Leasing Game Intro to Flex Leases Henderson County January 12, 2011

Leasing Game Intro to Flex Leases

Henderson CountyJanuary 12, 2011

Greg [email protected]://www.ca.uky.edu/agecon/index.php?p=169

Dept. Agricultural EconomicsUniversity of KentuckyDecember, 2010.

Agricultural Economics

The Leasing Game (#1)

• Tenant Farmers: Each have capacity to farm up to 1000 acres each. → Bid on lease land.→ Goal is to maximize net profit.

• Landowners (Me): Have land to rent out to farmers. Will tell you how much at the start of each game.→ My goal to maximize my cash rents.

Expected CostsInputs: Corn (150 bu) Soybeans (45.5 bu) Seed $76 $45 Nitrogen $74 $0 P, K, and Lime $66 $50 Pesticides $30 $20Total Inputs $246 $115Machinery and Labor $116 $82Other: Drying Grain $19 $0 Crop Insurance $15 $15 Misc. $20 $20 Land Rent Variable Variable Operating Interest $12 $7 Total Other $61 $37Total Costs $428 + Land Rent $238 + Land Rent

Summary Revenues/Costs

Yield and Price: Corn SoybeansExpected Yield (rotation) 150 45.5Future's Price Fall 2011 $3.50 $7.50Grain Revenue $525 $341Direct Gov’t Payment $20 $20Total Revenue $545 $361Total Costs (Less Land Rent) $428 $238Gross Return $117 $123


Time to Bid

Make an offer to rent my land.


Results-Leasing Game (#1)

What was the winning strategy?

Where would rents end up if we repeated?


Increased Production Capacity (#2)

• Tenant Farmers: Have capacity to farm up to 1250 acres each.

• Landowner(s): Have same acreage.


Time to Bid



Increased Commodity Prices (#3)

• Tenant Farmers: Still have capacity to farm up to 1250 acres each.

• Landowner(s): Have same acreage.• Commodity prices increase.


Summary Revenues/Costs

Yield and Price: Corn SoybeansExpected Yield (rotation) 150 45.5Future's Price Fall 2011 $5.25 $11.85Grain Revenue $788 $539Direct Gov’t Payment $20 $20Total Revenue $808 $559Total Costs (Less Land Rent) $428 $238Gross Return $380 $321


Time to Bid



Uncertainty of Net Revenue

What if we are uncertain about net revenue (price and/or yield)?

What affect will this have on rents for a long-term lease?

Who will end up getting most of new leases?


The Leasing GameApplication Today

Was it easier to predict net revenue when corn was at $2.50/bu or today?

What happened in the past if corn fell from $2.50 to $1.50?

What happens today if you base cash rent bidding decision on $5.00 corn and it falls to $3.00?


Nuclear Scenario$ 6.50 Soybeans (elevator)

$ 3.00 Corn (elevator)$.30-N; $.30-P; $.30-K

Gross Return

CornGross Return

SoybeansGross Return

Rotation

125 bu corn $31 $50 $40

150 bu corn $91 $87 $89

175 bu corn $151 $122 $136Note: Subtract land rent to get Net Return.


Risk Management Options

1) Flexible Cash Leases2) ACRE Program


ACRE ProgramFSA Program: Give up portion of direct payment. Get downside revenue protection. Revenue guarantee can only go up/down

10% per year.


ACRE Price GuaranteesWorst-Case Scenario

(Assumes Avg. State Yield)

Corn Soybeans2011-2012 $4.37 $10.452012-2013 $3.93 $9.412013-2014 $3.54 $8.46


20

What is a Flex Lease?

Lease rate will vary from year to year. Based on price and/or yield. Usually has a base rate (floor) that the

lease cannot go below.


21

More Specifically:

Landowner shares price/yield risk. Limits profit potential when revenue high. Limits loses when revenue low.


22

Why Consider a Flex Lease?

1) Negotiating tool with landowners.2) Potentially protect you if prices fall.

Example:Cash and Flex Lease

Expected Price of $5.00/bu

Final Corn Price

Cash Lease Rate

Flex Lease Rate

$4.00 $200 $175

$5.00 $200 $225

$6.00 $200 $275


24

Options for Flex Leases

Important Point: These are only examples (although

common ones). Need to tailor Flex Leases to your

needs/requirements as well as the landowner.

Infinite ways to write Flex Leases.


25

Options for Flex Leases

1) Price Ratio Price2) Bushel Equivalent Price3) Revenue Ratio Price/Yield4) Revenue Percent Price/Yield5) Revenue Base + % Price/Yield


26

1) Price Ratio Simplest Flex Lease. Have a base rent and adjust for price

increases. If price increases by 25% than base rent

increases by 25% (typical).

