As a Young Farmer looking to start or expand your own business, the pathway to success isn’t always clear. Buying land is one possible approach, but the prospect of making such a large investment may seem daunting or out of reach. In this article we will examine the potential pro’s and con’s of leasing as a means of starting or expanding your farm business.
What is involved in leasing?
In a leasing arrangement the lessee pays the landholder to use their land for primary production. Leasing can be a mutually beneficial arrangement for a landholder who no longer wishes to farm their land, and a lessee wanting to scale up their business without incurring the capital cost of purchasing land. Primary production lease agreements have a higher level of complexity than other types of lease agreements due to the high number of variables such as land prices, seasonal conditions, Consumer Price Index (CPI), experience of the lessee and expectations of the landholder.
Leasing costs can be decided on a flat $/ha basis. This is often based on a percentage of land value, adjusted to CPI and linked to other factors such as rainfall. Primary production lease agreements most commonly run for periods of 3-5 years. A longer lease term generally allows for terms and conditions that will take longer to “repay”. For example a five year plus agreement might allow a clause that the lessee applies lime every five years.
A legal lease agreement is crucial to protect both the landholder and the lessee and to clearly define conditions and responsibilities for both parties. A lease agreement should consider factors such as livestock insurance, fences and infrastructure, rates payments and repairs and maintenance. Other areas where a landholder might set additional conditions include, annual fertiliser rates, stocking rates, types of stock, and expected pasture conditions at end of term. Virtually any conditions are possible with agreement from both parties. In more complex situations an independent property condition report might be justified. It is also a good idea to include an agreed process for conflict resolution in your contract so there is a system in place of managing any issues that arise during the lease term. People in Dairy (Dairy Australia) have some useful tools for land leasing including a leasing checklist and leasing agreement template.
Other factors to consider
It is important when you are applying for a lease to consider what factors will make your proposal most attractive to the landholder. The landholder won’t necessarily favour the highest financial offer. They may give greater weight to things like a potential lessee’s experience, personality, how they farm, ability to make payments, willingness to agree to lease conditions and their intention to invest in maintenance (eg. soils, weeds, infrastructure). Maintaining good relationships with neighbours and other industry contacts and sticking to your word in business dealings might be the key to securing a lease in the future.
Pro’s of leasing
A potential upside of leasing is avoiding the substantial upfront capital investment required when purchasing land. The benefit in this situation is that you also avoid borrowing and servicing a high level of debt. This will minimise the amount of financial risk you take on, meaning your business will be better positioned to cope with the unpredictability of seasons and markets. It will also minimise the level of interaction you will need to have with your bank or lending partner. If you do find yourself needing to borrow smaller amounts of money to invest in assets like stock and machinery you will have the opportunity to establish a good working relationship with your banker or lender while taking on a lower level of risk.
Leasing will also give you the opportunity to focus on learning the ropes of running or expanding a farm business, and to invest in assets like machinery and stock gradually while you build up savings for future capital investment. Demonstrated experience in running a successful farm business and having smaller necessary assets behind you already when going to purchase land could mean you are looked upon more favourably by lenders when the time comes to apply for finance.
Another potential opportunity that may arise from a leasing arrangement is a lease to buy option. This is less common and will depend on the vision of the individual landholder. Any terms related to a lease to buy agreement should be discussed in initial negotiations and set out in writing in any subsequent lease agreement.
Con’s of leasing
There are also some downsides to leasing, one being the absence of exposure to capital gains from the appreciation of land value. It is also important to consider the impacts of uncertainty tied to whether or not agreements will be renewed at the end of their term. You will need to consider if the application of maintenance and capital fertiliser is required. If it is then it could be a costly activity. This means there is also the possibility that you will miss out on long term benefits associated with any investments made in things like weed control and soil health.
The personality and farming style with yourself and your landholder is also an important consideration. Ongoing disagreement and conflict in the relationship can negatively impact personal and financial outcomes for both parties. If the owner of the land intends to keep living on the property this can potentially increase tension. As the operator of the property you need a certain level of privacy and access to run the business. It’s also important that the person living on the farm will also need to maintain some level of “enjoyment” of the land. They might wish to retain access to sheds, pumps, dams etc. There is also the often heard comment that, “they don’t run the place like I used to!”
Ultimately you need to weigh all these risks alongside your budgetary constraints, as a lessee your exposure to market and seasonal variables is far greater and overpaying for a lease could result in heavy financial losses.
The first step you should take before entering into any negotiations with a landholder is to have a clear understanding of your budget. This means establishing the maximum amount you can afford to pay for a lease for your business to remain profitable. You also need to be certain that you have access to enough cash to cover the running cost associated with starting your business or expanding your operations. You may need to borrow money to do so. In which case the cost of this needs to be accounted for in your budget.
While leasing land might be attractive don’t forget you also need to stock it. Weigh up the risks and be comfortable that you can meet your financial obligations in tighter times. The landowner will still expect lease payments in a dry season!
A leasing arrangement can work to offer benefits for both parties if personalities, farming styles, and financial goals and constraints are a good fit. For a young farmer these arrangements can provide a pathway to land ownership or business expansion that may have not been otherwise achievable. It is important if you are considering taking on a lease that you consult with legal professionals before any agreement is signed. If necessary it is also advisable to work alongside an independent consultant to ensure that you have a clear sense of your budgetary constraints and the risks and opportunities involved with any given arrangement.
- Watch the Young Farmer Business Network Farm finance – Getting Prepared online workshop recording
- Listen to Ag Vic Talk podcast – Turning your dream of running a farm into a reality with Sarah McLean
- GRDC Leasing and Share Farming Fact Sheet