By: Paul Dietmann
Senior Lending Specialist, Compeer Financial
As they begin the process of searching for their first farm, the question of affordability arises in the minds of farmers. Should they be looking at farms in the $300-400,000 range, or can they afford something priced at $800-900,000?
The answer to this question consists of three parts:
1) Cash available for the down payment
2) Cash available for any necessary improvements to the farm after purchase
3) Cash flow needed to make payments on the new real estate loan.
Creating a balance sheet is the first step in answering the affordability question. In particular, we want to calculate the farm’s net working capital position. Net working capital is the farm’s current assets (cash and other short-term assets) minus its current liabilities (any debts due now or within a year such as credit card debt). We want to make sure the farm operation has a threshold amount of net working capital to withstand any unexpected setbacks. Anything above that threshold is considered to be cash available to invest in new farm real estate.
(For a more in-depth discussion of farm balance sheets and the calculation of important financial measures such as net working capital, please see The Land Connection’s publication Financial Risk Management for Specialty Growers.)
The amount of cash needed for down payment may be lower than many first-time farm buyers fear it will be. If a farmer and the property she or he is buying qualifies for assistance under the USDA Farm Service Agency’s Beginning Farmer Down Payment Program, the required down payment is only 5%. Under this program, USDA-FSA will finance 45% of the purchase at a 1.5% fixed interest rate on a 20-year note. A commercial lender will finance the remaining 50% on a 30-year fixed rate note, often at a discounted interest rate.
A 5% down payment requirement certainly helps beginning farmers purchase their first farms. However, sometimes an issue pops up after the transaction closes. Significant work may be needed on the house or outbuildings and, with only a 5% equity position in the real estate, there is no ability to borrow additional funds to complete the work. In this situation, the farmer will need to have cash available for any projects beyond the purchase of the farm.
If a farmer has saved up the required down payment and other funds needed for farm improvements, the next step is assessing the farm’s cash flow. A lender will typically ask for a projection of cash flow for the year following the farm purchase. There needs to be enough cash available from farm income plus nonfarm income to cover all operating expenses, family living expenses, existing loan payments, new farm loan payments, replenishment of working capital reserves, and a bit of cushion after all of these other demands on the farm’s cash.
Without having a specific farm purchase in mind, it can be a bit difficult to put together a cash flow analysis and give a farmer an accurate “here’s the most you can afford to pay” number. However, if the farmer has a good idea of the acreage, facilities and location of their dream farm, a lender should be able to come up with a ballpark estimate of the affordable purchase price.
Purchasing your first farm can be an exciting and terrifying experience. An accurate balance sheet, a cash flow projection, and a rough upper limit on purchase price can help a farmer approach the process with confidence.