Commercial real estate is facing high headwinds — yet this one overlooked offshoot is still overperforming

Meanwhile, the regional banking crisis in the U.S. could trigger what Moody’s Analytics calls a “doom loop.” Small regional banks are 4.4 times more exposed to CRE loans, which means the liquidity crunch could start having an impact.

All together, prices for more traditional commercial real estate sectors have dropped for the first time since 2011, with some hedge funds and investment banks worried about even more pain ahead.

Yet, despite headwinds, appetite for real estate remains high. As traditional real estate sectors underperform, investors are adapting — and one often-overlooked segment of the commercial real estate sector seems to be outperforming.

The Federal Reserve Bank of Chicago's quarterly survey found that high-quality farmland was 15% more valuable in 2023 than the same period last year. That marks the eighth consecutive quarter of year-over-year growth.

Farmland’s relative resilience could highlight why CRE investors should be paying closer attention to this niche asset class.

Farmland — a historically defensive and uncorrelated asset

During economic turmoil, many investors go on the defensive — preserving capital gets higher priority than yield hunting or capital appreciation. Farmland, however, could be in a position to deliver all three.

Farmland’s unique characteristics have made it a traditionally stable asset class that may attract defensive investors in 2023. Many of its characteristics, such as inflation-linked returns and passive income, are similar to regular real estate. However, farmland tends to have an advantage over other real estate when it comes to stability.

Historically, farmland has had low volatility while delivering attractive absolute returns. Between 1992 and 2022, the standard deviation of farmland prices was 6.64%, according to data collected by farmland investment manager FarmTogether. That’s 98 basis points lower than private real estate and only 104 basis points higher than bonds over the same period. The asset was also significantly less volatile than publicly listed real estate and equities.

Even gold experienced more volatility than farmland over this period. Based on the LBMA Precious Metal Prices index, gold had a volatility (or standard deviation) of 14.52% over this 30-year period. That’s more than double the volatility of farmland for an asset class that is traditionally considered a safe haven.

Source: FarmTogether — Introduction to Farmland Investing

Like traditional real estate, farmland’s value comes from two sources: income and capital appreciation. In farmland’s case, income is generated from selling crops, while capital appreciation is driven by structural factors such as population growth and the increasing scarcity of arable land.

Powered by these fundamental trends, farmland’s total return has been net positive almost every single year since 1992. Even in challenging times, like the fourth quarters of 2001 and 2019, losses were only 0.1%. Over the past three decades, farmland’s average total annual return has been 10.71%.

Source: FarmTogether — Introduction to Farmland Investing

However, farmland’s historically attractive risk-adjusted returns are only part of the equation. The other aspect of farmland investors may find appealing is its historic lack of correlation with other asset classes.

Between 1992 and 2022, farmland had a positive but low correlation with private real estate of 0.42, according to statistics collected by farmland investment manager FarmTogether in its paper "Introduction to Farmland Investing." That means the headwinds currently faced by many segments of the CRE market have not impacted farmland values or performance. Farmland had negative correlations with US-based stocks (-0.05), bonds (-0.17) and REITs (-0.01) during the same time frame.

Farms have also been somewhat correlated to the rate of inflation. From 1992 to 2022, U.S. agricultural land values had a positive correlation of 0.17 with the Consumer Price Index.

Low correlation — coupled with historically low volatility and stable returns over extended periods of time — have made farmland an attractive choice for investors looking to diversify their portfolio. This is why sophisticated investors like Bill Gates, Ted Turner, Jeff Bezos and Warren Buffett have allocations to this asset class.

The Oracle of Omaha is very familiar with this niche asset class. Buffett purchased a farm a few miles north of his native Omaha in 1986 — an investment in which he saw “no downside and potentially substantial upside” — and his son Howard Buffett spent half his life as a farmer.

How a 1031 exchange can make a good deal better

Another concept Buffett is very familiar with? Tax deferrals. The billionaire investor has compared tax deferrals to interest-free loans from the government. And, like traditional real estate, farmland, under certain circumstances, may qualify for a tax deferral under the 1031 exchange option.

A 1031 exchange, also known as a like-kind exchange, is a mechanism that enables the potential to defer realization of capital gains, depreciation recapture and other federal tax liabilities on an investment property when it is sold – as long as another "like-kind property" is purchased with the profit gained by the sale of the first property.