Ag Matters - Are flexible cash rental agreements the right choice?
Cash rental agreements on farmland are generally the most widely accepted for farmers and landlords. However, after a bountiful crop year, like this year, there is often interest to renegotiate the rental agreements.
Cash rental agreements are simple, clean, and efficient for both the renter and landlord. This is especially true when the renter has multiple landlords. The common alternative, the crop share arrangement, adds additional layers of complexity for the renter, especially when the renter operates multiple tracts of land from multiple landlords.
The cash rental agreement is also attractive to the landlord because he/she can plan on the certain level of revenue without the worry of unfavorable weather or crop prices. Indeed, many landlords are retired farmers and may have had enough of the uncertainly of crop production.
However, with farm size increasing, and with certain landlords that have greater tolerance for risk, the flexible cash rent option may be desirable.
In essence, flexible cash rental agreements are a floating value that is typically based on two factors, price and yield. Typically, this floating amount has upper and lower limits -- which should be equal. For example, if the normal cash rent is $50/acre, a flexible cash agreement may float as high as $70/acre or as low as $30/acre. The set points, if there are any, may be as close or far apart as agreed upon and should depend on the risk and reward desired.
Advantages of flexible cash leasing
n Financial risk is reduced for the farmer if the cash rent is lowered when revenues are low. Conversely, the landowner will share in economic "windfalls" if the rent is adjusted upwards when above-normal revenues are realized, and if the arrangement qualifies for sharing farm program payments.
n There is less communication and joint decision making than with a typical crop-share lease, which may have possible social security and income tax advantages for the landlord.
n Flexible cash rent may better meet the objectives of the landlord and tenant than cash rent, particularly if the landlord is willing to share the risk and the tenant is interested in reducing risk.
n Properly designed flexibility will reduce the need for frequent renegotiation of cash leases.
Disadvantages of flexible cash leasing
n The landowner has more financial risk than she/he would with fixed cash rent. However, if there is greater risk, there should be the potential for greater reward.
n Most of these agreements are based on price and yield; the landowner will need to trust the tenant to accurately measure production -- similar to a crop-share lease.
n The renter will typically share some of the "economic windfalls" from above-average years. There is a price for reduced risk.
n Because flexible cash leases are not widely used, people are often unfamiliar with them.
n Farm program payments need be considered, adding another layer of complexity.
n With multiple-crop enterprises, such as wheat and soybean, arriving at an adjustment trigger price and/or yield for two or more crops is more complicated.
n The initial agreement is more difficult and time consuming than conventional lease agreements.
n Scheduling payments can be complicated under a flexible cash lease. For example, with a two-payment agreement, if the total rent calculated at the end of the year is less than the first installment, is some of the first installment refunded or is no additional payment made? If the first installment is non-refundable, it, in effect, becomes the minimum cash rent.
While conventional cash leases may be rather "generic" in nature, the flexible cash lease is often more of a "designer" type of lease. It is most beneficial to the parties involved when it is designed around objectives on which the landowner and the farmer mutually agree.
To be successful, there needs to be deliberate involvement and negotiation by both parties. However, the landowner and tenant who are willing to work together in designing a flexible cash lease, and then refine it over time, may have considerably more opportunity to satisfy their objectives than they would with fixed cash rent.
For more information on land rent and other sticky issues, contact me at the Polk County office in McIntosh or at the Clearwater County office on Wednesdays. Our toll free number is 800-450-2465. If e-mail is your thing, contact me at email@example.com.