The U.S. Department of Agriculture announced in August it planned to distribute $4.7 billion to farmers as part of the initial wave of a $12 billion aid package. Farmers themselves seem less than thrilled with the bailout, with the prevailing sentiment that those dollars are flowing to larger agricultural conglomerates. Sen. Ben Sasse (R-Nebraska) may have summed up the general sentiment now swirling throughout many farming communities when he told CBS News that farmers and ranchers in his state don’t want more bailouts, but the ability to sell overseas.

While much of the media coverage has focused on the political dustup resulting from the move, the new tariffs also put a renewed spotlight on some of the major issues facing U.S. agriculture.

Even before the tariffs were announced throughout the spring and early summer, the industry was experiencing serious headwinds. Soybean prices, for example, dropped 19 percent to a 10-year low while corn fell more than 15 percent, according to CBS News. Additional tariffs are likely to exacerbate the pressure on farmers.

But there are additional and more macro challenges facing the industry. Farm incomes hit a 12-year low in 2018 at $59.5 billion, while farmer profits are expected to drop 6.7 percent, according to the U.S. Department of Agriculture.

The reality is the majority of U.S. farms are not producing at their full potential due to a variety of factors, ranging from lack of capital resources and expenditures to generational issues. To meet the growing demand from the global expansion of the middle class, agricultural supply must increase and commodities need to flow freely. However, fueling a rise in global supply is predicated on the appeal the agricultural market holds for investors who are willing to ride the wave.

ATTRACTIVE ASSETS

Despite what could be the nascent stage of a full-blown trade war, the farming sector possesses two characteristics that make it particularly attractive to private investors with experience in the sector looking at the long term. One key factor is the potential for economies of scale centered on small farms. About 90 percent of the nation’s 2.1 million farms are characterized as “small family-run” operations, which both increases the financial risk and limits farmers’ ability to reinvest in the business. What’s more, up to three-quarters of small firms have profit margins of less than 10 percent. However, thin margins could serve as a catalyst for selling the land to an operator with greater economies of scale and subsequently wider profit margins.

Another major factor concerns the structural issues surrounding farmland ownership and the demographics of many owners. Family-run farms operate about 51 percent of available farmland in the country, but account for just 23 percent of production. Compare that to just 3 percent of farms considered “large-scale family farms” that account for 45 percent of production. Global markets have similar dynamics when it comes to share. A key reason why small farms give reinvestment short shrift is due to an aging farmer population. Reinvestment into farm operations tends to decrease as operators age; the average U.S. farmer is now in his or her late 50s.

AGING OWNER BASE

Against that backdrop, investment horizons for smaller farms are fairly dim, particularly when up against the need for incremental investment to upgrade infrastructure or introduce irrigation or innovative technologies and processes into farm operations. Many small firms lack the resources to invest in innovative technologies designed to improve efficiencies with regard to planting, harvesting, planning and water usage. Adding insult to injury, those who do invest in sophisticated, digital machinery face again huge costs when new machinery breaks down, and it’s unlikely to be replaced. Inadequate investments often prove counterproductive: Lower levels of property investment can translate into lower productivity and have a deleterious impact on overall property value — both in the near and longer term.

Taken together, the trends present an interesting opportunity for private investors who have a keen understanding of the lower end of the farming sector and see untapped value among smaller farms rather than dormant businesses hopelessly behind the curve. Like any financial undertaking, investors must possess a deep and specialized knowledge of the market to increase odds for success.

It’s quite possible the current downward pressure on operating margins — particularly those faced by operators who lack scale — could spur these owners to consider monetizing their most valuable asset, land, through the exploration of a sale. But an out-and-out sale of the property is not the only option for investors. Rather than selling to an agricultural conglomerate in an age of increasing consolidation in the sector, investors can become partners with these farmers and help to preserve the small, family-farm nature of U.S. agriculture. They can also acquire a significant chunk of the business so they don’t have to incur all the risk. Patient investors can be nicely rewarded for implementing property improvements that can boost productive capacity at the farm level.

SEEDS OF OPPORTUNITY

This is the proverbial win-win strategy: Having both a willing seller and a viable path to property improvement are critical components for making these transactions work for both parties. Regardless of what you think about the potential increase in long-term agricultural demand, the opportunity for investing in the farming sector stems from nearer-term global dynamics.

In a market environment in which property improvements and potentially attractive acquisition pricing can provide a solid return on investment, how you handicap increasing demand for agricultural commodities is an additional — although not essential — reason for investing in small farms.

Investors have to be careful not to get bogged down by the politics now gripping the nation’s farming sector due to the skirmish over tariffs. Rather, serious investors have to keep their eyes peeled on the potential upside many small farms possess. For those who are willing to plow through, there are ample reasons for investing in this asset class.

Jim Gasperoni is co-head of real assets at Aberdeen Standard Investments.