WEST LAFAYETTE, Ind. — Federal loan interest rates are one driver impacting agricultural income; rising or falling rates are something owners of farmland should keep in mind when managing real estate assets, according to Jason Henderson.

An economist who is vice president of the Federal Reserve Bank of Kansas City and executive of its Omaha, Neb., branch, Henderson spoke about interest rates at the March 27 Financial Health of Farming and Land Values conference at Purdue University (where he will also take over as director of extension and associate dean of Agriculture in May).

Persistent demand “shocks” – such as the boom U.S. agriculture has experienced for several years – mean higher income that leads to higher land values and capital investment purchases to keep filling the demand. Factors in this century’s boom for U.S. farmers so far have included export demand for soybeans and ethanol demand for corn, to name just two.

Another type of “shock” driver for farmland value is interest rates. Lower Fed interest rates as Americans have seen the past several years, he said, are associated with higher incomes and lead to yield lower capitalization or cap rates. A cap rate is based on the annual return a buyer expects a property to yield.

“The cap rate is a relative term; value relative to revenue, returns or income,” Henderson clarified. “So land values that rise more quickly than revenues yield a lower cap rate. This is the situation today in the Corn Belt – despite record high incomes, land values are rising faster than cash rents.

“I think current land values do reflect current (economic) conditions,” he said of agriculture. “It’s just that, how many of you expect land values to reflect conditions three years from now?”

For one, the USDA is anticipating U.S. farm income to drop over the next decade.

Figures he presented show from 2011-13, the annual average national farm income has been $121 billion; between 2014-2022, it’s expected to drop to $94 billion, though this is higher than it was before 2011.

The USDA anticipates through next year, crop cash receipts will fall, while livestock receipts hold steady and high cash expenses stabilize; after 2015, it sees crop and livestock cash receipts should rise – but so will cash expenses.

The Federal Reserve has kept interest rates low for a while. “But someday, interest rates will rise,” Henderson said. “We just don’t know when.”

Phil Abbott, a Purdue ag economist, said interest rates are low not just because of Federal Reserve policy but also because businesses perceive relatively few investment opportunities in the economy right now.

Learning from the past means looking at what changes Indiana farmland values have undergone in the past century, adjusted and presented in today’s dollars. For example in 1900, according to USDA figures, Henderson said about half the state’s farmland was valued between $1,000-$1,999 per acre in 2011 value (equivalent to about $75 in 1900).

By 1920, about half the state still had the same land values – but it was a somewhat shifted half. Lower-valued lands had moved up into that bracket, and a healthy portion of the 1900 $1,000-$1,999 land had moved up to between $2,000-$2,999 an acre, in 2011 value.

In the 1910s, World War I boosted farm exports and prices, Henderson explained. The Fed elected to keep interest rates low to finance U.S. involvement in the war. But conditions in the 1920s that brought about the Great Depression also led to lower farmland values so that by 1930, nearly half the state’s farmland acres were still in the $1,000-$1,999 range – but most of its other half had dropped to the $500-$999 range.

Things did not change much by 1940, but it was in that decade he pointed out World War II boosted ag exports and prices again. That was also close to the time he said hybrid corn seed meant steadily increasing yields. By 1969, roughly three-quarters of the state’s farmland was valued in the $2,000-$2,999 per-acre range or higher; nine years later, nearly all of Indiana was in the $3,000-plus range.

In 1982, Henderson said then-chair of the Federal Reserve, Paul Volcker, raised the interest rate. In a 2000 PBS interview, Volcker explained he had wanted to cut inflation by reducing the money supply and that “the way the economy was behaving, sooner or later you were probably going to have a recession. There was a feeling that the Federal Reserve created the recession. I think economic conditions created the recession.”

This, coupled with trade restrictions, began cooling land values in 1982, Henderson said.

By 1987, only small portions of Indiana had farmland valued at $3,000 an acre or more, with the rest worth less – lower than 1969 levels. (This is still in 2011 dollars.)

In the 1990s, farmland values began to recover and by 2012, the Indiana farmland average was $6,200 per acre, he said. Other Midwest and Plains agricultural states have been experiencing similar or even better booms, according to the Fed.

Non-irrigated values in Indiana were up 10 percent in the fourth quarter of 2012 over the previous year, but Iowa saw an overall 20 percent gain in the same time. And Kansas, Nebraska and the Dakotas all saw gains a few percentage points on either side of 30 percent.

If interest rates have been low for a while, why isn’t inflation advancing more quickly? Henderson said it’s because right now, lending is down. While he said the Fed printed roughly $2 trillion after the 2008 economic bust, more than $1.5 trillion is sitting in banks right now as reserves.

The Fed began buying banks’ bad mortgage-backed securities after the 2008 crash, Henderson said, in an effort to keep money flowing in the U.S. economy. Abbott added the Fed has conducted three rounds of buying since 2009.

Henderson said it’s the same thing the European Central Bank is now doing with its nations’ sovereign debt in the middle of their own recession, and it’s what Japan is finally doing after two decades of recession, Abbott noted. Basically, it’s “buying time” until economic conditions stabilize, Henderson said.

He said the United States is doing fairly well; investors still flock to buy our Treasury bonds even now.

“We don’t look like some of the countries in Europe,” he explained. “We sure don’t look like Japan (which is seeing depreciation of its currency). In some ways, we’re the best-looking house on a really poor block.”

When the Fed starts paying banks a higher interest rate, the banks will loan more reserves out, he said. One thing farmers and landowners can do to try to get ahead of inflation is monitor eventual decreases in excess reserves – this is public information the Fed updates every two weeks online at www.federal reserve.gov/releases/h3/default.htm