Example: $200 base rent. $4.00 base corn price. If actual price is $5, then $5.00/$4.00 = 1.25

$200 x 1.25 = $250 rent for year


27

2) Bushel Equivalent Price-based Flex Lease. Landowner gets a set number of bushels

as rent along with the final harvest-time price.

Thus final price determines the rent.

Example: 50 bu base X $4.00 = $200 rent for year. 50 bu base X $5.00 = $250 rent for

year


28

3) Revenue Ratio Just like the price ratio Flex Lease. Have a base rent, a base revenue, and

adjust for final revenue increase. If revenue increases 20% from the

base, then rent increases 20%.

Example: $200 base rent. $700 revenue. If actual revenue is $840, then

$840/$700 = 1.20 $200 x 1.20 = $240 rent for year


29

4) Revenue Percentage Cash-lease version of a crop-share. But usually with min. base rent. No inputs contributed by landowner. Can link yield to county average (or

some % of the average)

Example: Landowner gets 35% of revenue.150 bushels X $4.50 X 35% = $236


30

5) Revenue Base + Bonus Base rent, base revenue, and %

landowner gets above the base. Sounds more complicated that it is.

Example: $200 base rent; $700 base revenue; 50% of revenue above base.

150 bushels X $5.50 = $825 total revenue.$825-$700 = $125 revenue above base.$125 X 50% = $62.50 additional rent.$62.50 + $200 base = $262.50 total rent.

Base Plus Bonus Flex LeaseFlex Lease Information: Cash Rent (for comparison) $200Base Land Rent $150Can final rent go below base rent? No Corn SoybeansTotal Costs (including base land rent) $600 $400Base Gross Revenue $600 $400Rent - % of Gross Revenue above base 50% 50%Bonus Land Rent $75 $48

Flex Rent (Base + Bonus) $225 $198

Flex Rent (rotation) $211 Increase from Cash Lease 6%

Example:Base + Bonus Flex Lease

$200 Cash Lease Comparison50% Bonus Revenue

Corn Price

Flex Lease

Net w/Flex Lease

Net w/Cash Lease

$3.00 $150 -$107 -$157$4.00 $150 $18 -$32$5.00 $211 $81 $93$6.00 $274 $144 $217$7.00 $336 $206 $342

Soybean Price 2.2 x Corn Price.

Base Plus Bonus Flex LeaseFlex Lease Information: Cash Rent (for comparison) $200Base Land Rent $150Can final rent go below base rent? No Corn SoybeansTotal Costs (including base land rent) $600 $400Base Gross Revenue $600 $400Rent - % of Gross Revenue above base 40% 40%Bonus Land Rent $60 $38

Flex Rent (Base + Bonus) $210 $188

Flex Rent (rotation) $199 Increase from Cash Lease -1%

Example:Base + Bonus Flex Lease

$200 Cash Lease Comparison40% Bonus Revenue

Corn Price

Flex Lease

Net w/Flex Lease

Net w/Cash Lease

$3.00 $150 -$107 -$157$4.00 $150 $18 -$32$5.00 $199 $94 $93$6.00 $249 $168 $217$7.00 $299 $243 $342


Revenue Percentage Flex LeaseFlex Lease Information:

Cash Rent $200Minimum or Base Rent $150

CornSoy-

beansLand Rent - % of Gross Revenue 35% 40%

Flex Rent $263 $198

Flex Rent (rotation) $230 Increase from Cash Lease 15%

Example:Revenue Percentage Flex Lease$200 Cash Lease Comparison

35%-Corn 40%-Soybeans RevenueCorn Price

Flex Lease

Net w/Flex Lease

Net w/Cash Lease

$3.00 $154 -$110 -$157$4.00 $184 -$16 -$32$5.00 $230 $62 $93$6.00 $276 $141 $217$7.00 $322 $219 $342


Price Ratio Flex LeaseFlex Lease Information: Cash Rent $200Base Rent $200Minimum Rent $150

CornSoy-

beansPrice Ratio (current price / base price) 1.00 1.00

Flex Rent (base rent x price ratio) $200 $200

Flex Rent (rotation) $200Increase from Cash Lease 0%

Example:Price Ratio Flex Lease

$200 Cash Lease ComparisonCorn Price

Flex Lease

Net w/Flex Lease

Net w/Cash Lease

$3.00 $150 -$107 -$157$4.00 $160 $8 -$32$5.00 $200 $93 $93$6.00 $240 $177 $217$7.00 $280 $262 $342



39

Flex Lease Summary Different flex leases have advantages

and disadvantages. Needs to be understandable to

landlords. Need to understand the risk-reward

tradeoff. Not for all landlords.


40

Let’s Look at Your Examples

Switch over to Flex Decision-Aid


Questions?

Leasing Game Intro to Flex Leases Henderson County January 12, 2011

Documents

Transcript of Leasing Game Intro to Flex Leases Henderson County January 12, 2011