Farmland's inflation-hedging characteristics

Key takeaways

• Farmland demonstrated its inflation-hedging potential by producing positive inflation-adjusted real returns over the past two years: The correlation between inflation and farmland returns remains dynamic.
• Agricultural production cost categories markedly increased, but higher prices and stable output led to record-setting total U.S. farm revenue, despite high inflation.
• Crop types are affected by inflation differently due to varied structures of production cost components: In 2022, row crops fared better than select permanent crops, with a number of market factors determining crop-specific financial performance.
• Unlike other asset classes whose value may depreciate over time, farmland can retain its value, and with inflationary pressures forecast to ease, the outlook for farmland investors remains bright.

Farmland is often regarded as a real asset class that provides investors with attractive risk-adjusted returns, portfolio diversification benefits, and access to natural resources with sustainable management practices while providing positive performance during inflationary periods. In today’s unsettled and highly dynamic macroeconomic environment, especially as inflation remains elevated, some investors may look to farmland for potential stable returns and protection against inflationary pressure.

U.S. farmland fared well in inflationary environments

Farmland’s inflation-hedging potential has been recently substantiated by its ability to produce positive inflation-adjusted real returns as inflation soared: Annual inflation in the United States averaged 6.8% over the past two years, quadrupling the previous ten-year average inflation rate of 1.7%.¹ U.S. farmland, as represented by the National Council of Real Estate Investment Fiduciaries (NCREIF) Farmland Index, generated positive and increasing total returns during 2021 and 2022. In comparison, other asset classes saw considerable performance swings during the same period, generating negative nominal returns in 2022, a year of tightened monetary policies and elevated inflation. Resilient and strong performance by farmland investments over the past two turbulent years demonstrates the case for the asset class’s portfolio diversification and inflation-hedging benefits.  

Source: NCREIF, Macrobond, as of December 2022. Returns for farmland, timberland, and commercial real estate are represented by the NCREIF indexes for the respective asset classes. Large-cap stocks are represented by the S&P 500 Index. International stocks are represented by the MSCI EAFE Mid and Large Cap Indexes. Government and corporate bonds are represented by IA SBBI® US LT Govt TR USD and IA SBBI® US LT Corp TR USD from Ibbotson Associates. Index definitions are included in the disclosures below. It is not possible to invest directly in an index. Past performance is not indicative of future results. 

Positive correlation may provide protection

The correlation between investment returns and inflation is a key indicator of the potential inflation-hedging capability of an asset class where a positive correlation indicates that investment returns may rise along with inflation. Rolling analysis shows that the correlation between NCREIF Farmland Index returns and U.S. inflation has been dynamic and overwhelmingly positive, and readily apparent during the late 1990s, the entire first decade of the 2000s, mid-2010s, and early 2020s. The most recent positive rolling correlation (5-year rolling periods ended 2020–2022) reinforces farmland’s apparent inflation-hedging capacity. Nevertheless, the correlation pattern hasn’t been consistently positive and has turned negative during a few brief periods over the last 27 years. 

Source: NCREIF, as of December 2022; U.S. Bureau of Labor Statistics, as of February 2023. CPI refers to the Consumer Price Index. Index definitions are included in the disclosures below. It is not possible to invest directly in an index. Past performance is not indicative of future results.

The two instances of negative rolling correlations (2011–2013 and 2017–2019) can be attributed to the different directions taken by farmland returns and inflation rates. The economic recovery after the Great Financial Crisis (GFC) was considered lackluster, with only modest economic growth and inflation below the U.S. Federal Reserve’s desired 2% target² during five of the first seven post-GFC years. Meanwhile, farmland returns improved significantly during that period, especially from 2011 to 2015, when the NCREIF Farmland Index posted double‑digit percentage annual returns for five consecutive years. The difference between the robust performance of farmland and a modest and extended economic recovery contributed to the sporadic negative correlations; therefore, from an investor’s perspective, a negative correlation may be interpreted as the asset class’s ability to outperform otherwise moribund growth in the broader economy during a period of below-target inflation.

Short-term production costs poised to ease; long-term challenges persist

Farmland’s inflation-hedging features can be attributed in part to farmland's finite availability and the food products it produces: As the economy grows, demand for agricultural products increases, driving up farm product prices and helping to mitigate input cost inflation. Like many other aspects of the economy, agricultural production faced heightened cost pressures in the aftermath of the global pandemic. U.S. inflation surpassed 2.5% in March 2021 for the first time since the beginning of the pandemic. Since then, major agricultural production cost categories have experienced marked increases and, as a result, total production expenses increased 19% for U.S. farmers from 2021 to 2022.³ Responding to increased demand, supply constraints, and increased input costs, prices of farm products also increased: From March 2021 to December 2022, the overall price levels of farm products increased more than 40%, represented by the changes in the Producer Price Indexes for farm products, partially offsetting rising cost pressures. The ability of farm goods prices to provide relief from higher production costs encouraged farmers to continue growing crops, with the combination of higher prices and stable output leading to a record-setting total U.S. farm revenue in 2022, despite multidecade high inflation rates.

