Allocations to farmland investments have grown significantly in the past decade as wealthy individuals, fund managers and institutions are beginning to invest in land across the United States. Billionaire Bill Gates recently became the largest private landowner in the country with a portfolio of more than 269,000 acres of farmland accumulated through Cascade Investments, his family office. Gates is not alone, however, as a wide range of asset managers, from state pension funds to sovereign wealth funds, direct more capital to farmland through direct land purchases and investments in existing funds.

The U.S. farmland market is 2.2 times larger than other U.S. real estate asset classes. Yet, institutional farmland ownership represents less than 1 percent of the more than 300 million acres of land compared with 10 percent to 20 percent institutional ownership across other real estate property types.

Farmland is often priced at levels inconsistent with underlying asset profitability due to limited institutional farmland ownership. Instead, farmers buy land based on emotional factors or proximity to existing operations instead of productivity or crop viability analyses commonly used by return-motivated investors.

A lag effect between productivity-enhancing technologies and farmland market prices exacerbates inefficient asset pricing. Innovations such as precision agriculture and new irrigation technologies improve the productivity of the land. As a result, past land sales may not factor in these recent advances because of the often-informal analysis that goes into land sales, creating a disconnect between the selling price and the land’s actual value.

Pricing also marks a critical differentiation between farmland and other real assets such as commercial and residential real estate. Data resources such as comparables, asset condition and location, which are not yet available at scale for farmland, are used to calculate real estate values. While investors can still uncover good value in the real estate market, farmland presents more of an opportunity to find mispriced assets because valuations are not as data-driven or readily available to the public.

Farmland pricing may also benefit from the growing number of aging farmers who continue to operate smaller, generally low-revenue farms. From 2012 to 2017, the average U.S. farmer age increased 1.2 years to 57.5, including about 34 percent over 75, a 26 percent increase; the number of farmers decreased 3.2 percent during the same period. Since the average U.S. farmer retirement age is 75 and farmers over 65 own $1.2 trillion of U.S. farmland assets, the aging farmer population presents a buying opportunity for potential farmland investors.

Smaller farmland tracts (average U.S. farm size is 443 acres) can be consolidated into larger, more efficient operations and leverage economies of scale as farmers sell their land upon retirement. The generational wealth transfer that may occur in the next five to 10 years may also allow investors to partner with and support the next generation of farmers through more innovative investment structures, ensuring continuity in the industry while driving new growth.

Farmland presents a compelling investment opportunity because it has historically been one of the most stable asset classes, delivering investors positive returns without significant deviation. The NCREIF Total Return Farmland Index has generated positive returns every year since its inception in 1991. While short-term returns tend to vary more significantly, the average gross return of the index has been about 11.5 percent over the past 25 years.

This article was excerpted from the XA Investments report titled Reframing Farmland as an Investment. Read the full report here.