The credit crisis is not the first to befall the British property industry, and farmland values have weathered the storm before. Here, Brown & Co‘s Tom White suggests they will buck the trend again

The credit crisis, and the end of the recent property boom, was an inevitable consequence of the behaviour of the banking industry, which had thrown away traditional lending criteria and instead paid bankers and brokers on commission without regard to sound financial principles.

In the face of a recession triggered by the property slump we should analyse whether a downturn in the economy will have a negative impact on farmland values. Certainly demand from lifestyle buyers of residential farms will lessen as bonuses are cut. But the market for commercial farms has often, historically, moved contracyclically to the mainstream property market.

Events, Dear Boy
The prime factor determining the value of land has always been agricultural profitability. However, there is also the “Harold Macmillian Factor” – the impact of “events, dear boy, events”.

After the UK joined the European Economic Community in 1973 farm profitability improved and land values escalated. City institutions poured capital into land investment during the “leaseback boom” in a decade of economic recession, high inflation (peaking at 20%), the Winter of Discontent in 1978/9 and unemployment rising to 3.5m.

During this turmoil land was seen as a hedge against inflation and rising farm profits allowed rents to rise, resulting in good investment performance. However, as the economy recovered, and both residential and commercial property boomed during the 1980s, farmland values in Lincolnshire more than halved between 1984 and 1986 when wheat prices collapsed.

A collapse in property prices followed at the end of the decade after the Chancellor unwisely announced double mortgage tax relief would be removed on the 1 September. A frenzy of buying in an already overheated market came to an abrupt halt, reminiscent of current circumstances. When the bubble burst potential buyers withdrew from the market when they perceived they could buy cheaper tomorrow.

Black Wednesday
The housing market slumped, thousands of households were in negative equity, repossessions rose and the Stock Market crashed. The crisis culminated on 16 September 1992 when the Chancellor Norman Lamont announced the UK’s exit from the Exchange Rate Mechanism. Black Wednesday for him and most of the economy, but “Golden Wednesday” in the history of British farming. The McSharry reforms of the Common Agricultural Policy, a year earlier, had linked support payments to the euro, as a result of which farm profits improved and land values rose.

During the mid-1990s British farmers benefited from the weak pound but also the impact on world food prices of the booming Tiger Economies of the Pacific Rim. Wheat was £130/t and sugar beet £37/t. Speakers at farming conferences at that time talked of the inexorable rise in demand for grain from the Far East as populations of China, Thailand, Indonesia and Malaysia drank more beer and, with increasing affluence, converted from rice to a meat and poultry diet. Does this sound familiar to readers?

An abrupt end to the boom years of those Pacific economies, and a strengthening pound, resulted in a significant fall in wheat price. While farm profits fell, green shoots were emerging as the property market gathered momentum for the sustained period of growth, which has only recently come to an abrupt end.

Property boom
The farmland market is, of course, complex. While a commercial arable farm might have remained unsold in 2005 through lack of demand, city bonuses were making a significant impact on farms with residential and amenity benefits. The opposite might now apply. Institutional funds have reappeared as a buyer of farms in response to excellent investment performance since 2006. The Investment Property Databank calculates total returns from rural property in 2007 at 25.7%, with comparative data for commercial property at -3.4%, residential property 17%, equities 5.3% and bonds at 6.4%.

Though there are now indications that buyers of UK land may be less aggressive, and that there might be a correction after trebling of land values, I do not believe that the fundamentals have changed. Certainly farm costs have increased and wheat price has fallen back from earlier in the year. However, £6000/acre is less, in real terms, than land sold in the late 1970s at £2250/acre. A significant upward correction was overdue.

There will inevitably be cycles in the value of farmland. However, assuming the retention of existing fiscal benefits, farm land will remain in demand.