Inflation effects vary by crop type

The impact of input cost inflation differed across crop types due to the varied structures of production cost components. Material inputs (variable costs), such as fuel and chemicals, experienced more pronounced cost increases than long-term capital costs (fixed costs), such as machinery and equipment, during the 2021/2022 inflationary period. Therefore, the operating cost impact varied considerably across crop types; for example, the costs of material inputs account for more than 60% of total operating costs for row crops, such as corn and soybeans. While these material inputs saw rapid and sizable increases in 2021/2022, their price levels have also since declined more markedly from peak levels; fertilizer costs, for instance, have declined nearly 40% since peaking in April 2022. On the other hand, production costs for permanent crops tend to be skewed toward cost categories that have experienced more structural and long-term increases; for example, about 75% of commercial apple production’s operating expenses are associated with labor and services.⁴ While costs in these categories exhibited less volatility in the recent inflationary period than material inputs, they’ve steadily trended higher at a more consistent pace and aren’t expected to see meaningful moderation in the future. Efficient operations and economies of scale are key to managing these long-term cost pressures. 

Crop-specific market factors play a key role

In addition to macroeconomic factors, the effect of agriculture-specific market movements on returns tends to depend on crop-specific factors, outweighing inflation effects. Changes in crop revenue in 2022 over 2021 for various crop types demonstrate that while overall crop revenue increased nearly 20% despite high inflation, receipts varied by crop type: Corn and soybean revenue increased 25% and 30%, respectively, in 2022, while tree nuts experienced revenue declines as the fruit and nut sector saw flat growth in cash receipts. The drivers behind this varied financial performance indicate root causes beyond inflation, as corn and soybeans benefited from robust export demand in the past two years in addition to recovering domestic demand coming out of the pandemic. Global conflicts that restricted supplies from other countries, the temporary spikes in demand from China, and recovered yields collectively contributed to higher prices and row crop cash receipts in the United States. On the other hand, almonds faced downward pricing pressure due to high stock levels, attributed to logistical challenges slowing shipments, resulting in high inventories despite declining production and, therefore, weighing on total revenue. Pistachio prices fared better than almonds despite global logistical disruptions, yet experienced total revenue declines due to 23% lower yields for the 2022 crop.⁵ These market factors played key roles in determining crop-specific financial performance.

U.S. farmland can offer stability and value protection

In addition to inflation hedging, another key attribute attracting investor interest in farmland is its capacity to preserve value: Unlike other asset classes whose value may depreciate over time, land-based natural asset classes such as farmland may retain their value. As a tangible and productive asset that meets a basic need and can generate income through agricultural activities, regardless of the inflationary environment, farmland investments can offer a valuable source of stability and security. U.S. farmland values have been resilient against downward pressure, with land values appreciating in all but seven years in the past five-plus decades. U.S. institutional farmland investments, as represented by the NCREIF Farmland Index, have generated an annual average land appreciation return of 4.1% since the index’s inception in 1991, significantly outpacing the average inflation rate of 2.5% during the same period. Overall, farmland's value-preserving capacity makes it an attractive option for investors looking for a stable, long-term, low-risk investment strategy.

Farmland remains attractive to many long-term investors

Looking forward, with inflationary pressures forecast to ease, the outlook for farmland investments could remain bright. As the world gradually recovers from the production and logistical disruptions resulting from the pandemic, the recent easing of global supply chain disruptions and constraints has enabled global producers to begin moving agricultural products more quickly. Markets are already starting to demonstrate an acceleration in positive shipping momentum; for example, U.S. almond and pistachio exports experienced double-digit percentage increases in recent months, leading to year-over-year growth in volume and more balanced markets.⁶ The Chilean cherry industry is expected to register a record-setting year for export values, as China’s ports fully reopened and valuable farm goods begin to move more freely.⁷ Manulife Investment Management believes positive market factors, together with the long-term value-preserving characteristics of farmland, continue to highlight agricultural investments as an attractive option for investors looking to hedge against inflation while also generating stable long-term returns.

A version of this article originally appeared in Global AgInvesting.