Beef Cow Rental Arrangements

AGRICULTURAL ECONOMICS Beef Cow Rental Arrangements Kevin Dhuyvetter Department of Agricultural EconomicsKansas State Universitykcd@ksu.edu -- 785-532-3527 Damona Doye Department of Agricultural EconomicsOklahoma State Universitydamona.doye@okstate.edu -- 405-744-9813

Loan Payments for a $2,000 Cow Purchase at 6% Interest

Ag leasing resources… • www.aglease101.org(lease-related information developed as part of a North Central Region project) NCFMEC-01 – Fixed and Flexible Cash Rental Arrangements for Your Farm NCFMEC-02 – Crop Share Rental Arrangements for Your Farm NCFMEC-03 – Pasture Rental Arrangements for Your Farm NCFMEC-04 – Beef Cow Rental Arrangements for Your Farm All bulletins include examples and fillable forms and in some case reference supporting spreadsheets that are available.

Beef Cow Rental Arrangements For Your Farm (NCFMEC-06) and KSU-BeefCowLease.xls spreadsheet  Identifies questions to answer, discusses factors impacting equitable arrangement, and includes examples of leases and worksheets that can be used for individual operations. Basically does all the math behind the worksheets shown in NCFMEC-06 

Breeding Livestock Share Leases Advantages to livestock operator: • Makes use of working capital without tying up capital for breeding livestock • Obtain capital over and above the limits of credit agencies • Borrowing of capital at a fair rate of interest (assuming the lease is equitable) • Permits an increase in the volume of business • Helps the beginning operator get started in livestock production • Provide return to labor if the operator is underemployed • Share the risk of the operation with the owner

Breeding Livestock Share Leases Advantages to livestock owner: • Can maintain a breeding herd even though labor is not provided • Provides a source of rental income • Provides an opportunity for returns on capital investment • Means of transferring ownership over a period of time • Possible income tax and social security advantages

Breeding Livestock Cash Leases Advantages to livestock operator: • Generally operator has full control and responsibility for management decisions • Benefits from above average prices and production Advantages to livestock owner: • Provides a fixed income without any operating expenses • Possible income tax advantages Often viewed as easier than share leases. Are they?

Determining the terms of a lease ... How are cash lease rates or the terms of livestock share leases established? P S Cattle owner Producer D Q

Economist’s definition of “FAIR”

A good crop share lease should follow 5 basic principles 1. Yield increasing inputs should be shared 2. Share arrangements should be adjusted or re-evaluated as technology changes 3. Total returns divided in same proportion as resources contributed 4. Compensation for unused long-term investments at termination 5. Good landlord/tenant communications

Determining equitable shares… • Identify all costs to be included • Identify the costs contributed by each party and the costs to be shared • Calculate the percent of total costs contributed by each party When all three factors are determined, the owner and operator should share income in the same proportion as they contribute to the operation.

Other factors to discuss… • How will replacements be handled? • What about pasture, crop ground, machinery and equipment, buildings, etc.? • What is acceptable death loss and how will death loss be documented and shared? • Condition of cows when returned, breeding and vaccination programs to follow. While there is no right answer that fits every situation, it is generally recommended to keep replacements and other assets out of the cowherd lease.

Other factors to discuss… • Quality and usefulness of contributions • Owner may have buildings and equipment that served him or her well, but are of little value to the new operator’s management plan. • Quality and value of assets can vary considerably (e.g., genetics, age, and condition of cows). • Negotiation and communication skills are essential to resolving disagreements of the value of such contributions. • Is management considered a contribution, who provides it, and how is it valued?

Basic Principles • Economies of size: What costs should be used to value contributions?

Basic Principles • In competitive industries, Price = Cost(on average in the long run) • Difficult concept for many to grasp • Opportunity costs often are not considered • Even competitive markets can deviate from this principle for relatively long time periods • Can be multiple year time periods when one party appears to be getting a better deal

Cow-calf profitability drivers… • Analysis of KFMA cow-calf enterprise analysis returns • 1979-2011 all operations(examine time effect) • 2007-2011 operations withat least three years of data(examine producer effect) • Paper available on web(www.agmanager.info)

Average returns are highly variable over time… Avg = -$101.34 and Std = $85.91(top 1/3 = -$8.29 and bottom 1/3 = -$199.09  $190.78) Source: Kansas Farm Management Association (KFMA) Annual Enterprise Analysis Reports

Returns are more variable across producers…

Beef Cowherd Lease Analysis Example of equitable shares calculated using KSU-BeefCowLease.xls spreadsheet and costs from KSU budgets. Note: given inputs entered for share lease, the spreadsheet also calculates cash lease values using various methods as well.

Example – avg costs • Replacements purchased or raised outside of the lease • Owner provides breeding stock (cows and bulls) and portion of misc costs • Vet, drugs, and supplies shared equitably • Operating costs based upon MF-266 (KSU) • Total cost = $1,129Equitable split = 68.0/32.0

Example – high costs • Replacements purchased or raised outside of the lease • Owner provides breeding stock (cows and bulls) and portion of misc costs • Vet, drugs, and supplies shared equitably • Costs based upon MF-266 (KSU) with adjustments to reflect low 1/3 profit group • Total cost = $1,227 (+$98)Equitable split = 70.4/29.6

Example – low costs • Replacements purchased or raised outside of the lease • Owner provides breeding stock (cows and bulls) and portion of misc costs • Vet, drugs, and supplies shared equitably • Costs based upon MF-266 (KSU) with adjustments to reflect high 1/3 profit group • Total cost = $1,030 (-$99)Equitable split = 65.1/34.9

Determining equitable shares… So, what is the “right” answer? • Average cost operator = 68/32 (operator/owner) • High cost operator = 70/30 • Low cost operator = 65/35

Basic Principles • Competition: We observe owners getting a larger than “fair” share • Difficulty in accounting for all costs • Willingness of operator to sell labor and capital at below market rate • Low cost operators sharing their advantage with owner via higher rent (i.e. it is “fair” rent) • Local “thin” market conditions

Basic Principles • Non-Profit Motivations • Motives other than profit appeal to beef cow-calf livestock industry participants • Retiring generation may simply want to “help out” the younger generation

Other Issues/Considerations… • Written leases are strongly encouraged • More detailed thought process • Reminder and guide • Spell out annual negotiation, termination, etc. • What is the motivation for the lease? • Is everybody on the same page? • Communication is key! • Expectations of parties need to be clear and realistic

For more information and decision tools related to leasing, go to AgLease101or aglandlease.info or beefextension.com Thank You!

Beef Cow Rental Arrangements