Comparing the stock market and Iowa land values: A question of timing

By Michael Duffy
Associate director and professor of economics

The recent passage of the 2002 farm bill and the current calamities in the stock market have resurrected a perennial question. What is a better investment—the stock market or farmland?

Iowa farmland values have risen over the past two years and recent estimates suggest that this increase is continuing. Based on the Iowa State Land Value Survey, the 2001 estimated increase in Iowa land values was 3.7 percent. This increase in land values followed two years of declining values. Since 1990 the estimated average value of Iowa land has risen 59 percent, from $1,214 to $1,926 per acre. Current estimates are that land values have increased another 1.4 percent in 2002.

In contrast the stock market, as measured by the Dow Jones Industrial (DJI) average, has closed the year lower for the past two years, including a 7 percent drop last year. However, the DJI had risen from 2,633 in 1990 to 10,021 in 2001. This represents an increase of more than 280 percent, in spite of the decline in the past two years. On June 30, 2002, the Dow Jones closed at 8,506, down 15 percent for the year.

Is the drop in the stock market, coupled with the increase in land values, causing people to shift to land investments? Does this make sense economically, in the short term and the long term?

Setting up a comparison

To answer the question of which is the better investment, I will compare and contrast the returns over the past 50 years. I also will discuss some of the important factors to watch over the next few years.

The returns to land or stocks are composed of two parts. The first is the capital gains or the increase in value. Obviously, this also could be a capital loss in the event of a decrease in value. The second component is the yearly returns. The yearly average rent and the average dividend will be used as the proxy for the income from the alternative investments.

The annual percentage changes in the DJI and Iowa land values reflect considerable yearly variation in both investments. For land, since 1950, the average percentage change is 5 percent with a standard deviation of 12 percent. Percentage changes for land range from a plus 32 percent to a negative 30 percent. The Dow Jones Industrials show an average percentage change of 9 percent with a standard deviation of 16 percent. The yearly percentage change in the DJI ranges from a plus 44 percent to a negative 28 percent.

The average land rent since 1950 has been $63.06 per acre. The average dividend for the Dow Jones Industrials has been $60.92. This includes only the dividend estimate for the first half of 2002.

There are two assumptions to be made when considering which is the better investment. First, I will assume $1,000 is invested in each alternative at the beginning of the period discussed. The amount of land or stock purchased will depend on the existing value. The $1,000 will increase or decrease only by the change in value during the first year. Second, all of the rent or the dividend will be reinvested in the land or the stock market. Taxes are not considered, only the average percentage increases in value are at issue.

Comparing past returns

Figure 1 shows the return to $1,000 invested in 1950. At that time, $1,000 would have purchased 4.59 acres or 4.25 shares of the DJI. Using the assumptions above, the value of the land through the first half of 2002 would have been $257,645 versus a DJI value of $248,466. In other words, the value of the land investment would be 4 percent higher than the stock investment.

Figure 2 shows what would happen if the $1,000 investment in land or the DJI had been made in 1970. At that time $1,000 would purchase 2.4 acres or 1.2 shares in the DJI. By the middle of 2002 the land investment would have been worth $40,816, while the DJI investment would have been worth $31,932. A land purchase in 1970 would have approximately 28 percent greater value relative to a DJI investment.

Figure 3 presents the $1,000 investment results had they been made in 1980, near the peak in Iowa land values. In 1980, the $1,000 investment in land would have only purchased .48 acres of land or 1.04 shares of the DJI. By mid-year 2002, the land investment would have been worth $4,954 while the DJI investment would have been worth $17,433. This means the DJI investment would be worth almost three and one-half times the land investment.

Finally, Figure 4 shows what would happen if the investment had been made more recently. In 1990, the $1,000 would have purchased .82 acres of land or .39 shares of the DJI. The $1,000 in land would have been worth $3,851 on June 30, 2002 and the DJI would have been worth $4,233. The DJI investment would be 10 percent higher than the land investment since 1990.

Things are somewhat different in the immediate past. The $1,000 invested in land in 2000 would have been worth $1,271 in the middle of 2002, while the DJI investment would have been worth $848.

