The impact of farmland price changes on farm size, financial structure enterprise choice

This research develops a theoretical framework within which the impact of farmland capital gains and losses on agricultural production, finance, and enterprise choice decisions can be analyzed. A preliminary test of this theoretical model is conducted using a deterministic dynamic programming model of a central Iowa farm firm in the period 1970-1984. Though the theoretical model was developed to examine the impact of farmland price changes, it may be extended to analyze decisions involving any durable assets which may earn capital gains or losses;The model suggests that real estate capital gains provide incentives to increase farm acreage, incur greater debt to purchase the appreciating land, and decrease holdings of more liquid nonland assets. Capital losses tend to have the opposite effect because decisionmakers seek to economize on land use to avoid the capital drain. Limited availability of land, the inability of many farm decisionmakers to attract outside nonfarm equity, and adjustment costs may dampen or even eliminate these effects in some cases, but the empirical work suggests that in recent years conditions are such that capital gains effects could be observed. The theoretical model suggests that if borrowing against unrealized capital gain is permitted, land price risk may force decisionmakers to build added financial flexibility into their operations by reducing farm acreage, cutting debt use, and increasing holdings of liquid, nonland assets;The empirical model suggests that the asset and financial restructuring on U.S. farms in the 1970s toward greater land investment, more debt, and smaller holdings of nonland assets was a response to the large farmland capital gains of the period. This research draws a direct link between land price increases of the 1970s and farm financial stress of the 1980s. With greater land investments, more debt and fewer liquid assets, many farmers were financially vulnerable in the situation of low farm income and dropping asset values that they encountered in the mid 1980s. The study suggests that in the environment of falling land prices experienced in the 1980s, farmers in general will seek to hold less land and reduce debt loads. In this context, the farm financial crisis of this period can be seen as a set of problems encountered in moving from a period of large farmland capital gains to a period of stagnant or declining land prices.