Buying a farm - financing and debt

I've been working on purchasing a new farm property for the last three months, and what I'm going to write about here is based on that experience; if you're looking to purchase a farm at some point, you might find this interesting. 

First, this may not be news to you, but it is to banks:  Farms are comprised of land.  With my farm purchase this became an issue because there's 70 acres of land.

This causes three problems:  First and foremost, the lenders in this area, and I suspect all over the country, are all set up to make mortgage loans on houses, and because of this specialization, anything that isn't a house on a small lot causes them problems.   Second, banks don't like to lend on bare land.  Third a large number of acres may make it impossible to finance due to fears that it will be an income-producing property. 

The banks role in a mortgage, in a simplistic sense, is to find the borrower and then make sure that the borrow conforms to various standards that are now in place.  They do this primarily so that they can take your loan and sell it to various entities that use them as income streams.  In order to be attractive in this secondary market, the loan has to conform to various standards, and the one that bites you with farm properties is that most of the loans are limited to 10 acres or less. 

Specialized Agricultural Lenders
What that meant in my case is that it restricted the lenders who could make the loan in the first place; either to a specialized lender, like Farm Credit Services or Janus Ag Finance, or to a local commercial bank like Coastal Community Bank. 

The terms offered by these specialized lenders are typically worse than any mortgage loan you can get.  For example, Farm Credit Services gave me a rough guideline of 35% down at closing, 15 year amortization and 5.5% interest rate, fixed.   The other financing options were similar in price; some had a little lower down payment (never below 30%) some higher (as much as 45%) and various amortizations, but never anything over 20 years. 

Some lenders -- Farm Credit again -- offered a rebate of the interest you paid as a dividend.  In their case, they offered .75% back, lowering your effective finance rate to 4.75%, which is actually a pretty good rate for this sort of loan.  

In this situation a local commercial bank can be your best bet.  They will often know the community and the situation, and can make a loan with that knowledge that a national or multinational bank can't or won't.  In my case the bank that owns the property has a name that seems like it's local, but it's actually a gigantic Japanese bank.  I asked them if they'd finance this purchase:  I got a flat NO; which I felt was odd because they already own the property, and it shows on their books as REO; we could have closed a loan months ago if they had. 


USDA programs
The USDA does offer loans and financing directly, and at rates that are at or below the rates offered by specialized ag lenders.  For more information on these, click here.   Some of these programs require that you be turned down by other lenders prior to applying; some have age restrictions (is that legal, btw?) and so on.  I chose not to pursue this path because I could qualify for a loan using standard resources, and the word is that these programs are both paperwork heavy and take a long, long time to close.    In retrospect, since I'm now at month four of my own loan process, maybe the wait is normal when you buy farms.  When I talked to folks they gave me a 4-6 month timeline,  which I thought I could beat with a conventional financing scenario. 

House and Land
I'm going to use numbers from my own property; they're public record, so there's no real secret there.   It's 69.5 acres of land, split into four tax parcels.  One 15 acre parcel has all of the buildings on it; the other three are mostly clear cropland, with maybe 2 acres of woods.  The county assessor calculates that these four parcels are worth $788k, including land and improvements. 

  I'm purchasing the property for $420k, and putting $170k down, leaving a balance of $250k that I'd like to finance.   Yep, 40% down based on purchase price.

What's it worth?
  In this area the county assessor actually does a pretty good job of calculating the value of the land; if anything they are a little conservative; when you look at sale prices vs assessed value, the sale prices are usually around 10% higher than the assessed value.   So there's an argument that this property is actually worth around $866k.

( If you'd like to read a pretty informative article on property assessments in this area written by another farmer, click here. She saved $250 a year by doing a couple of hours work. Pretty good pay. )

So the LTV (Loan To Value) ratio, based on assessed value, is pretty good; I'm actually only looking to finance 28% of the value of the property.  Since most residential loans will finance 80% of the value of the property, or 90%, or 95%, this is a pretty safe bet for the bank.  

But banks don't like bare land, and they don't use the assessed value, and if it's an income-producing property, or could be, our looks like it could be, or has more than about 10 acres, you are pretty much limited to the specialized ag lender or commercial loan territory.

The trick to getting a better rate is to separate the house from the acreage, and if there are structures that look like they could be income producing (like giant barns or milking parlors or whatever), having those be on a separate lot. 

