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Farmland VS Residential Real Estate for Investment
Comparing the two assets.
Comparing the two assets.
Farmland isn’t a class asset of its own but belongs to the real estate investment class.
The real estate investment class is made of different asset classes.
The designation of these assets depends on the law in each country but broadly, they’re similar.
These asset classes are:
Residential real estate: real estate where people live.
Commercial real estate: malls, shops, etc.
Industrial real estate: buildings with production capacities (factories).
Special purpose: government buildings, schools, parks, churches.
Land: vacant land (currently not being used), undeveloped land (land that needs work prior to any type of development), and agricultural land (farmland, forestland, etc).
In this article, we will outline the differences and similarities between farmland and residential real estate.
1. The Nature of the Assets
Residential real estate is real estate where people live and sleep.
Houses and apartment buildings are essentially the two types of residential real estate one can invest in.
Long-term hotels or camping sites are not considered residential real estate, but commercial real estate.
Residential real estate can be bought or built. Should they choose the latter, investors must first buy residential land, then build a property on it.
It takes time due to the regulations to respect and the need to obtain approval from authorities.
Farmland is different. It’s just…land.
This land is managed and cultivated by a professional.
2. The Return of the Assets
Real estate earns income in two different ways.
The price appreciation.
The rent paid by the tenant.
Property price appreciation is an indirect type of return. For the investor to earn it, they would have to sell the property or use the property as collateral to borrow against.
The rent paid by the tenant is paid every month and ensures the investors with regular cashflows.
Farmland has the same sources of revenue. Sometimes though, an agreement is made with the farmer that the owner of the land will benefit from X% of the harvest in exchange for decreasing the rent.
In this way, the owner also shares the risks.
Farmland price appreciation and real estate price appreciation really depend on the country we’re looking at.
In the Netherlands, residential real estate has been appreciating (much) faster than farmland in certain cities (Utrecht, Rotterdam, Amsterdam).
In Romania, or Poland, farmland has been appreciating faster.
In Estonia, both real estate and farmland have been appreciating fast lately.
In terms of yield compared to the value of the land, residential real estate will yield a little bit more than farmland, but that also depends on where the farmland is located.
Farmland located in northern countries will not yield as much as farmland located in warmer countries, for example.
Depending on the price-to-rent ratio, farmland or real estate may be more advantageous.
3. The Risks of the Assets
This is where the differences begin to appear.
Residential real estate contains more risk than farmland.
The first risk is the risk of the real estate cycle.
Real estate works with debt, and the debt cycle lasts approximately eight years. That means that every eight years, there is a boom-bust in the real estate market (in theory).
This may jeopardize homeowners that rent out their houses to tenants and borrowed money against it.
As the value of the house decreases, the bank demands a quicker refund of the loan (depending on the jurisdiction, laws, etc).
The second risk is damage. Fire, flood, a tree falling on the property, tornadoes, are other risks that need to be taken into account and for which the owner needs insurance.
Then there is the risk of unpaid rents. While there aren’t any official statistics, it’s estimated that roughly 10% of renters fail to completely pay their rent.
Finally, there is the risk of damage to the property by the tenants.
Farmland, next to that, is a breeze to own.
The risks mainly concern weather and mismanagement.
Weather-wise, fire or flood can destroy the harvest but won’t prevent a subsequent harvest the next year (or the next harvest period).
Mismanagement is a bigger problem, as land pollution or land exhaustion is harder (and costlier) to fix.
However, both of those risks are extremely rare.
Most of the time, farmland owners visit their land once a decade, and let the farmer take care of it.
While farmland and residential real estate both increase in price, the rate at which they increase is different because it’s based on different economics.
Real estate is based, as we said, on the debt cycle. Farmland prices aren’t based on any cycles. They’re based on the supply and demand for land, and the food prices.
The more people are born, the more people eat, the more valuable farmland becomes.
Since the worldwide population keeps on increasing, the price of farmland will keep on increasing as well.
Many landlords are reluctant to deal with their tenants, so they leave it to an agency.
If not, landlords must be ready to solve their tenants’ problems. They must be ready to fix what’s broken inside the unit and compensate for any lack of energy or running water.
The apartment often needs a complete remodelling once tenants that remained for more than three years eventually move out.
When tenants do move out, landlords must find new ones, organize visits, diligently run background checks, answer questions, sign contracts, collect deposits, etc.
Every months, landlords must make sure that their rents have been paid, and must kindly remind tenants that didn’t pay it.
Farmland, next to it, is much easier. The state of the farmland is entirely taken care of by the farmer who pays his rent once a year.
This article outlines the differences and similarities between investing in real estate and investing in farmland.
Real estate is much more common but farmland has many advantages that real estate doesn’t have.
Finite supply, growing demand, and yearly appreciations are a few of them.
Interested to begin your farmland investment journey?
Join LandEx today and invest in high-quality Estonian farmland from €10.
Go to landex.ai to know more.