Measuring farmland and farm building values
Measuring Farmland and Farm Building Values
Real Estate Values Were Revised
In 1991, we revised our procedure for estimating farm real estate values. Because 1989 and 1990 estimates represent forecasts indexed from the 1988 Bureau of the Census bench mark values, 1989 and 1990 State and U.S. estimates were revised according to this procedure. Newly available data show that some relations among economic variables can no longer be expected to hold. Farm building values have a stronger influence on farm real estate value than originally thought. Until 1990, we used Bureau of the Census farm real estate estimates as bench marks and our annual farmland value survey as bench mark movers for intercensal years. We assumed we could measure the annual percentage changes in the value of real estate with the annual change in farmland. The Bureau of the Census estimates farm building values less frequently than real estate values, but the existing estimates reveal major changes in the components of farm real estate. When we compared the 1980 Bureau of the Census estimates of farm building values to the recently released 1989 value, we discovered building values had risen from 14 to 21 percent of the total real estate value. We used this information to revise the procedure by which we make farm real estate estimates. The 1990 and 1991 farmland value surveys provided the 1990-91 percentage change in land values. We estimated percent changes in the building component of farm real estate value using secondary information. Thus, we derived our 1991 farm real estate estimate as the sum of movements of each of the two components.
Why Do Changes in Land and Building Values Diverge?
Changes in land and building values likely reflect different impacts from the same economic forces. At times, values may move in opposing directions and by different percentage amounts. However, analyses of historical data show that relative movements are systematic and predictable. That is, we can track movements in both components provided we can identify how one component–for example, land values–moves. Land and building values likely equal the present discounted value of returns investors anticipate from asset ownership. So long as anticipated land and building income streams change by the same percentage amounts in response to economic forces, land and building prices will maintain their relative levels. At times, anticipated income streams from land and buildings, and therefore values, are identically affected by economic forces. Some of the costs of owning land are identical to the costs of owning buildings. For example, loans for farm real estate typically cover land with the existing improvements, including buildings. Therefore, the interest rate implicitly is equal for both the land and buildings. In some areas, landowners pay ad valorem taxes on their real estate, again implying equal tax rates for land and buildings. Federal income tax rates also apply equally to income from land or buildings. Although land and buildings share many factors affecting returns and ownership costs, there are two reasons to suspect that investors’ anticipated income streams will not move together in percentage terms. The market value of these assets can move at different rates and possibly in opposing directions under some conditions. Two factors induce investors to revise their anticipated income streams by different amounts. First, building ownership costs (as a percentage of value) are generally larger than land ownership costs. Increases, for example, in anticipated inflation rates lower land ownership costs more than building ownership costs and the income streams move by different amounts. The second factor, the Federal tax code, reinforces the divergence in anticipated income streams created by changing inflation rates. Annual costs of maintaining land and buildings differ. Costs for land are significantly less than for buildings. (Maintenance costs strictly for land do not include costs of installing and maintaining permanent land improvements such as terraces, drainage systems, fences, or irrigation.) Buildings do physically wear out with use. Maintaining their productive capability requires some periodic repairs and maintenance. Thus, building ownership costs are likely to exceed land ownership costs as, for example, a percentage of value. To help keep this cost difference in mind, we refer below to land as if it were a non-depreciable asset (even though it is not an infinitely-lived asset) and to buildings as depreciable assets. Depreciation and inflation together cause depreciable and non-depreciable asset prices to diverge. If potential investors anticipate an increase in the inflation rate, they are likely to revise their expectations of income from land and building ownership. Those revisions will cause the price of both land and buildings to rise, but not at the same rate. Most empirical studies of the effects of inflation on the cost of financing capital purchases indicate that, after accounting for Federal tax-deductible interest payments, the cost of financing increases less than the increase in inflation. Asset owners benefit from inflation because it reduces ownership costs relative to asset values. Anticipated inflation can cause asset prices to rise at different rates because the farmland and building ownership costs are different. Because land ownership costs, as a percentage of land price, are generally less than building ownership costs, as a percentage of building price, an increase in inflation rates has a relatively larger cost-reducing impact on land values. If investors see land costs falling relatively more than building costs, they will also expect the rate of return to be greater on land than on buildings. The differential rates of return should spur investment in land and diminish investment in buildings. In this case, land prices must rise relatively faster than building prices. Conversely, land prices will fall faster than building prices when inflationary expectations decline. The Federal tax code also causes depreciable and non-depreciable asset prices to diverge when investors expect increasing inflation. The tax code allows a deduction for depreciation of farm buildings (excluding the non-business sections of owner-operator dwellings). Land, net of improvements, is not depreciable for tax purposes. When anticipated inflation rates rise, the tax code induces investors to revise downward their expectations of income from building ownership because the historic purchase price rather than the current replacement cost determines the size of deductions. The inflation-adjusted value of the deduction diminishes with increasing inflation. Suppose investors seize every opportunity for profitable investment. Then, after-tax rates of return should be the same for all assets, regardless of the ability to deduct depreciation expenses. Increasing inflation means that the value of depreciation deductions diminish, so long as historic purchase prices determine deductions. Equivalently, building owners receive smaller benefits from ownership. Maintaining the rate-of-return equality in the face of reduced benefits from building ownership is possible only if land and building prices diverge.
What Was Done To Estimate Land and Building Values?
Empirically, we found a strong correlation between (anticipated) inflation rates (measured as a 3-year moving average of the GNP deflator) and the ratio of land to building value for the United States and the 10 farm production regions. The findings support the argument that inflation has different consequences for the expected net-of-taxes income streams from land and buildings. When the different income streams are discounted, impacts vary on imputed values for land and buildings. Those values move at different, but now predictable rates. We used the statistical relationship between inflation rates and the land-to-building value ratio to estimate building value changes. In summary, we used three pieces of information to estimate real estate values: the Bureau of the Census estimate of the value of farm real estate (the bench marks for land and for buildings), the year-to-year percentage change in farmland values (estimated from our annual land value survey), and the estimated land-to-building ratio (derived from the relation between inflation rates and the ratio). Thus, we applied two movers to the Census bench marks. The two separate movers allow us to estimate separately land and building values. Further, because we use secondary information to estimate the ratio of land to building value (the GNP deflator), we can make estimates for earlier years. Tables 4 and 5 contain separate estimates for building and land values annually back to 1980. [Fred Kuchler and Patrick Canning] [Tabular Data 4 and 5 Omitted]
COPYRIGHT 1991 U.S. Department of Agriculture
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