer a potentially advantageous financing alternative to grow their operations.  Of course, a farmer is free to use other financing options if they deem them to be better suited to achieving their goals.

To summarize, in the case study presented above, the net financial result to a farmer is as follows:

The Skyline option compares very favorably to the alternative of using more conventional financing, the latter of which resulted in the farmer owning only 1,000 acres as opposed to 3,000 acres of farmland. While under the Skyline model some of the farmer's land value is hedged, the farmer still ends up with far more exposure to land values, they do not have to pursue a potentially less desirable tenancy agreement, and most importantly they own and control the entire 3,000 acre land package.  As the farmer is not a tenant, they do not run the very real risk of potentially losing the land to another farmer. Also, the land can only be sold by the farmer because they own it outright.   

A typical land value hedge contract would have a term of 10 years although every situation is different and every contract is negotiable.  The greatest potential benefit from utilizing Skyline’s form of financing becomes most apparent once the land value hedge contract expires in 10 years.  For example, assuming the farmer repays 20% of the mortgage debt over the 10 year period and land values increase 5% per year over that time, the farmer’s future financial position would be as follows:

The farmer’s future equity value would be $3.36 million which represents 34% of the total land value.  At the end of 10 years, the farmer would now have the option of eliminating the land value hedge and refinancing his ownership of the entire 3,000 acre land package using traditional debt as he now has sufficient equity to do so. Thus utilizing Skyline's form of financing results in the farmer being in a superior position than any other available model would (i.e. traditional debt financing or renting land).    At the end of 10 years Skyline would still offer its financing services to the farmer, but they are under no obligation to use them.  Throughout this process Skyline will never have any ownership or control over the land.