Among the complaints raised by British farmers parking their tractors in Whitehall to protest at the Chancellor’s plan to reduce APR (Agricultural Property Relief, the 100% relief from inheritance tax enjoyed by farmers since 1992), is the very modest income return generated from farming. For many it can be not much more than 1% and anything over 4% is exceptional. It is worth considering why returns should be so modest from such an important industry and why is there such a disconnect between asset value and income. We will then look at a comparable farming industry on the other side of the world.
Let’s start with farm subsidies. These are now in flux following the Brexit departure from the European Common Agricultural Policy, but for the best part of 30 years, the taxpayer provided a virtually guaranteed income stream, linked directly to the area of land farmed. It should be no surprise that such certainty of government backed income should attract a very low cap rate and push up land prices.
And then consider APR, the partial loss of which is causing so much anguish. While it is hard to measure the value placed by individual farmers and landowners on not paying inheritance tax, there is no doubt that the avoidance of a 40% tax is worth pursuing and for which paying a premium is worthwhile.
At the same time, another relief, this time rollover relief from Capital Gains Tax (CGT), with the benefit of which a farmer who sells his farm for development (never for a modest sum) is able to avoid paying CGT, if he (or she) reinvests the proceeds in another farm. That is quite an incentive to chase land prices higher.
With all the talk, under governments of both hues, of the need for very substantial house building, not to mention development of commercial property, the prospect of possible development gain permeates the valuation landscape. A planning consent can be akin to winning the lottery, but the prospect of such a ticket tends to impact neighbouring farm values, with a very broad definition of ‘neighbouring’.
Farmland in the UK is often accompanied by a lovely period house, and possibly an interesting shoot (note Jeremy Clarkson), the value of which to a buyer is of much more consequence than the potential returns from attaching farmland. Land values tick up once more.
The business of farming involves managing land, some of it not very productive, in the face of global competition. However, with the confounding factors outlined above, all of which place upward pressure on farmland values, it should be no surprise that operating returns to farming are modest, and that they place many farmers in challenging situations with regard to succession, retirement planning and even reinvestment in the business.
Travel, however, to the other side of the globe, and the farming environment looks quite different, as do returns to farming. New Zealand abolished farm subsidies forty years ago (and do not regret that decision), and do not struggle with any of the disruptive taxes or, of course, the reliefs which accompany them. There is no inheritance tax, no capital gains tax and no stamp duty on land purchase. This gives remarkable line of sight between net farm income and underlying capital values. In an unsubsidised environment lacking other distractions, there is a need to generate an income sufficient to reward capital and to provide for future generations. ‘Normal’ returns to farming are in excess of 5%.
Research by a large German insurer has indicated that, for farmers in a subsidised environment (as those in the UK), total return is dominated by capital appreciation – around two thirds of the total, while for those in an unsubsidised farming world the balance, over time, is roughly 50:50.
However, even with a general policy backdrop, which has encouraged entrepreneurial and effective food production, New Zealand is not immune from policy error. Kiwis are not alone in the world in fretting about overseas ownership of farmland – the original source of wealth and power. The Overseas Investment Office (OIO), introduced to give visibility of incoming capital seeking to invest in sensitive assets (including farmland) in New Zealand, and which worked well for nearly three decades, was tightened under the previous government to the extent that overseas equity investment to farming was all but choked off. At the same time, the Reserve Bank, acting to reduce systemic risk, increased the regulatory capital requirements for commercial bank lending to agriculture. This had the effect of reducing flows of debt capital to the industry – an effective double whammy. It is worth noting that capital flowed readily to the residential housing market, in which regulatory capital requirements were less onerous.
Prior to 2017 and the election of the Labour government, New Zealand had the most liquid and transparent farmland market in the world. The result of restricting capital flows to a key industry has been a reduction in the number of transactions, less reinvestment on farm, and a slowdown in the ‘normal’ capital activities of a capital hungry industry – succession planning, business growth etc. Farmland values have flatlined, even with increasing income returns (now 8% to 10% in the most productive sectors ). The ‘normal’ capitalisation of rising incomes into land values has stalled.
However, a new government has recognised the damage being done to important sectors earning export dollars and have announced changes to OIO regulations to be introduced in 2025. This can be expected to see a reversion to the mean for income returns and a rise in farmland values – a clear line of sight.
In the UK, by contrast, we can expect to see much of the same, with confounding tax and policy factors overwhelming returns from the production of food.
