A Next-Wave Investment Thesis
‘Market sentiment’ refers to the emotions that underly supply and demand changes. These can offer early signs of the trends that will eventually surface in capital markets.
First, the Macroeconomic Setup
Actions and outcomes are notoriously lagged in macroeconomics. For example, a year in to the higher interest rate environment, much attention is being paid currently to the flight of capital out of high-risk agtech startups. Farmland may be next, but likely to a lesser extent.
While both have generated much investor interest in recent years, agribusiness startups and farmland investments are essentially two separate asset classes. The rise in interest rates has reduced investor capital in agribusiness quicker and deeper than farmland, because:
Farmland is a relatively stable long-term investment, and therefore more resilient. High interest rates have more immediate microeconomic, short-term influences on individual farm businesses (see below).
According to the excellently thought-out Agribusiness Matters, some agribusiness startups were grossly overvalued by a chase from investors that is no longer viable with today’s higher opportunity cost of capital.
Microeconomic Impacts
Higher interest rates can directly raise farm cash rents, borrowing costs, and carrying charges in commodity markets. The average grain farmer’s cost of production inches steadily higher in each of these areas, gradually over time.
Here are some ways that regenerative farmers might weather this trend:
Recently-announced new land investment fund Fractal will be offering discounts on borrowing rates for better practice adoption, such as no-till, cover cropping, and foliar in-season nitrogen fertilizer application.
In some regions, government payments are available to directly offset other annual production costs including seed (legumes and cover crops), nitrogen-release inhibitors, as well as some equipment needed for liquid fertilizer application and grazing on farmland, and setting aside marginal land for wildlife habitat and pollinator strips.
Adding grain storage capacity helps position farms to take advantage of wide carrying charges (price premiums for deferred delivery) in cash markets. Grain bins are low-risk, maintain resale value, and depreciate slowly.
Furthermore, maintaining control of physical grain will help farmers to monetize the field-level regenerative practice data and ecological outcomes. It buys time post-harvest for cleaning and separation, and to discern and negotiate the right contract terms for selling the associated data.
Where to Next
Interest rates appear poised to remain stable for the short to medium term. Forecasting further out involves factoring in uncertainty around politics, the performance of global trading infrastructure, overseas economic activity, and much more… however, long-term cyclical analysis still points to more increases than decreases in interest rates in the years ahead.
As the cost of production grinds higher along with interest rates, high-input, large-scale, heavily-leveraged farms will feel the pinch relatively more than small-scale commercial grain and livestock farms, on a per-unit and gross-margin basis. If they wish to, smaller farms may currently be well-positioned to capitalize on new market economies such as:
Scope 3 and ESG reports that will differentiate some market participants from others, in the eyes of their customers, investors, and regulators.
There are monetizable opportunities to drop some common tools like pre-harvest desiccation and crop insurance, and to manage the alternatives effectively with more hands-on management of every acre.
Access is open to new premium market segments that seek to support community-minded family farms and field-level data demonstrating measurable ecological improvements over time.
Favorable banking terms might also be negotiated in exchange for the above.
Maintaining the ability to earn carry in markets for stored commodity crops, and to monetize data attached to owned inventories for new buyers entering this space.
Summary
In conclusion, small-scale commercial grain farms appear to be the ‘better buy’ for farmland investors right now, as compared to large tracts with minimal historic field data. Missing-middle startups look similarly attractive. There is a noticeable shift in the high-level marketing messaging coming from new-age institutional investors, compared to venture capital communities of years past.
When the wave of ag investing first took hold, it mostly went into precision agriculture, imagery, and farm management apps; over time the focus turned also towards farmland and biological crop inputs. Investors and startup founders alike were enamored with groundbreaking, disruptive, scalable and lab-based innovations… more so than product-market fit, cash flow, customer revenues, and user engagement metrics.
At a minimum now, due diligence and the valuations applied to each piece of the global food system must come with greater scrutiny, due simply to higher interest rates. At best, farm business owners and investors will sink into the emotions behind the changes driving current market sentiment, and note the shift in tone.
Consider the cautionary tale of Heme+ from Impossible Foods, introduced to unlock the potential for mass production of vegan burgers that tasted like traditional hamburgers. At the time, “…plant-based heme made via fermentation of genetically engineered yeast, and safety-verified by America’s top food-safety experts and peer-reviewed academic journals,” sounded exciting and promising. Not so much today.