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Another Real Estate Bubble?

Another Real Estate Bubble?

In October of 2012, 80 acres of farmland in Iowa sold for $21,900 an acre. Fantastic news! Or is it? The record-setting sale became one of several examples demonstrating inflated land values in the Corn Belt and leading many to speculate that there may be a new real estate bubble growing in the Nation's heartland.

Throughout many of the Great Plains states (Illinois, Indiana, Iowa, Kansas, Missouri, Nebraska, Ohio, North and South Dakota) prices have risen by over 50%. In Nebraska, they've seen prices almost double over the past three years. And in Iowa prices have soared to over 80% resulting in land prices that some speculate to be overvalued by as much as 100%.

Booms like this in the past have resulted in rather tragic declines. From 1900-1919, for instance, farmland in the United States gained 70%. However, a rise in interest rates and slowed food imports after World War I saw land prices collapse and not recover for nearly twenty years. The Farm Crisis of the 80s had similarly devastating effects of which the farm industry has never fully recovered. While neither could be blamed on one singular event, inflated values were a shared trait and the recent trend demonstrated above creates justifiable concern for what may come.

Much of the perceived extravagance comes from fervent interest in commodities like corn and wheat. According to United Nations' estimates, the global population is expected to rise by roughly 25 million per year. The obvious and inevitable result is more mouths to feed and that growing demand for food, coupled with the increasingly scarce land on which to grow it, will logically create a rise in grain prices. While it is believed that investors make up only 1% of those vying for these opportunities — and even though institutional ownership is banned in states like Iowa — competition in this market remains stiff. Paul Ashworth of Capital Economics points out, "The states with the biggest gains in farmland values are notable for also being the nation's largest producers of corn and wheat. To some extent, the rise in farmland values in the Corn Belt and across the Northern Plains is a natural response to the prolonged rise in agricultural selling prices."

Since 1970, US farmland has outperformed both stocks and bonds. According to the NCREIF Farmland Index — a group that measures returns for agricultural properties bought as investments - US farmland returned 17.6% in 2012. In contrast, the Standard & Poor's 500 - the US benchmark index - returned 13.5% and the EAFE returned 14%. American Farm Investors expect farmland in the United States to continue to appreciate through 2021.

So what does all this mean? Well, for most of us not much. Ashworth says, "We do not believe that a bursting of this bubble would have any systemic risks for the wider financial system. Nevertheless, a slump in farmland prices in the Corn Belt could hit some small community banks very hard and it would be devastating for the farmers involved."

Because farmland ownership is more concentrated than homeownership and because its value is roughly ? that of residential, then any speculation or fear about a new real estate bubble might me much ado about nothing.

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