Handling rising rental rates
June 17, 2016
The summer grazing season is here, and as cow-calf producers haul pairs to pasture, 40 percent of the land acres being utilized are in rental agreements, according to the 2012 U.S. Census of Agriculture. Leasing land can be a challenge with rising costs, increasingly complicated rental agreements, and competition from other ranchers fighting for the same ground; however, there are some important things to keep in mind to avoid hassle and heartache.
"In this day and age, I usually recommend my clients rent their land on a per acre basis," said Jake Fischer, attorney for Swier Law Firm based out of Corsica, S.D. "It's the cleanest, simplest way to make sure all parties know exactly what they're getting into. More clarity means each party can better plan their budgets, and make better informed decisions knowing exactly what they're getting into with a lease contract."
So what should be included in a rental agreement? There are some essential terms that Fischer said should be included in any lease.
"Be sure to include a legal description of the premises, so both parties are absolutely clear what is rented and what is not," recommended Fischer. "The document should also include the length of the lease agreement, including clear start and end dates and the rate, including the total rental amount. The lease should also include a total rent payment, with specific payment dates to avoid any confusion over whether certain acres within a parcel are included in the rental agreement (say, some low areas or other areas that are not grazed, but are included within the parcel). It should also have a clear statement of which party controls the hunting rights and privileges; this can be especially important in states with big hunting tourism business. Finally, I also generally advise clients to include clear terms about renewal and/or non-renewal of the lease agreement. There are a lot of misconceptions about what happens at the end of a written agricultural lease — whether it automatically renews or automatically terminates. So, it's best to simply lay out, explicitly, what those terms are."
“In this day and age, I usually recommend my clients rent their land on a per acre basis. It’s the cleanest, simplest way to make sure all parties know exactly what they’re getting into. More clarity means each party can better plan their budgets, and make better informed decisions knowing exactly what they’re getting into with a lease contract.” Jake Fischer, attorney for Swier Law Firm in Corsica, S.D.
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These terms are incredibly important to be laid out in clear detail, particularly as rental rates increase. If the uptick in 2015 rental rates continues, producers can expect to pay more this year.
According to Shannon Sand, South Dakota State University (SDSU) Extension livestock business management field specialist, "Despite a downward change in feed and live cattle prices in 2015, cash rental rates still increased. The state average for pasture/ rangeland rental was $31.40 per acre in 2015 and $28.40 in 2014. That was a 10.5 percent increase in rental rates in just one year."
Sand has been collecting data for the SDSU Land Value Survey, which she says suggests an increase in pasture rates for 2016. The full report will be available at the end of June on igrow.org.
"While there appears to be an increase in pasture rental rates for 2016, it is unlikely to continue into 2017 based on commodity prices, continued decreases in farm and ranch income, and the volatility in the market," said Sand. "Given the volatility in the market and the decrease in market prices, it will be extremely important for producers to know their breakeven prices and to be very conscientious of the price they can afford to pay for leased ground in 2017."
Sand offered some advice for producers thinking of signing the dotted line.
"Do your homework," she said. "See what the local and regional rates are in your area. If you're the landowner, know your soil and your ground and what it can grow and what it can't. There is a wide range of prices, if you have good ground, good fencing, good water, you're going to be at a higher end range of rates. If you're renting the land, communication is going to be key to a successful relationship. Be open with the landlord to maintain strong relationships. Get a good idea of the capabilities of the land and negotiate the rates from there."
Fischer agreed that maintaining open lines of communication between landlord and renter is vital in any lease agreement.
"Clear communication is the biggest key to a successful lease agreement," he said. "If you see a potential issue coming, don't wait until it's too late to communicate with the other party. Most folks are simply looking for up front communication and are willing to work with one another to solve potential problems. However, avoiding a potential problem with silence usually ends up in the problem becoming an even bigger problem. Take the time to write a letter or an email, or make the phone call."
It can be hard to guess what problems might arise during the course of an agreement, but being proactive about those you know might come up can avoid potential problems. For example, fencing is an issue that will need to be discussed with both parties.
"Fence maintenance is something that can be negotiated," he said. "The terms might often differ based on the length of the lease. However, a typical arrangement would be for the the renter to provide the labor for fence maintenance and the landlord to provide the materials. Usually, fence maintenance and purchases should be mutually agreed upon by both parties before anything is done; this is also usually a provision within the lease."
Fischer listed other potential issues that might need to be included in the agreement.
"Make sure to be clear on when, and on what terms, the lease agreement terminates," he said. "Make sure you're clear on exactly which acres are included in the lease agreement. If there are any special issues concerning the ground being rented, mention them in the lease agreement. Maybe someone has an access easement over the property. Maybe there's a well that needs special care. Maybe a certain neighbor is particularly picky about the state of their adjoining fences. Make sure to at least discuss these issues before entering into a lease agreement and, at best, include these terms in the written lease agreement."
How short or long an agreement lasts is contingent on both parties, but Fischer said 3-5 years is the "sweet spot."
"Most grazing contracts are for a term of years, usually three to five years; I think this length of contract is right in the sweet spot," he said. "It allows the tenant some forward planning on what type of grass resources they're going to have over the next few years, which allows them to factor that into their business planning. For the landlord, they know exactly how much money they will be receiving on this land for a good period of time, without sacrificing flexibility over the long term. As a result, the landlord isn't locked in to a specific tenant or rental rate for too long a period."
With volatile cattle prices expected in the upcoming year, producers may have to have difficult conversations with their landlords about the rising rental rates.
"You've got to make a clear economic case to your landlord about why you can't afford the high rates of the past few years," said Fischer. "If you're locked in to a long term contract, there's not much you can do except attempt to appeal to your landlord's good sense. If you're negotiating a new contract, but can't afford a given rental rate, the same negotiations, with clear evidence, will be helpful. You should never enter into a contract you don't think you'll be able to afford. You're setting yourself up for more trouble in the future."
Sand said she expects producers to hang onto their land, for now, instead of letting leases go because of the downward market trend.
"At this point, producers still have some cash reserves from the last couple of years, so they will hang onto the land as long as they can," she said. "However, I could see some turnover happening next year as margins get tighter. Producers are really going to have to put pen to paper and figure out what really works and what they might need to let go of."
Before signing the dotted line, make sure to cross the t's and dot the i's. Fischer recommends having an attorney review any leases to avoid potential pitfalls.
"I would always recommend having an attorney review any leases or lease provisions you're not sure about," he said. "They can provide useful advice regarding the long term and/or legal implications of certain provisions within a given lease."