Increasing numbers of institutional investors are seeking access to an asset class that lacks a liquid alternative. Meanwhile, farmers have long realized the importance of land values with respect to their bottom line. While futures and options are available for crop risk, no such risk reduction tools are at hand for declining land values. A futures contract based on a legitimate crop land value index would provide a hedging tool for farmers and speculative opportunity for traders.
Although no futures contract on land values currently exists, that doesn’t mean it isn’t viable. Here, we examine the makeup of the Peak Soil Iowa Cropland Value Index and discuss how a farmland futures contract linked to it can be hedged with a basket of existing commodities. This opens the prospect for locals and institutional investors to furnish liquidity support with the ability to hedge their exposures.
Down on the farm
Farmland has long been recognized for its attractive diversification features. Yet despite growing demand for the investment, concerns about pricing sustainability are becoming increasingly prevalent. While excess leverage has not fueled today’s land valuations, it’s clear the 1980s farmland bubble remains lodged in the minds of property owners. The complexities of physical ownership and the lack of effective hedging tools act as further hindrances.
A functioning farmland futures contract would address most marketplace concerns and needs. The Peak Soil Iowa Cropland Value Index is designed using “corn suitability ratings” from recorded property sales data rather than surveys. (A survey is vulnerable when a party providing data can economically benefit from that contribution—a lesson that might have served purveyors of Libor well.)
Yet, a well-designed index does not necessarily result in a viable futures contract. The respected Case-Shiller Home Price Index never took hold as a futures market. In all cases, liquidity is king. Participants will wait on the sidelines until they know they can get their price, buying into or selling out of the market. Still, history shows that with the right circumstances, vested parties will back a contract in its infancy.