Is farm land a bargain???

The drop in milk prices has quickly flowed through to the price of farmland, with the median dairy farm selling price dropping from a peak of $5.5 million in October last year to $3.2m in April this year, a decline of 41% in six months, according to the latest Real Estate Institute figures.While such a sharp fall in value will be a source of pain for anyone who bought at the peak, it does raise the question of whether now is the time for buyers to snap up a bargain reports NZX. According to the latest newsletter of farm syndication company My Farm, "the irony of the reduced dairy payout news is that the next six to 12 months may be the best period in the last five years to buy a farm or a share in one". "From an investment perspective, the ideal situation exists. Strong fundamental demand for dairy products, along with depressed asset prices." But other analysts, such as University of Waikato associate professor Stuart Locke, who has a special interest in agribusiness finance, believe a more cautious approach is warranted because the milk price may remain depressed for several years and farm prices could have further to fall. Last week My Farm director Andrew Watters was on the road inspecting new dairy farms to purchase and roll into managed investment syndicates."The three key assets when buying a dairy farm are land, Fonterra shares and stock," he said. And over the past year or so, the cost of cows had declined from about $2200 a head to $1400. Fonterra shares had dropped from $5.57 (per kg milk solids) to $4.52 and the average per hectare price of dairy land had fallen 15-20%. "So the combination of all those things is a reduction in the total price of somewhere between 20% and 25%." Against that, My Farm weighed up the likely expenses of running the farm and the income it would generate. Watters said they based their initial income projections on Fonterra's current payout estimate of $4.55 per kg of milk solids and on top of that there would be a small amount of income from selling stock, which could raise the total equivalent payout to around $4.70. Operating costs would be equivalent to about $3.20 per kg, and finance costs (with 35% of the purchase price debt funded) would be about 80c, taking total costs to $4 and leaving the owners with an operating margin of about 70c per kg, Watters said. So even at the current low payout levels the farm could make a profit, although Watters admitted that at those figures the owners wouldn't get rich. This is where Locke's view differs from Watters'. Speaking from his Waikato farm, Locke said he had been following prices for milk and butter on the Chicago futures market.These suggested prices would remain soft into 2011 and the forecasts that banks and other analysts had presented suggested dairy prices could remain at around current levels until 2013, he said."I don't see a sudden lift. Maybe the long-term average [dairy payout] price is somewhere around $4.50 to $5." He believed a sustained period of low earnings would force a major change in the farm financing model and further falls in farm prices.Figures he prepared for a presentation he gave to farmers at last week's National Fieldays event at Mystery Creek showed that since 1987, the milk price payout had doubled, while the cost of dairy land had increased nearly seven-fold. "So the long-term figures have been indicating a long-term return on assets of around 2%.