How to be sure it is fair for the landowner and tenant
March 14, 2016
A cash land lease is a simple method of permitting one party to farm lands owned by another party. The tenant pays rent to the landowner, farms the land, and receives all of the income generated by the crop produced. For practical purposes the landowner takes no role in the tenant’s farming activities.
Landowners and prospective tenants may consider entering into a crop-share lease of farm land rather than a cash land lease.
Crop-share leases have existed in various forms for centuries. In a crop-share lease, the landowner and the tenant divide the farming inputs among them.
It is, in effect, a joint effort by the landowner and the tenant.
Reasons to consider a crop-share lease
For the landowner, a higher rate of return on its investment in the land may be available because the landowner is entitled to a portion of the income generated by the crop produced. For the tenant, up-front costs are reduced as the tenant may avoid a cash payment to the landowner at the outset as would be necessary in a cash lease arrangement. Less up-front cash may especially benefit new or younger farmers with fewer financial resources.
Before entering into a crop-share lease, the landowner and tenant should consider that the benefits come at a cost. The landowner will be exposed to more risk as the landowner has invested funds in farming operations, and by the nature of the crop-share lease, the landowner will necessarily be more involved in farming and planning operations. The tenant may receive a lower overall return due to the share of the crop paid to the landowner.
A lease that is fair to both sides
If the landowner and the tenant wish to enter into a crop-share lease, the landlord owner and tenant should strive to create a lease that is fair to each of the parties. Of course, the parties can agree to any legally permissible terms they desire, but for a lease to be fair to the parties, the return to each of the parties should match what the parties each contribute to the operation.
Prior to entering into the lease the landowner and tenant should prepare a list of what each party is to bring to the operation and the budgeted costs for each. For example, the landowner will contribute the land to the enterprise, and would also typically be responsible for real estate taxes and any required maintenance of the land. All other costs, such as machinery, repairs, fertilizer, seed, fungicides, insecticides, are typically contributed by the tenant.
Value of contributions
Assigning a value to the landowner’s contribution of the land can be done by first determining the current fair market value of the land for agricultural use. After value is determined, a percentage rate (generally 4-7%) is multiplied by the fair market value of the land to determine the annual value of the landowner’s contribution of the land. A simpler method to determining the value of the land, or a method that could be used to confirm that the annual value of the landowner’s contribution of the land is reasonable, is to determine what similar land in the area was recently leased or is currently offered for lease on a cash lease basis.
After the landowner and tenant have determined all of the contributions to the enterprise and identified the responsible party for each cost, each party’s respective contribution is then divided by the total amount of contributions to the enterprise by the landowner and the tenant. The resulting fractions are each party’s portion of the yield. For example, if the landowner’s contribution to the enterprise is $20,000.00 per year, and the tenant’s contribution is $80,000.00 per year, the landowner would then be entitled to 1/5 of the yield of the enterprise ($20,000.00/($20,000.00+$80,000.00)), and the tenant would be entitled to the remaining 4/5.
If entering into a multi-year lease, the parties should attempt to incorporate flexibility into the lease so that as costs change, equipment is replaced, and other factors affect the lease relationship, each party’s percentage changes.
If a landowner and a prospective tenant are considering entering into a crop-share lease of farm land rather than a cash land lease, a careful determination of each of the party’s contributions to the partnership, and an allocation of the proceeds earned from the partnership, will go a long way toward creating a lease that is fair to each of the parties.
Jay Hoodenpyl is a real estate attorney who practices with Nexsen Pruet's Agribusiness team. He regularly provides guidance to landlords and tenants on matters such as commercial lease agreements, acquisitions, sales and development.