Keith Woodford reflects as to whether the farming rules of the game, including the importance of cash flow versus capital gain, have changed, irrespective of any capital gains tax, and what this means for the future

Keith Woodford reflects as to whether the farming rules of the game, including the importance of cash flow versus capital gain, have changed, irrespective of any capital gains tax, and what this means for the future

Regardless of whether or not a capital gains tax is introduced, the rules of farming have changed.  Cash is becoming a lot more important.

I recall going to a conference in late 2000 or thereabouts, soon after my return to New Zealand after an absence of close on 20 years. I recall a lecturer from Massey University expounding how farming in New Zealand involved two separate businesses.

The story went that there was a cash business based on production that was all about survival. And there was a capital gain business that was how wealth was generated.

This was something that I had known from my earlier days in New Zealand, but it was something I had also largely forgotten about while working overseas, where things were very different.

I am not trying to imply that capital gain was not relevant where I was working overseas, but its importance was much less. And so now that I was back in New Zealand, I spent some time thinking about the reasons why things were different in New Zealand.

The answers were not hard to find. It was the lending policy of the banks and the lack of a capital gains tax, combined with inflation, that were together driving the New Zealand reality. And I often wondered if this was leading to a mis-allocation of resources.

However, when I was lecturing to Lincoln University students in farm management, I cast aside the question of whether or not the rules of the game were leading to mis-allocation. My job was to teach them how to play the game according to the rules that society had set.

The rules were not hard to understand. With no capital gains tax, plenty of interest-only finance, and inflation quietly doing its thing in the background, there was a big incentive to get on the ladder. Survive the first few years and time would look after things from there.

The biggest problem was to get onto the first rung of the ladder.  Those who were already on the ladder were able to use their growing equity combined with financial leverage to crowd out new entrants and so the established farmers expanded their holdings.

From the turn of the century through to when the GFC hit in late 2008, the land-price pump was working well.  Product prices were good, dairy was flavour of the decade, and most people seemed happy.  Those people who could not get onto the first rung by themselves had new options to join syndicates or become equity partners. They could also play the same game in the rental-housing market, where the first rung was easier to climb aboard.

The result was that as long as there were enough believers, then the model became self-fulfilling.  Land became more and more expensive.

The model worked across many rural industries, but it worked best in dairy. DairyNZ itself got on the bandwagon. Courses in ‘building your business’ combined with courses in ‘mark and measure’ became all of the rage. Actually, they still exist.

As with all games, there were winners and losers. Sharemilkers were particularly at risk, and some lost everything. Sometimes it was a lack of skill but other times it was just bad luck with timing. But losers tend to go quietly, whereas winners take all and become exemplars for others to model themselves on. 

During this period, the most successful players were able to increase their wealth at 20 percent per annum and even more. At 20 percent per annum compounding, it only takes 3.5 years to double one’s wealth. They were great times for the winners.

 Since the GFC of 2008/9 and through until recently, the rules were tweaked a little, but the overall model still worked.  The combination of reducing interest rates and ongoing willingness to lend on an interest-only basis was enough to keep land prices heading north, although perhaps at lower rates.

It is hard to identify the precise turning point, but some cool breezes that started blowing around 2016 have now picked up speed. With the exception of land that has potential for kiwifruit or other big-income crops, or has special locality value, then rural land prices are at best static and in most cases declining. Indeed, many land markets are totally dead at this current time.

So what has caused the change?

The two biggest changes are that banks are now requiring capital repayments and overseas investors are no longer welcome.  Kiwis themselves lack the new equity capital to invest. There is also a lack of confidence related to the impact of new and prospective environmental regulations.

There is a huge irony in all of this. That irony is that product prices for many of our agricultural products have never looked better. So, the cash returns could be strong, although some of this will be required to repay bank loans using tax-paid funds plus capital expenditure on environmental management.

Someone smarter than me once made the comment that predictions are always risky, particularly when they relate to the future.  And as the famous Murphy once said, what can go wrong will go wrong. And as one of the many Smith’s said, Murphy was an optimist.  So indeed, nothing is for sure.

