Stay managing with less risk or 50:50 or equity share??

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Fri, 02/15/2013 - 12:14 #1

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11 years 10 months
Farmy
Last seen: 02/15/2013 - 18:28
Joined: 02/15/2013 - 12:09

Stay managing with less risk or 50:50 or equity share??

My husband has worked on dairy farms for 20 years and we are in a good financial position, owning our home and a small lifestyle block (well by owning it, having a mortgage on it). Husband has managed a small dairy farm for the last 10 years (220 cows) and earns a salary of around $75k (NZ). Our accountant recommends that we step up to either 50:50 or equity share, the farm owners are unsure but are prepared to listen to our proposal. We are unsure ourselves, with 3 young children and never having enough hours in the day as it is, it seems like a minefield jumping in to such a scary financial position. We have an excellent accountant and the banks seem more than willing to hand out at the moment but we aren't risk takers (obviously as still in the same place we were 10 years ago).  Now we look back and wish we'd jumped into 50:50 10+ years ago, will we look back in another 10 years and think we should have done it?!  Any advice appreciated.

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Sun, 02/17/2013 - 08:12 #2
rogermartyn
Last seen: 03/08/2018 - 21:05
Joined: 10/20/2011 - 16:16

 

Hi

In helping with some answers to your questions, I think it is worth illustrating what borrowing money can and can't do for you.

The figures I'm using have been plucked out of the air, simply to illustrate the point. Consider the following.

 

Scenario 1

Compare investing just your own capital of $10,000 in farming with no borrowings to borrowing $70,000 so enabling you to invest $80,000 in farming where in both instances, the (gross) return on investment in farming is 8% and the cost of borrowing money is 5%

 

 

 

Borrowings

$0

  

$70,000

  

Own capital

$10,000

  

$10,000

  

Amount to invest

$10000

  

$80,000

  

return on all investments

8

%

8

%

equals

$800

  

$6,400

  
         

less cost of  borrowings @

5

%

5

%

equals

$0

  

$3,500

  

nett position after borrowing costs and repayment of borrowings

$10,800

  

$12,900

  

percentage better/worse off

8

%

29

%

 

 

Scenario 2

Similar to Scenario 1 except the tides have turned against you (hard season, milk price dropped, interest rates climbed) so that now the (gross) return on investment in farming is 5% but the cost of borrowing is 8%

 

Borrowings

$0

  

$70,000

  

Own capital

10,000

  

$10,000

  

Amount to invest

$10000

  

$80,000

  

return on all investments

5

%

5

%

equals

$500

  

$4,000

  
         

less cost of  borrowings @

8

%

8

%

equals

$0

  

$5,600

  

nett position after borrowing costs and repayment of borrowings

$10,500

  

$8,400

  

percentage better / worse off

5

%

-16

%

 

 

As you can see in scenario 1, the return of borrowing by 'gearing' your own capital can be great but as scenario 2 shows you the risks work the other way too. It also explains why some overnight millionaires have become overnight paupers.

 

Where does this leave you?

It has a lot to do with your own attitude to risk and your own belief in yourself that you can deliver the goods farming wise.

If you consider your own farming skills are average or better, and very importantly, you are up to making clear headed decisions in times of adverse conditions, then I believe there is a good argument in borrowing sensible amounts of money (the banks and accountants should ensure what's sensible) and the simply getting on with the job, that's what life's about. Even in bad times, if everyone else if in the same boat, and you can demonstrate to your bank, that you're as competent as any, they are likely to facilitate a bad situation to see you through (with a nudge that is) - banks are in the business of making money, not real estate.

 

If however borrowing keeps you awake at night, and causes family fights etd, it's better off not to go there. There is no right or wrong here, it is how you're built and we all need to accept this.

 

Regarding whether to take an equity position or not, I'm a bit unsure what you mean here.

If the equity is in land, I'd tread carefully, in these times of high Aussie dollar exchange rates. Farming land will probably hold its value but unlikely to make huge capital gains if any. A banker in broad acre sector tells me farm banking activity is slow now, farms are not selling because no one wants to buy.

If the equity you're talking about is in livestock, then that might be quite different. Animals literally 'grow' into money and if you are a good herd manager, you can have a great influence over their production and therefore profit. Animals are also alot easier to cash up than land when the time comes to share the spoils.

 

With the return on land being typically just a few percent, I wonder if the real opportunities lie in leasing land and focusing your capital investments (and therefore borrowings) into readily productive activities be it milking cows, producing beef, raising crops etc, ie whatever your skills can reward you with best.

I think one of the most difficult issue here is to get fair and reasonable lease arrangements. Many landholders expect a return on their property similar to the income of a farming activity plus having capital gain, but with no investment themselves in terms of either working capital or physical input to the activity that generates the income. It can be difficult for to get them to lower their expectations and for them to get their heads around the issues. Nonetheless, I believe leasing is an area well worth persuing with good money making opportunities possible

 

I hope these comments help

all the best

 

Roger

 

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