December 4, 2017

SETTING UP FLEXIBLE LEASE AGREEMEMTS

A growing number of farm operators and landlords are considering a “flexible cash lease” rental agreement as an alternative to straight-out cash rental rates that may be difficult to “cash flow” for 2018. A typical “flexible lease” allows the final cash rental rate to vary as crop prices and/or yields vary, or as gross revenue per acre exceeds established targets. The use of a flexible cash rental lease is potentially fairer to both the landlord and the farm operator, depending on the situation, and how the flexible lease is set up.

A “true” flexible cash lease allows for the landlord to receive additional land rental payments above a “base” land rental rate, if the actual crop yields and/or market prices, or the gross revenue per acre, exceed established “base” figures. A “true” flexible cash lease would also allow for the “base” rent to be adjusted downward, if the actual crop yields and prices, or revenue per acre, fall below the established “base” figures.

Most flexible leases have been modified in recent years, and only “flex” upward with added rental payment to the landlords, if the “base” crop yield and/or prices, or revenue per acre, are exceeded. The modified “base rent plus a bonus” approach is acceptable if the “base” cash rental rates are kept within a reasonable range. If the “base” rent is set too high, above breakeven levels, resulting in a “loss”, it is very difficult for the producer to recoup any of those losses with a flexible lease. There are many variations of flexible land rental leases in existence, some that are very workable, and some that do not work as well. In most “flex leases”, one-half of the “base rent” is paid prior to planting, and any bonus or additional rents are paid with the second half or final rental payment.

Flexible leases can work well for newer or younger farm operators that may not be able to afford the higher cash rental rates for farm land. Most Ag Lenders support of the use of flexible leases as a way to reduce financial risk in a farming operation. A flexible lease makes it easier for producers to utilize risk management tools such as crop revenue insurance policies and forward pricing of grain. A flexible lease, with a fair base rental rate, allows landlords the security of a solid base rental rate, while having the opportunity to share in added profits when crop prices and/or yields exceed expectations. Flexible leases are a nice alternative for Landlords that want to continue to work with long-standing farm operators, without setting cash rental rates too high to keep the current tenants.

One of the biggest challenges with flexible cash rental leases is determining the “base rent” per acre, which in most instances is the minimum rental rate for the year on a land parcel. The “base rate” should be adjusted upward or downward annually, depending on changes in crop price expectations, average crop yields, or the projected “break-evens” for crop production for the coming year. The best way to establish the “base” rental rate is to have a rental rate per acre that is agreeable to both the landlord and farm operator, with an established method of calculation. There are several different ways to approach the determination of a “base rental rate”.

Many flexible cash leases require a “base yield” of some type. The easiest method to get a base yield is to use the crop insurance APH yield, which is updated annually. Another alternative to determine a base yield for a crop could be using the producer’s actual verified annual production on a farm, which is averaged over a period of years. Actual yield calculation on the farm for a given year can be determined by warehouse receipts, settlement sheets, scale tickets, bin measurements, grain cart weigh wagons, yield monitors, or any other method that is acceptable to both the landlord and farm operator.

The “base price” for a crop could be the projected harvest (October) price at the local grain elevator or processing plant for that crop on a specified date prior to planting (ex. – March 1 or April 1 for corn and soybeans), and the final price is the price for that crop at the same location on a specified date in the Fall (ex. — October 15). In some instances, a weekly or monthly average price at the local level from planting to harvest is used to determine the final price. Whatever method is used to determine both the “base” and final prices should be consistent, using the same grain elevator or processing plant as a source for the local grain price.

With the occurrence of much higher crop input costs in recent years, some flexible cash leases have been modified, and are now based on gross revenue triggers that exceed the cost of production, rather than on crop yield and price triggers. In this type of lease, the landlord only receives additional cash rental payments beyond the “base rent” when the final gross revenue per acre (yield x price) exceeds the established cost of production for the year. Typically, the added “flex” rent payment to the landlord would be a set percentage of the added gross revenue per acre above the established cost of production per acre, which is usually around 30-35 percent for corn, and about 35-40 percent for soybeans, with a “maximum” rental rate per acre.

Just as with crop yields and prices, determining the established cost of production for a crop for the year can be a challenge. Some possibilities would be to use cash flow statements for the year prepared by a farm management advisor, ag lender, or the producer themselves. Many Universities and farm management associations have average cost of production data available. There also probably needs to be allowances in a flexible lease to allow for added costs or expenses due to weather or emergencies.

There are many variations to setting up a flexible lease agreement between a landlord and farm operator, including using yield only, price only, or a base crop revenue compared to a harvest crop revenue, with or without using cost of production, and many more. The big key, regardless of the flexible lease agreement, is that both the landlord and tenant fully understand the rental agreement, and the calculations that are used to determine the final rental rate. It is also very important that flexible lease agreements, as well as all land rental contracts, be finalized with a written agreement. Successful “flexible cash lease agreements”, just as any other long-term cash rental agreements, have always involved cooperation, trust, and good communication between the farm operator and the landlord.

Kent Thiesse, Farm Management Analyst, has prepared an updated Information Sheet titled : “Flexible Lease Agreements for 2018”. To receive a free copy of this Information sheet and other land rental information, contact Kent Thiesse at: kent.thiesse@minnstarbank.com

Iowa State University has some very good resources on flexible cash leases and written cash rental lease contracts, including sample cash rental contracts, which are available on their “Ag Decision Maker” web site, which is located at: http://www.extension.iastate.edu/agdm/. The University of Minnesota has a computer spreadsheet titled “Fair Rent” which is an excellent resource for determining equitable land rental rates and evaluating flexible lease examples, and is available on the following web site: https://fairrent.umn.edu.

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Note — For additional information contact Kent Thiesse, Farm Management Analyst and

Vice President, MinnStar Bank, Lake Crystal, MN. (Phone — (507) 381-7960);

E-mail — (kent.thiesse@minnstarbank.com)