Nevertheless, there is reason to believe that we may be moving into an era where inflation remains muted, where cash returns from agriculture are reasonable, and capital gain might at best be modest.

Inflation, of course, will be determined by Government monetary and fiscal policy. And with governments, there are always uncertainties.

In all of this we need to keep reminding ourselves that we have an export-led economy. Europe does not need us – with or without Britain. Also, America does not need us. Africa cannot afford us. That leaves Asia. We wouldn’t want to mess that up.

Some months back a former New Zealand Prime Minister said to me that even from a narrow economic perspective, there were more important things than a capital gains tax for Government to focus on. I am coming around to that perspective. A capital gains tax would indeed mean new rules of the farming game, and all sorts of sneaky ploys to get around those rules. There might be smarter ways to achieve a fairer society.

*Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. His articles are archived at You can contact him directly here.

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Always good Keith. I'm a city boy who doesn't like the smell of cow shit all that much, but understand what's been going on for a while now. Food is a key ingredient for life & it's a shame that the farmers seem to be more focused on the price of their land than the quality of the products they produce. Food is our (NZ Inc's) ticket to the future & the more value we can add before it heads offshore the better in my opinion. If the state of some of our rivers & streams tells us about the way the land is being treated then we've still got a lot of work to do, and that applies as much to the towns & cities as it does to the landed gentry.

it's a shame that the farmers seem to be more focused on the price of their land than the quality of the products they produce. Long John, please make an effort to get out on to a farm(s) and talk to the farmers. That farmers focus on the price of their land, rather than the quality of the products they produce, is perception rather than fact. As a farmer my view is, it is the msm and non farming commentators who focus on the price of farm land. Many younger farmers are asking how do they get their stories out there to counter the msm bias. Sadly, the reality is that people just don't want to believe the 'real life' positive stories from farming families. There is work going on to better inform people what happens on farms and Fonterra Open Gate Days are but one such initiative.

I don't think there are many farmers around, who wouldn't sell today, if they were offered the book value of their farm.

Farmers love their farms, it is their life and who they are. The emotional connection is real especially if people have put 25yrs in.
Do you think we should sell?

Good thoughtful piece, Keith. A quick way to see CG in a farm's financials is to look at the Revaluation Reserve.....

I recall a comment from Bob Jones once commenting that he would never buy a farm as it would never stack up as a business proposition. Those were when there were a lot of young aspiring farmers chasing their dream and that was before the aggregation of holdings.

Basel Brush 111
The irony is that Bob Jones could have made a lot of money by buying farms - assuming that his existing assets were not unduly encumbered with debt , and that he had bought wisely.
Within a diversified portfolio, land remains a better asset than gold within the low-risk component of a portfolio, with the one downside being illiquidity. Some years back I recall a discussion with a portfolio manager who included low-cost summer dry sheep country in his portfolio for precisely this reason. He was comfortable with the reality that it was only producing a cash return of 2-3%. And with other property investments, location has always been important.

An excellent article.
The features you describe can exactly apply to the changing rules of residential rental property investment.

Good question you raise Keith.

A further question would be how do you play the game when it approaches the end of the interest rate cycle. Given credit availability works in inverse to the quantity of money, then capital gain is definitely the way to go in a credit fueled asset bubble. Until it isn't.

So the question is, how close are we to the end of the interest rate cycle?
If you had asked me five years ago. I would have suggested that low interest rates were a short term aberration. Now I am not so sure.

We farm in Northland. I agree - the irony is that commodity prices are strong and yet farms, particularly dairy, are falling in price.Our last purchase will realistically show between 8% and 9% return on total assets. With conservative debt levels currently costing around 5% the return on equity is favourable compared to other property investment. I mention this only because I am sick of negative sentiment around the future for farming in NZ. Farming is giving me and my family a good life. I was recently approached by an outsider for assistance. My genuine advice was take a $mil off what he was originally going to offer and work on no capital gain for the next 10 years. If the purchase worked under that scenario then it probably made good business sense.