Boundary Line Adjustment
Even though this land could theoretically be worth the assessed value or more, it's sat on the market for months without a buyer.  Part of that is the finance issue;  as it sits, in order to buy this property you have to either have all-cash or go through this financing maze I'm talking about here.    In my case I've chosen to go with a commercial loan for a couple of years.  That closes the sale, and I can start working the ground there.  After the sale closes, I'll do what is called a boundary line adjustment, or BLA for short.    There are four tax lots included in this purchase, so I'll take one of those lots and redraw the line so that it includes the house, septic field and the well that serves the house, along with any appropriate buffer space, and nothing else.    In this area, a house on 5-10 acres sells for $300-500k.  Houses are very expensive in Western Washington.    This house will be towards the bottom of the scale.  The 15 acre parcel with the house and barns appraised on a residential appraisal at $460k.  

The house shuffle
When the house is on its own lot I can then refinance it as a conforming mortgage loan; effectively lowering my interest rate to current mortgage rates, from 5.5-6% commercial loan rates to around 3.6%, knocking my payment down from $1900 a month to around $1200 a month.    If it does end up appraising for $350k, at 80% LTV that'll yield about $280k.  The refinance pays off the commercial loan completely. 

So in about six months I'll have a 250k mortgage on the house on a few acres, and I'll own the other 64 acres, barns and outbuildings free and clear. 

Debt - why borrow?
  Normally I'm against debt, but I think that in the next decade or two that we are due for inflation.  Our economy has been sputtering along, but we are doing very well compared to the rest of the world.  The US dollar has become the reserve currency for the entire earth; when you're in any other country on earth and your local currency, government or situation is unstable, US $100 bills are what you buy.  When you do so you basically give the US a $100 loan, and it's widely reported that over 75% of all $100 bills are outside the USA.    This has meant that our currency has been stable, recognized and valued as an island of stability.  But I think that as the years go on we will see more and more countries dropping the US dollar, as Australia recently did. 

  Our reserve currency status has kept inflation at bay -- when the US dollars leave the country they're not chasing goods and services here.  I can see a time when they come back, and there are billions more dollars chasing goods today than we have ever had before.  And that says inflation to me. 

So for me, money in the bank earning .1% per year isn't an attractive option.  I much prefer land as a long term investment, and so I'm buying more land, as I have for the last decade.  I skipped the housing bubble, buying my last house in 2000 and selling them all between 2004 and 2007 because I thought that house prices were outrageously high, and then started purchasing again after the big crash in 2008.    I still think that there are bargains to be had in housing and land.   Like the farm I wrote about here.   I still think that property is a bargain, just liked this one better. 

Our current inflation rate is somewhere between 2 and 3% right now; and it's considered to be acceptable to be at that level.  So a 3.6% loan is really a 1.6% loan, and if inflation goes up even a tiny bit that's free money.  Interest free loan.    And there's always the mortgage interest deduction, which easily makes it profitable to borrow the money.   You get paid to borrow this money.  That's a pretty sweet deal.   

Summary

  Properties which have the house on a separate tax lot from other structures like barns or acreage over 10, are more expensive to purchase, but cheaper and easier to finance. 
  Properties that are not easy to finance can be bargains if you can figure out a way to buy them
  Once purchased, you can often re-arrange the property so that it becomes easy to finance or sell in the future, and by doing so probably increase the value of the property.   
  Your lowest cost financing is often in the form of a mortgage, so the more you can borrow in the form of a mortgage the lower your typical cost of finance will be. 
  Specialized lenders will finance properties that traditional lenders won't, but at a higher cost, too.
  It's worth working hard to get the lowest possible mortgage payment. 
  If you feel that inflation is likely, owning hard assets is a traditional way to protect your net worth.
  I particularly like farmland as an investment because it's taxed at a far lower rate than most other land.  Which means that the carrying costs are either zero, or profitable if you choose to lease the land to another farmer. 

   If you are not comfortable with the math, or even if you are, please do sit down with a CPA, land use expert and an Attorney and double check what I'm saying here against your own personal situation and finances.   I'm not an attorney, and I'm not a CPA, and I'm certainly not a land use  professional.  I'm talking about what my personal thoughts and opinions are about finances and trends.