Land Expensive, Production Low, Profits Dwindle

Who Am I?
“I am the basis of all wealth, the heritage of the wise, the thrifty and prudent. I am the poor person’s joy and comfort, the rich person’s prize, the right hand of capital, the silent partner of thousands of successful people.

I am the solace of the widow, the comfort of old age, the cornerstone of security against misfortune and want. I am handed down through generations, as a possession of great value. I am the choicest fruit of labour, the safest collateral and yet I am humble. I stand before every person bidding them know me for what I am and asking them to possess me.

I am quietly growing in value through countless days. Though I may seem dormant, my worth increases, never falling, never ceasing. Time is my aid and the ever increasing population adds to my gain. I defy fire and the elements, for they cannot destroy me.

My possessors learn to believe in me and invariably they become envied by those that have passed me by. While all other things wither and decay, I alone survive.

The centuries find me younger, always increasing in strength. All oil and minerals come from me. I am the producer of food, building materials and the home to every living thing. I serve as the foundation for homes, factories, banks and stores. I have not been produced for millions of years yet, I am so common that thousands, unthinking and unknowingly, pass me by”.

“Who am I? I am Land.”
The above text was on display in one of the offices of a land investment. It could easily be re-titled “The Farmers Creed in that it reflects the intrinsic value that is attributed to owning land and farmers have been some of the main beneficiaries of accumulating land over the decades. Based on this experience, the decision to purchase land is often underpinned by the expectation that the intrinsic value of land will cause its price to continue to rise into the future. Consequently, the economic hurdle before committing to a land purchase often relates more to “affordability rather than an expected rate of return from the operating profit derived from the extra land.

Economy of scale is one of the key competitive advantages of Kenyan Cereal farmers and has been an important driver of productivity gains in this sector. The benefits of scale are reflected in the desire by family farm businesses to continue growing by purchasing additional land as it becomes available.

Over the past decade, land prices have grown at a much faster rate than operating profits. This has made additional purchases of farm land less affordable relative to the income that land is capable of generating. If this trend is to continue, it will slow the rate at which family farms are able to expand through land purchases because it will take longer to accumulate sufficient equity through retained profits and we will have reduced capacity to service debt.

With these trends in mind, there is need to rethink the structure and the way to utilise capital resources. There is need to identify opportunities for Kenyan farm businesses to make better use of their own resources and to find strategies to allow these businesses to cope with the reduced affordability of farm land.

The rural land is a combination of two businesses: farming and a real estate business. We must start thinking of these as two separate activities and begin analysing the performance of each as stand alone businesses. This is essential if we are to be sure that each activity is contributing to our overall financial position in its own right.

Around the world, farm businesses have evolved to capitalise on the relative strengths of their operational or real estate activities and the following recommendations are based upon my observations of these businesses.

Leasing land allows you to lever the potentially high returns from an operating business. The short term nature of leasing arrangements in Kenya has meant the focus is on short term profits which often come at the expense of medium to longer term returns.

Basing lease arrangements on a share of profit approach would give both parties the confidence to agree to longer term deals which in turn would lead to a focus on longer term returns and better management of the land asset.

We need to focus on the scale of our operating businesses and make sure that we are operating scalable units.

Furthermore, when expanding our operating businesses, we need to work within multiples of scalable units if we are to avoid the large costs associated with diseconomy of scale. We need to benchmark the performance of our key operations and use this as the basis for determining optimum scale.

Learning to work with other people through joint ventures offers an opportunity to grow our operating businesses without tying up capital in additional farm land. Being prepared to work in a joint venture would also overcome the current lack of land available for lease in Kenya. Having a clearly defined set of procedures for startup, ongoing operations and for unwinding the venture is critical.

We should continue to buy farm land when suitable opportunities arise. However we should not assume that we should farm that land ourselves simply because we bought it. This is especially the case if it means running an operating business that is not at optimum scale. Being prepared to own land but not operate it also opens the door for farmers to benefit from diversifying into different geographical locations and also into different types of real estate investments.

Attracting external capital to invest in agricultural assets will be of benefit to existing operations only if it increases the amount of land available for lease. If we are to attract such capital away from other investments, we need to look at standardising our performance reporting and establish a benchmark index to measure the performance of agricultural investments.

These measures would allow more accurate assessment and comparison of existing investments and provide a guide to historical performance for those considering an investment in the agricultural industry.

There are opportunities to make more efficient use of the capital we employ in our farm businesses and the first step in taking advantage of these opportunities is to recognise the two distinct activities that make up the business of farming in Kenya.

Leasing land offers the opportunity to achieve higher returns on capital compared to the situation where the land is owned by the operator. Similarly, the annual operating profit can be divided to show a return to the land assets and also to the operating assets.

Leasing land effectively allows a farmer to isolate the return on operating assets and dedicate his resources to this activity rather than diluting his returns by tying up capital in farm land.

However, the success of this model is contingent upon the return to total assets exceeding the rental paid for the farm land. If the amount of total profit halve, then the return to operating assets would fall from 16.6% to 1.9%.