Keith the issue may not be low interest rates but a Bank liquidity problem.

Agree. I don't think we'll ever see high interest rates again. There ain't enough planet left to do the repaying with, barring massive de-valuation of 'money'. And some European banks - particularly Swiss, for obvious real-estate reasons - are heading below zero. The interesting thing about sub-zero rates is that they reward borrowing - meaning the signals are counterproductive.

How long they can plug the dyke, is the interesting question

Agreed. Banks are probably never going to be able to raise rates again, without the 'economy' falling over. We are at the point where the capex for future energy projects is not bankable (shale have yet to pay) and that really means that society can no longer pay it's way. Plus which there's the debt overhang - never bigger but with never-less underwrite available. Interesting times.....

"We may be moving into an area where inflation remains muted". Keith,we have been in that era for many years now. I have graphs of long-term inflation for NZ,the US and the UK and these show very clearly that here,inflation started to fall rapidly in the early 90s,while in the others,well before that. I have argued that this era is not the anomaly,but the period that the period of exceptionally high inflation was. At 73,I remember it well in the UK and it is seared into my memory. I have not argued that the cycle has been abolished,but that it will be very much more muted,next time round and that's not happening any time soon.

I too recall the time when inflation started to run away - here it was in the early 1970s. My concern is that even at the current muted levels and target of 2%, we do still see inflation expectations built into investment decisions. And when real investment returns are low, then even 2% inflation can be highly distorting. Also, I note that the Reserve Bank now has dual objectives of price stability and employment levels, and I have some concern that the Phillips Curve still has some credibility within Government and official circles. I am also of the perspective that government deficits and how they are funded, together with the reserve ratios required of banks, are much more important than the OCR.

The Phillips Curve was a typical attempt by 'economics' to be a science.

Went pear-shaped decades ago - as is 'global growth' nowadays. Their problem is that they can only look backwards. We are heading for permanent zero and below zero interest-rates. This, counter-intuitively, will encourage borrowing which will be increasingly unrepayable. Cometh the new paradigm, goeth the old mantra.

"Went pear-shaped decades ago"
Really? Perhaps the original Phillips curve, but it's still pretty important.

The Phillips curve (perhaps a misnomer, which is what is confusing you) is still a pretty important framework for understanding the (dynamic) relationship between wages and inflation.

And, as for "The Phillips Curve was a typical attempt by 'economics' to be a science."
Well, it wasn't an attempt; it was the scientific process. - 'Ol Billy (Quite a sciencey guy; an engineer by training. You should visit the reserve bank and see his mechanical equilibrium machine) pointed out the observation using empirical methods. Built some theory around the relationship. Results were replicated. Theory was challenged (most notably by Milto). Further empirical tests confirmed the expectations challenge. Neo/modern Phillips curve framework proposed. (Repeatable) Empirical testing supports new theory.

Sounds pretty sciencey, to me.
Ironically the only thing that makes it unsciencey is when the uneducated debate it.

Phillips only used data from the UK, going back 100 years. Samuelson and Solow added to it, and by the mid 1960's, it had 'entered the lexicon of economic truisms' (Ashworth, 1995). Until 1970 - the year of Peak real oil in the US, and just before Nixon was forced to abandon the gold-standard.

Since then, 'despite some valiant attempts by Milton Friedman' and others to create one, there is no percievable pattern to the data-points at all.....'

I see it as one of the first of a series of 'decouplings' which should really puzzle someone who thinks like you. It must be quite bewildering, this last decade or so. And it's about to get much more so.

A rule, in physics, is something like the 2nd Law of Thermodynamics. Sort of immutable, stands the test of time and all that. What we have here is a relationship between two measures, which is fine if you want to bother, but given that the discipline involved fails to ascertain what is really driving BOTH, it's no use predicting anything.

It would be of more use to relate the total of the expectations earned from 'employment', to the planetary underwite remaining. Now THERE'S a relationship......... Downward curve, steepening, is my hypothesis.