NEWS for North Dakotans
Agriculture Communication, North Dakota State University
7 Morrill Hall, Fargo, ND 58105-5665

March 16, 2000

NDSU Ag Economist: Crop Shares Another Way of Managing Production, Price Risk

Renting land on shares, as opposed to cash rent, provides a means of managing the risk of production and price. For that reason, many farm operators may need to reconsider their rental arrangements in light of current economic conditions, says an agricultural economist with North Dakota State University.

"With thin operating margins, producers need to look at all types of risk management tools," says Dwight Aakre, extension farm management specialist at NDSU.

Historically share renting was common, but since the 1970's, a high percentage of rental contracts have been converted to cash rent. Aakre says cash rent is more convenient, reduces problems associated with storage and marketing, and provides both parties with a known value for budgeting purposes.

"The downside of cash rent is that history has shown it continues to adjust upward when the ability, or at least the perceived ability to pay exists," Aakre explains. "But seldom does cash rent adjust downward when the ability to pay declines."

Renting land on shares is not necessarily a way of paying less rent, on average, but crop shares do allow for matching the cost of land with the ability to pay for the current year, Aakre explains. In years of low gross returns due to price, yield or both, the value of the rental share will be less.

"This is the downside for the landowner, but it improves a poor cash-flow situation for the operator," Aakre says.

In years of high gross returns (again, due to price, yield or both), the landowner receives higher-than-expected rent, and the operator, likewise, receives higher income and is therefore better able to afford it, Aakre explains.

The fundamental principal for establishing a crop share agreement is that both parties share in the income in the same proportion that they share in expenses. Aakre says all costs of producing the crop need to be accounted for and credited to the party paying for them.

"It is important to include all inputs, including labor and management. All inputs should be valued at opportunity cost," Aakre says.

Variable costs are generally cash purchases and therefore valued at the price paid. The fixed costs of land, machinery, labor and management are more difficult to value. Land is often valued at the average net cash rent, which is the cash rent minus real estate taxes.

"Net cash rent represents the opportunity foregone if the land is rented on shares," Aakre explains. "But in addition to net rent value, the owner is also contributing the real estate taxes paid."

Machinery costs can be difficult to determine. The costs associated with machinery consist of depreciation and interest on the money invested in the machinery. The most accurate estimate would be to calculate these costs per acre for every machine used, but this calculation can be quite cumbersome, Aakre says. A good substitute for actual machinery costs would be the machinery cost estimates listed in the projected crop budgets provided by the NDSU Extension Service.

Labor and management costs also can be difficult to determine. If an accurate record of time spent on all functions of crop production was available, then applying an opportunity cost to the hours per acre would be appropriate. Lacking such detailed records, a substitute approach would be to divide the amount withdrawn from the farm for family living and divide this figure by the number of acres cropped to determine the amount each acre must support. Aakre says, "The problem with this approach is that it may not reflect the actual market value for this resource."

Based on his calculations of fixed-cost values, Aakre offers examples of crop-share arrangements:

• For a spring wheat-soybean rotation in south central North Dakota, the cost contribution works out to be 23.4 percent by the landowner and 76.6 percent by the operator (see accompanying table). Income--both market income and government payments--should be shared in a similar manner. Should the parties desire a different share arrangement, the landowner could contribute to other input costs. There is economic justification for the landowner to be contributing to the cost of yield-enhancing inputs, which include fertilizer and possibly pesticides. In this example, if the landowner were to pay for 30 percent of the costs for fertilizer, herbicide, fungicide and crop insurance, the share of contributions would be 30 percent by the landowner and 70 percent by the operator. Returns from this arrangement should be shared in the same proportion.
• A wheat-fallow rotation in western North Dakota works out to 33 percent for the landowner and 67 percent for the operator. In this situation the landowner is supplying only the land and the operator is providing all other inputs. This is the traditional share arrangement in North Dakota, but it is no longer equitable with continuous cropping. Crop income and government payments should be shared in the same proportion.
• A corn-soybean rotation in the southern Red River Valley works out to 30 percent for the landowner and 70 percent for the operator when the landowner pays 30 percent of the cost of fertilizer, crop insurance and drying. (High cash rents in the valley keeps the landowner's contribution relatively high despite higher operating inputs for corn production.) Crop income and government payments should be shared in the same proportion.

"The Farm Service Agency does not require the shares of government payments to be the same as the shares of the crop," Aakre concludes. "Their only requirement is that the landowner must receive some share of the payments. How the payments are shared is left to the landowner and operator to determine. But with a cash rental arrangement, FSA regulations require the entire payment goes to the operator."

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Source: Dwight Aakre (701) 231-7378
Editor: Dean Hulse (701) 231-6136

Click here for a pdf version of this graphic. (6KB b&w table)