Farmland as investment

It has been said that timing is everything in the success of a rain dance. It would appear the same thing is true when determining whether land or the stock market is a better financial investment. For the most part, it appears that the returns to the stock market are higher; however, there are periods when an investment in land would produce greater rewards.

This raises several interesting questions, including whether or not land is a ‘good' investment and which is the ‘better' investment. It is important to remember the majority of farmland purchasers are already farming. Since 1989, the ISU Land Value Survey has asked the respondents who was the primary purchaser of farmland that year. In 1990 and 1991, existing farmers represented over 80 percent of the purchasers. This number dropped to 67 percent in 2001. This is important because for the most part farmers do not buy land strictly as an investment. They buy land for a variety of reasons and the expected return is only one of many factors.

The proportion of purchasers classified as investors by the ISU land survey respondents has risen considerably over the past several years. In 1989, investors represented only 12 percent of the purchasers, but in 2001 they represented 27 percent of the purchasers. Many of the purchases over the past few years have been for a variety of nonagricultural uses, including summer homes, hunting camps, and other recreational purposes.

Investors also may purchase farmland to diversify their financial portfolios. Given what has happened to the stock market, the lessons learned in the land market during the 1970s and 1980s should not be forgotten; that is, what goes up also can go down and there is no such thing as a market that will always increase.

Short-term influences

What will happen to the value of farmland over the next several years? As always, the future is hard to predict, but in this case it is especially difficult. There are several factors that will have an immediate impact on land values and other longer-term factors that will determine the future investment performance of land.

Two critical factors will influence land values and returns over the next few years. The first of these is the future of the government farm programs. As noted, farmers are the primary purchasers of farmland and net farm income determines how likely farmers are to entertain thoughts of buying land. Over the past several years, the majority of net farm income has come from direct government payments. It appears that the new farm bill will continue the relatively high level of government payments. Have these payments already been factored into land prices? Will these payments continue? This one of the critical factors that will affect the performance of the land market.

The second major unknown will be the performance of the stock market over the next few years. If the market continues to decline, it will have a decided impact on investor interest in farmland. Land that was purchased for recreational purposes could come back on the market and depress prices. If the Federal Reserve takes steps to prevent major problems in the overall economy and if this includes raising interest rates, land values will be affected. Finally, a declining stock market may encourage investors who are looking for a safer place for their money to consider land purchases.  There could be positive and negative effects on land values from a prolonged decline in the stock market. At this time it is not possible to know which economic and social factors will exert the most pressure.

Land values are always influenced by the returns available. The financial returns are affected by the levels of production and demand.  Weather and technological changes have a tremendous influence on the supply. And, in the global economy, changes in supply and demand conditions around the world can impact Iowa land values.

Long-term influences

In the longer term, there are changes occurring in agriculture that will have an influence on land values. One of these is the structural change of increasing farm size. If this trend continues, there will be fewer farms and farmers. This will alter many aspects of the rural countryside, including land values.

Another element of change is the increasing age of Iowa farmland owners. Based on Iowa State University studies, 38 percent of Iowa farmland was owned by people over the age of 65 in 1997. This means that over the next few years a sizeable percentage of Iowa farmland will change hands. Will it enter the market, will family members retain control, or will it be divided? No one knows for sure, but this is likely to have an impact on land values.

The performance of the land and stock markets has been nearly equal over the past 50 years. But, timing has been important. From 1970 to date, land has outperformed the stock market. From 1980 to date, the stock market has done better. More recent track records show the land market has produced higher returns than the stock market.

What are the future investment trends? What will happen to land values? These questions are difficult to answer. At present, in my opinion, land values will continue to hold steady with only slight changes. There will be year-to-year variations, depending upon the current conditions and outlook for agricultural returns. In the long run, I think that land values will increase. But, for how long and by how much, no one knows. And, there is always the potential for downside risk if the government support programs change substantially.

From 1970 to date, land has outperformed the stock market. From 1980 to date, the stock market has done better. More recent track records show the land market has produced higher returns than the stock market.