The difference between success and failure in business is how well that business is able to manage risk. This special issue of The Progressive Farmer provides ideas for managing risk in one of the most volatile times ever in agriculture.

Reduce Your Risk With a Hybrid Lease
A flex lease may be your tool to protect against wild swings in cash rents.
By Marcia Zarley Taylor

That risk became evident this summer as commodity prices began to plummet from historical highs. In turn, potential profit margins for 2009 will be dependent in part on when the cash rent was negotiated.

Flex lease relief. These hybrid leases, part cash with a bonus formula attached, are a "risk averter" that Rob Rettig considers essential to today's high-stakes agriculture. While still a novelty in farm country, variable cash rent "solves a lot of problems by making my relationship with landlords more stable," the Napoleon, Ohio, farmer says.

"I don't have to worry about my neighbor offering to pay my landlords $5 more per acre than me. My motto is, 'Let's get a win-win situation for both landlords and us,'" says Rettig. Flex leases require a "we" mentality, he adds. "Cash rent is adversarial."

Anxieties about a 2009 cost-price squeeze are motivating more Midwest growers to convert to flexible cash rent contracts. "Otherwise, if we actually had low yields or $4 corn, we could lose money in 2009," says Ray Gaesser, a Corning, Iowa, farmer.

In the past two years, Gaesser has convinced all of his landlords to convert to flex terms, a move that could yield some stunning revenue for landowners when conditions allow.

"I told them that I knew my base rent was too low but that I'd add an incentive if they helped me keep my risks reasonable," he says. With higher prices than 2007 and what looks like 180-bushel corn and 50-bushel soybean crops in the field this year, Gaesser expects his flex landowners will come out much further ahead compared to conventional cash leases.

"For those people paying $400 cash rent in 2009 no matter what—whoa, it could be a disaster," he says. "Some of these leveraged people will go out of business before they know it."

Gaesser won't share specifics, but like Rettig he sets his bonus based on a fall harvest price. If the farmers' contracts mirror others in the industry, this risk-sharing arrangement could be worth hundreds of dollars per acre to landowners if their operators have a good year.

The Westchester Group, a farm management firm based in Champaign, Ill., is experimenting with similar formulas this year. To conform to Farm Service Agency guidelines and still qualify as a cash lease, Westchester discounted its normal cash rent, then had renters agree to pay a bonus based on either a February or October futures price—much like federal crop insurance adjusts for its harvest price option guarantees.

"If the lease had triggered at corn's high in June, the rent would have been over $450 an acre," says Murray Wise, CEO of the Westchester Group.

Wise thinks they need to refine that formula to be fairer to the tenants, but ultimately these hybrid leases could represent half of the firm's Midwest rentals within two or three years.

Record profit margins in 2007 and 2008 are stoking the cash rent fever. While many Iowa and Illinois rents hovered close to $200 during that time frame, landowners who custom farmed enjoyed net profits of $300 in 2007 and will likely capture $350- to $450-per-acre gains in 2008 based on market prices so far this year, according to several farm management firms. Even taking custom farming's higher-risk premium into account, farm managers believe that means cash rents have been underperforming by at least $50 to $100 per acre in the last several years.

"Rents have dramatically lagged from what they should have been, compared to land values; 2009 will be the catch-up year," Wise says.

Jim Farrell, president of Omaha-based Farmers National Company, says how much rents increase for 2009 may reflect how aggressively they were adjusted in the fall of 2007 and 2008. In many cases, commodity prices jumped considerably after lease terms were set. As a result, Farrell expects 20 to 25% across-the-board increases for 2009 for most Midwest properties.

On the property Westchester manages in Illinois, standard cash leases will start at $350 per acre in 2009—up from $250 to $290 levels at the end of 2008, adds Westchester's Patrick Trainor. "Last year, people paid $340 cash rents on some Champaign, Ill., properties (when corn was $4)," Trainor observes.

For legal tips and more, go to about.dtnpf.com/hybridlease