In one of our previous blog posts on Calculating Cash Rent we outlined different ways to calculate cash rent. More than anything that exercise reveals the shortcomings of the cash rent model and the difficulty of coming up with a cash rent that doesn’t leave too much money on the table while at the same time not opening your farmer up to potential disaster if mother nature doesn’t cooperate in a given year. Flex leases are a relatively new approach to solving that problem.
The biggest challenge with cash rents is trying to guess how much the land is worth without knowing the gross revenue it will produce. Flex leases eliminate a lot of the guessing. There are many different types of flex leases, but most retain the following characteristics:
- The rent paid adjusts automatically depending on yields and prices
- Risks and profit opportunities are shared between owner and tenant
- Owners are paid in cash and do not have to be involved in grain marketing or input decisions
The downside to flex leases is that they can be complex and they depend on your ability to gather good information. We at Tillable think flex leases are a great approach and supporting flex leases and the the data gathering that takes place, will be a core offering of our platform.
Types of Flex Leases
Flex leases generally fall into two categories:
Option 1: Gross Revenue à Rent paid at the end of the year based on the actual yield X the actual price of corn X 35-40%
Option 2: Base + Bonus à A base rent is determined and a bonus is paid after harvest that is dependent on actual yields and prices
If you decide on the first option you should consider a higher overall percent of the gross revenue because your farmer doesn’t need to pay any rent upfront eliminating the cost of credit.
There are a lot of different types of flex leases out there, but most variations fall under category two and the place where they often diverge is how to determine the bonus.
The base is normally set lower than a competitive cash rent. There are two approaches that we believe are fair, 1) take 80% of a competitive cash rent for your farm 2) set your base using the Productivity Index adjustment calculation: Base Rent = (Field PI/Co Avg PI) X price of corn X 4 yr. Co yield X 30-38%. (For more information on this approach and to find out where to find the information for the inputs, read our blog on Calculating Cash Rent)
There are many different approaches to calculate the bonus, but one we like is: Bonus = (price of corn X actual yields X 30-38%) – Base Rent
By using a base + bonus approach you make sure that you aren’t leaving any money on the table, are consistently fair to your farmer (and vice versa) and that your farmer doesn’t go bankrupt if mother nature or the commodity markets don’t cooperate in any given year.
Determining the Price of Corn and Yields
To determine the price in the calculation above we recommend selecting a local grain elevator and taking an average of the price from that elevator over the 9-12 months of the lease. A local grain elevator is often chosen to accurately account for location basis, which is the cost of transporting grain from a local elevator to a market.
An alternative approach is to use a market index, like the CME Group, but make an adjustment to the price that accounts for the location basis.
There is now more information available than ever before to help you accurately track yields, gone are the days (well mostly) of hand written scale tickets. Most scales have digital tickets, or at least printouts. You should be collecting these from your farmer as well as data from a precision agriculture tool, like Climate FieldView, My John Deere, Agleader, etc. Below is a screen shot from Climate FieldView that shows the yields for a particular field. We obscured identifying information, but you can still see how powerful the data is that FieldView and similar tools can provide.
You should make sure your farmer is using one of these tools and providing you with yield information. Or better yet, let Tillable do it for you. One of the advantages of Tillable is we gather all of the data for you and we will even do the flex lease calculations and make sure the money is automatically transferred to your bank account.
A flex lease is a fair solution for both a `landowner and the farmer. They are a little more difficult to administer and they do require gathering information on pricing throughout the year as well as on yields. Accurate data is critical – make sure you are requiring both scale tickets and yield information from a precision agriculture tool.
Flex leases certainly go a long way towards solving the problem of fairness when it comes to farmland rents, but they won’t help you understand whether or not you have the best farmer on your land. Tillable’s process not only helps you find a great farmer, but we provide you with comparisons to similar farms so that you understand how your farm and farmer are performing. The difference between an average farmer and a great farmer can be 20% a year.