What makes farmland a good investment?By: Naomi Game and Gareth Lay

Agricultural land has long been considered to be one of the most secure forms of investment, renowned for being a safe haven and held in the same regard as gold and diamonds despite its relatively low returns on capital. Yet agricultural land has much more to offer investors than just grazing livestock or growing cereals.

As global population growth is expected to reach nine billion in 2040 and with some predictions putting the population in 2050 as high as ten billion, the future outlook for land resources looks bright. There is an attraction to utilise less marginal land for renewable energy production through a range of resources whether it be exploration of natural gas, wind farms, hydro electric schemes, production of biomass crops or development for solar farms. This demand has driven up values on the lower quality land grades. However, there is more behind the attraction of agricultural land than simple agricultural outputs.

Lack of supply is not the only cause for the increase in land value. Prices are also rising due to significant tax benefits, which are available to owners of agricultural land.

Inheritance Tax relief, which would normally be charged at 40 per cent on the value of an estate worth more than £325,000, qualifies for 100 per cent relief on the land after two years of ownership if the land is farmed in hand. There are also benefits for owning land and letting it out to farmers under a tenancy agreement, which has the added benefit of a rising rental market. The alternative for non-farming investors in farmland, who wish to retain control of the land without purchasing the equipment to actually carry out farming operations is to enter into a contracting arrangement with existing farmers, thereby sharing their resources.

There are also attractive benefits in terms of managing income tax where profits from farming can be offset against losses over a rolling period. Typically many of the farming expenses and some of the farmhouse expenses can be offset through the farm accounts.

Agricultural land also qualifies for Entrepreneurs Relief when it is sold and becomes liable for Capital Gains Tax. If the land is sold as a trading business the benefits are a taxation rate of 10 per cent for qualifying tax payers rather than the typical 28 per cent paid under normal provisions.

According to the Royal Institution of Chartered Surveyors (RICS) farmland prices rose just over 2 per cent in the second half of 2012 on both transactions and opinion based measures. The survey also notes that there is strong demand from commercial farmers keen to expand production on neighbouring land who end up competing against investment buyers. Not only have commodity prices grown to allow farmers to acquire land but also financial institutions are very keen to lend into the agricultural sector at long term low rates as they appreciate the strength of security and the long term capital growth previously seen with agricultural land.

The RICS survey identified a national average land value of £6,783 per acre, which is a record high reflecting the lack of supply in a high demand investment sector. Regionally the most expensive agricultural land is located in the West Midlands at £7,625 per acre with the least expensive being located in Scotland at £3,750 per acre, mainly reflecting the low price of pasture land. Surveyors expect further price increases over the next 12 months, concentrated in the commercial sector of the market.

So what are the likely returns? As with all secure long term investments capital growth would appear to be the most significant benefit, above and beyond the initial return on investment, which would typically range between 1 per cent to 2.5 per cent. Capital growth has seen almost a doubling of land values in the past ten years, which has a backdrop of consistently generous farm subsidies and favourable fiscal policies coupled with the more recent strengthening of commodity prices.

However, investors need to be aware that while there are significant tax benefits to investing in farmland there are also risks attached particularly as Her Majesty’s Revenue and Customs (HMRC) is looking closely at investors who are acquiring farmland purely to qualify for the various tax benefits. The land owner of the land needs to be involved with the running of the farm on a day to day basis, but more importantly, if investors are looking to acquire complete holdings with residential properties they need to ensure that the main farmhouse is being used entirely for farm purposes if they are going to qualify for inheritance tax relief.

So what does the future hold for agricultural land? While tax benefits may come and go there is no doubt that those people who own and are in control of agricultural land in the future will benefit from consistent long term capital growth as well as attractive medium term incomes not only for good quality productive land but also less favourable and more marginal land, which has non-agricultural resources. Small investors and institutional organisations are likely to become involved with agricultural property. They are looking to acquire commercial plots of land (of over 100 acres) and this looks set to only heighten demand in the market. With the outlook for increasing land values some investors are standing back to see how the market pans out. But those investors may well miss the boat as evidence to date shows no signs of values falling.

About the authors

Naomi Game MSc MRICS is a Senior Surveyor with Bruton Knowles' Guildford office, delivering a wide range of professional advice and carrying out commercial estate management.

Gareth Lay Bsc (Hons) MRICS FAAV is an Associate and team manager in Bruton Knowles' Shrewsbury office, delivering valuation and property advice on a national level. He also acts as Bruton Knowles' expert on rural property matters.