Unexpected expenses are a concern for many farmers, whether it is for maintenance of equipment or to purchase a better tract, and these expenses may put financial strain on your operation. So how can you hedge the risk with the reward in farming? For many farmers, this means looking into a sale leaseback.
A sale leaseback is when you sell an asset (in this case, land) to another individual or company with the intention of leasing that asset back. This article will answer some commonly asked questions about sale leasebacks and why they might be the right move for your operation.
- Why Would You Do A Sale Leaseback?
- How Do Sale Leasebacks Function?
- Pros Of A Sale Leaseback
- Cons Of A Sale Leaseback
Why Would You Do A Sale Leaseback?
The cost of owning a farm is exponential. Farmland is considered a high cost, fixed asset. Depending on the soil type, region, and type of crop you’re growing, there may be any number of unexpected costs.
For example, in the Ohio region, where soils tend to be rich, dense clays, there may be a need for extensive drainage tile. These drainage systems help to keep your crops from standing in water, and in turn, increase your cash flow from crop yield ten fold.
In regions like South Georgia, where loose, sandy soils are more prominent and rainfall less abundant, you may not need drainage tiles, but you may need to invest in extensive irrigation systems to get enough water to your crops.
Both of these scenarios will easily require abundant capital up front for installation and need regular maintenance in the long term. So, why would you do a sale leaseback? The answer is simple: to mitigate cost risk while maintaining the right to utilize that asset.
Here is another scenario: You currently own and farm 1000 acres, but your neighbor is selling a property that is a contiguous tract to what you own and better than some of the land on the southern portion of your property.
You may want to buy that property to add to your current operation, but you don’t have the capital to do it without some help. In this scenario, you may be interested in selling off a tract of land that is not in an ideal location so you can then use that money to enter into a 1031 exchange agreement to purchase the new land.
The only downside to this scenario is that you would be losing the ground you sold. However, with a sale leaseback, you can maintain that ground as farmable acreage while simultaneously adding the new tract that is closer to home and better fits your needs.
How Do Sale Leasebacks Function?
Generally, a sale leaseback will function based on the contract decided between the buyer and the seller. These contracts are all negotiable, and the seller will have more control than the buyer over the terms of the lease.
Seeking out a professional land agent is a good way to ensure you have an agent that understands how complicated these contracts can be, and they will be able to help you determine the best lease for your goals.
Pros Of A Sale Leaseback
A sale leaseback can be mutually beneficial.
Consider this: a buyer with abundant capital to invest in a property, and the ability to maintain that property, despite the significant upkeep and maintenance risk, may not have the ability or know how to physically farm the land. However, a seller may have the knowledge and experience to farm the land, but they may not have the capital to maintain the expensive equipment on the property.
In this situation, the buyer and seller could work together to negotiate a sale leaseback agreement so that the buyer can benefit from rent cash flow, and the seller can benefit from crop yield cash flow.
Pros For The Buyer
As a buyer, a sale leaseback could be an opportunity to diversify your portfolio. Buyers entering into a sale leaseback agreement take many forms, but in land real estate, it is likely that a company has purchased the land and then used crowdfunding to fund that purchase. The individuals who participated in the crowdfunding are then considered partial owners of the property, and they may benefit from including farmland as an asset class in their portfolio.
Pros for the Seller/Lessor
A seller may benefit from tax deductions. When you sell a property and then lease it back, you’re no longer responsible for paying taxes on that property, but you may still maintain responsibility for the costs of operating your farm on that land. Because you’re no longer the owner of the property, these costs may qualify for tax deductions.
Further, if you sell a property with the intention of adding a new property to your acreage, you have the option to enter into a 1031 exchange by using the capital from your sale leaseback to fund the new property. This will exempt you from paying capital gains taxes on the new property.
Sale leasebacks will also allow you to secure a fair, long term lease. Many lessors in a sale leaseback will negotiate the lease well before the actual sale of the farm or tract. In this case, they have potential to secure a fair, long term lease to protect themselves from sudden, increased rent prices.
Cons Of A Sale Leaseback
While a sale leaseback is generally accompanied by benefits for both the buyer and the seller, you should still consider the cons of entering into this type of agreement.
Cons For The Buyer
For the buyer, being tied to the same operator for a long term lease may become a con if the operator is not doing their part to care for the land. Be sure to have a specialized land agent helping you through the process to ensure that the contract will benefit both you and the seller while also protecting the integrity of the land.
Cons For The Seller
For the seller, you should consider whether you’re willing to lose ownership of your asset. A farm is an asset class that has been largely overlooked. While you may have grown up on a family farm and never considered your farm as an investment, simply owning farmland is actually an investment.
Another con to consider on the seller side is the potential risk that accompanies rent agreements. While rent is generally negotiated on a year to year basis, it may be a good idea to explore the idea of a long term lease. If rent in the region that the farm is located suddenly doubles, would you still have the capital to continue your lease?
Working with a land agent instead of a residential real estate agent is beneficial because land experts are more well versed in contracts specific to farmland, such as a sale leaseback, as well as local market conditions.
Sale leasebacks are an interesting twist on the standard sale of a property. They may benefit the buyer and the seller, and help improve the livelihoods of farmers, landowners, and sellers.
Utilizing the services of a land brokerage instead of a general real estate brokerage throughout the process of a sale leaseback has many benefits. Agents involved in agribusiness more thoroughly understand the different nuances of buying and selling land, rather than just small real estate transactions, and they can help guide you in the right direction.
If you’re considering a sale leaseback and would like help from a land expert, reach out here to start the conversation.