How to get a foothold in farmland investment

A piece of land in the country is a fine aspiration for any City gentleman, but it could also prove a shrewd investment move.

With the markets far from certain and inflation a concern, farmland is looking more and more appealing.

Land has a lot going for it. There is nothing more tangible than a piece of earth to call your own and unlike similar investments, such as gold, land will provide an income. While it is possible to bring more land into production, it is clear that demand is going to continue to outstrip supply for the foreseeable future.

At a time when interest rates are at an all-time low and equities aren't what they could be, the stats for land look very attractive. Prices in the UK have almost trebled in the last decade, from £2,000 per acre in 2001 to £5,500 at the close of 2011.

Projections look attractive too, with Savills predicting that good-quality land will be worth 36% more in five years' time.

So why have land prices risen so much in recent years? First, and probably most importantly, commodity prices have gone through the roof. Wheat is more than twice the price it was 10 years ago. Then there's the attractiveness to investors of all tangible assets at a time of low interest rates. Add to this the fact that there is greater pressure on land from biofuels and urbanisation and you've got a recipe for impressive capital gains.

In the long term a raft of factors are almost certain to mean strong and sustained growth in demand and prices. With the world's population continuing to grow at an alarming pace and the UN predicting another 1.8 billion mouths to feed by 2030, agricultural commodity prices aren't likely to be going south for long any time soon.

This is compounded by the growing appetite for meat among the burgeoning middle classes in emerging nations. To produce one kilo of beef it takes up to 13 kilos of grain, ramping up demand all the more.

There are a range of opportunities for different investors too. Those looking to preserve capital or hedge may look for a safe bet with investment in the UK, whereas the more adventurous could go out on a limb and invest in uncultivated land in emerging markets.

David Gardener of DGC Asset Management thinks land is a good bet for people looking for solid long-term returns. "Investors wanting to stick their money into something for 10 years, which isn't gold, that will be more valuable in 10 years' time will be drawn to it. A lot of people have made money from gold but now they're looking to liquidate some of that and land is a great option," he told Interactive Investor.

Not only for the super rich

However, unless an investor has around £5 million in their back pocket it's unlikely they're going to be able to go it alone and purchase a farm large enough and of sufficiently high quality to give good returns. Several asset managers offer services to pool funds in order to purchase a viable tract. The average investor with DGC comes to the plate with £100,000, but the company says it has many who come with substantially less.

There is also UK based Braemar Agricultural Land Fund. However, this has shown disappointing growth since its launch in 2009 and has failed to attract the kind of investment that was hoped.

Most investors buy land and lease it back to farmers, meaning that there is very little risk involved. Some choose the slightly more risky, and potentially profitable, route of contract farming agreements. Under this arrangement the investor shares in the profits and losses of a farm.

Ian Bailey of Savills warns that investors need to be careful in choosing where to put their money as there is a great variation in the prospects for capital growth between different types of farms. "The larger high-quality farms, driven by high commodity prices, are at the top end of the market. You can expect to get income yields of around 3.5% to 4.5% and capital growth of about 6.6%, so that would mean returns of 10% overall.

"But with lower-quality smallholdings the residential factor is much greater and growth will be very low, with an income of just 1% to 2%," he says.

Phil Bicknell, chief economist at the National Union of Farmers, says that while outside investors are contributing to an increase in price it is farmers who are buying up most of the land. "That's driven by strong prospects going forward. So as a result we've seen less and less coming onto the market in the last few years and that makes it harder to find good, large farms to invest in."

With less land coming onto the market in the UK, some investors are looking further afield. This is something for the more adventurous, with the prospect of greater, but more risky, returns.

Ian Bailey said: "It can be massively profitable if you find the right property in the right place, but it needs a lot of research to check that it follows due diligence, but also that it's in the right area, with good soil, access to water and proper infrastructure.

"Governments can change regulations too. Argentina recently increased taxes on foreigners owning land for example."

But it's not necessary to go that far to find a bargain. Romanian arable land sells for between €2,000 (£1,635) and €3,000 per hectare, that's more than six times cheaper than similar land in Western Europe. But you might have to move fast, as foreigners already own 8.5% of cultivated farmland in the country.

Ethical concerns

There are pitfalls however, and not just financial ones.

Agricultural land investment can be destructive, at least according to the signatories of the United Nations-backed Principles for Responsible Investment in Farmland. This document sets out ways to avoid pitfalls such as those that would lead to the grouping of smaller farms into more economical and productive large-scale operations, which will certainly seem attractive to the hard-nosed investor, but may prove devastating to the subsistence farmer or herder.

There are also environmental concerns. Investment in previously uncultivated land may mean the destruction of virgin forests and the creation of mono-crop mega-farms.

Buying land anywhere in the world is not something that should be entered into lightly and it is necessary to enlist the services of experts who can help navigate the risks associated with location, quality, operation and legal issues. Ensuring due diligence will mean that there will be a much higher initial cost than other assets. David Gardener estimates that, as a guide, 10% should be added to the acquisition price.

This may be tempered somewhat by tax relief in some quarters. A number of developing countries are looking to encourage foreign investment with favourable tax regimes, but even at home there are advantages.

Business asset rollover relief may prove helpful in lessening the impact of inheritance tax and there are several incentives for owners of timber producing woodland.

If any more proof were needed that land is an attractive prospect, Warren Buffett has added his weight to the argument. He recently heralded land investment, telling investors that he expects land to outperform gold and other unproductive assets in the medium and long term.