Both Institutional investors and private capital funds invest in farmland acquisition to provide multiple benefits. It is a portfolio diversification strategy, due to its long-term appreciation value and operation in a broad sphere of markets. Institutional investors like TIAA have global funds, while private capital funds are generally limited to the United States. Private funds acquire farmland and generate revenue from switching to more profitable or higher-yield crops. Quantifying environmental impact, such as reduced nutrient runoff, or increased in-stream flows can also provide revenue from secondary markets. However, the lack of consistent metrics for quantifying environmental impact, along with myriad risks in agricultural operations make it challenging to assess how environmental impacts are linked to investment returns.
Agriculture and farmland are attractive options for institutional investors because of the low correlation with other asset classes, it is not subject to major fluctuations in inflation, and operates in a broad sphere of markets. TIAA’s strategy is to build a diverse portfolio in geographic location and crop type in order to optimize the risk/return ratio. The strategy includes oversight of external managers (on the ground asset managers to “identify, source, underwrite, and acquire manage individual parcels.” TIAA’s total holdings at the end of 2016 were nearly 1.7 million acres valued at $6 billion. TIAA has noted several challenges in farmland investment, notably water conservation, impacts from climate change, deforestation, transparency and worker health.
While TIAA has acknowledged and directly addressed issues of environmental impact in its holdings, sustainability does not appear to be a factor in assessing returns on farmland production. Additionally, overall returns on investment are not publicly available, so it is difficult to assess how returns may be affected by environmental outcomes or the other indicators. Integrating environmental performance indicators into farmland management is a key part of TIAA’s focus on being a good neighbor and managing external stakeholders. Yet, not directly tying investment returns to environmental performance may be a good thing. As much of the reporting relies on on-the-ground farmland operators and asset managers, tying performance to outcomes could raise perverse incentives by these operators to favorably report outcomes without actually improving upon environmental targets.
Impact Capital Funds:
“Impact” funds also invest in farmland, either as a diversification strategy, or as a single focus of the fund. Impact funds are similar to traditional private equity or capital funds, but often are driven not just by returns but in secondary environmental or social impact. However, it is often unclear as to how much environmental criteria, or “sustainability,” factors into the investment strategy or revenue generation. In fact, each firm operates under its own set of measurements to provide optimal return, which may include different types of outcomes and may not be independently verified.
There is a wide variety of strategies and focus areas among these companies. Some operate in targeted regions (i.e., northeastern US, northern California) while others focus on grass-fed beef production or regenerating soil carbon through intensive grazing practices.
One firm, Blackdirt Capital, which is based in Connecticut and primarily owns and manages farmland in the southeastern US, has been challenged to generate high enough returns to attract larger sources of capital from institutional investors. BDC’s model is based on purchasing “undervalued” farmland and switching it from commodity crop production to pasture for grass-fed beef and organic diary production. However, the value generated is not in the land itself, but in the premium price on the market for grass-fed beef (and organic dairy products). Due to the limited returns in land acquisition, BDC is transitioning from an owner-operator model to purely operations. Additionally, BDC focuses on the SE and NE for undervalued land because of the lower risk in securing water rights or irrigated acreage in the Midwest or West (as well as higher per acre acquisition costs).
Reducing Risk and Generating Returns
Other funds derive revenue from water rights trading or leasing, enhancing habitat to lease fishing access, or quantifying environmental benefits (e.g., reduced nutrient runoff) for secondary environmental markets. Many funds are reliant on federal grant funding programs to provide seed capital to adopt new practices on acquired farmland. Yet this does not eliminate risk entirely. There are physical risks: weather events that can damage crops or increased variability in precipitation due to climate change. Others are market risks: continued declines in premium prices or no market for specialty products that yield positive environmental outcomes. Political risks, like those for water rights trading may make it difficult to acquire additional properties with underlying rights in rural communities.
As such, it is difficult to compare the success of agriculture firms. Investment returns are variable, and there is no clear link between revenue and environmental outcomes. As many firms operate on a 10-year investment horizon, land appreciation value may be the safest assumption in any investment scenario. Establishing consistent environmental metrics to compare across agriculture funds can help identify better risk/return profiles and encourage broader-scale adoption by agriculture funds. Investment guidelines, similar to those used by TIAA for farmland acquisition, could help funds identify optimal properties and best practices that maximize both returns and environmental impact.