Flexible leases offer benefits for producers, landowners
Feed costs, including pasture lease, are the biggest expense in raising cattle. The problem facing many producers is that lease rates don’t adjust as quickly as market prices do, leaving them with thin margins, in the red, or forced to de-stock when cattle prices drop.
Market fluctuations have become more of an issue in recent years, since cash rental rates paid by cow-calf and stocker producers have trended up over the last 15 years. The University of Nebraska-Lincoln Department of Agricultural Economics has been tracking rental rates annually since 1981, on a price per cow-calf pair per month.
According to Jim Jansen, agricultural economist, Department of Agricultural Economics, University of Nebraska, a cow-calf pair is typically considered 1.25 to 1.30 animal units (an animal unit being a 1,000 lb. animal). However, this can vary depending on weight of cow and age of calf. On average across Agricultural Statistics Districts in Nebraska, the rental rate for one month of summer grazing is $57.64 per cow-calf pair. Using a herd of 300 cow-calf pairs as an example, and a 5-month grazing season, total pasture costs would conservatively be $86,460 not including mineral supplements or additional feed.
One problem with pasture rental rates is that they are relatively fixed within a given year and have trended upward over time. This benefits the landlord, providing a steady stream of income, but is detrimental to the cattle producer whose income varies with cattle market cycles and weather conditions.
Creating flexible grazing leases is one alternative becoming more popular among producers and landlords. In these agreements, cow-calf pair per month rental rates are allowed to flex within a predetermined range, conditional on one or more market factors that may include animal performance, market conditions, and/or grazing land productivity.
“Flexible cash leases in the crop industry tend to focus on elements of risk like crop yields, crop price or a combination of the two. On grazing land we generally don’t have a way to measure yield or a direct price for grass. The elements of risk, and the price associated with leasing the property must be related to the animals grazing it,” said Jansen.
If you are a cow-calf producer and concerned about calf prices in the fall, you are interested in what that calf is worth in the spring versus what it brings in the fall.
Another example might be calf weight. “In our area people typically haul cattle to pasture and transport cows and calves separately for safety. They could weigh calves before they go on grass, and weigh them after they are taken off the grass. A person might have some historical benchmark for typical rate of gain. This could be considered the ‘yield’ on the property,” said Jansen.
Another concern might be rainfall. If you know the typical rainfall in the area, this might be helpful, but this is a little harder to measure.
There needs to be a determination regarding what is typical for the area, whether rainfall, rate of gain, cattle prices, etc. “A person needs a base expectation, though we may not know what is typical in terms of prices. In the spring, if you look at futures markets, however, you might get a sense of what is typical, to build a flex lease,” he explains.
“One example is looking at percentage of change. When you put calves out on pasture in May, you look at the futures price. Let’s say feeder cattle futures indicate calves will be worth $150 a hundredweight when you take them off grass in October or November to sell. Come fall, we sell the calves and maybe the price is not $150. Maybe it ends up being $165. That’s 10 percent higher than we anticipated,” Jansen said.
“In Nebraska a common pasture lease would be $250 per pair for 5 months grazing. In some western states this might be $200 per pair for 5 months. If your calf prices are 10 percent higher than what you predicted, you’d end up adding another 10 percent (or $20) to the final cash rent—so you’d pay $220 per pair,” he says.
If prices in the fall are not as good we hoped, the cash rent would drop. “Let’s say calf price drops from $150 to $135 (10 percent lower—or $15 per hundredweight less). Deducting 10 percent off of $200, the final rent price would be $180,” he said.
“As part of a true flex-lease we need a ceiling and a floor to have a maximum and minimum. The landowner would not want to rent pasture if there’s a chance of getting zero dollars for some reason, and the stockman might not want to rent if the price of pasture goes up too much. The lease needs to protect both parties, so you establish a range.” If the base cash rent per pair is $200, maybe you’d put the maximum at $230 and minimum at $170.
If you are concerned about number of days you can graze, this could be another variable. In some situations—including drought—the grazing season may be shorter than average. “Let’s say the per-pair rate is $200 for 5 months (150 days) and you end up only grazing 120 days, or 80 percent of what you’d hoped for. You would discount the cash rent. And if you graze longer than 150 days, you would increase the cash rent to reflect the proportion of time,” Jansen said.
There are two strategies for dealing with drought. “You might run the same number of cattle you typically do, but cut the time period. Or you can reduce the number of cattle and still graze the typical length of time,” said Jansen. In a flexible lease, a seasonal rate could be converted to a daily rate; the cattle producer only pays for the actual number of grazing days.
Rate of gain is a little trickier adjustment. “People who keep good records might have some of that information. Basically it just comes down to whatever the two parties agree upon,” he said.
Elliott Dennis, assistant professor, Livestock Marketing, Department of Agricultural Economics (University of Nebraska-Lincoln) says some of the risks are insurable, to mitigate some of the risks for the producer. “We are essentially paying someone to take on that risk for us; it’s not that the risk has disappeared; someone else has assumed the risk,” he said.
“Basically we are passing the risk to someone else. A classic example would be if you have a mortgage on a home, you would buy home insurance. The bank transfers the potential of losing the asset to the insurance company and they guarantee that if your home gets destroyed the payout would go to the bank,” he explains.
“With livestock products, we are generally looking at futures and options. In this case it would be livestock risk protection, which essentially sets a floor price. If people are flexing on the feeder cattle index, if there’s a 7 percent decline in that index, the producer would pay 7 percent less in grazing lease fee. The benefit is that we can make up some of that 7 percent by receiving indemnity payments,” Dennis said.
“In down years we pay less because we have less money coming in, with the low markets. We don’t want periods where we have high costs and low income. That’s the nice thing about flexing it on our revenue rather than on our costs.”
A benefit of linking rental rates to market conditions is that most of these market risks are insurable. The grazing season may be unpredictable, but there are opportunities to lock in profits for producers who are watching the markets and have a good idea about their cost of gain. Looking long-term, some producers may benefit from establishing flexible grazing leases tied to market conditions that are insurable with a market-based product such as CME (Chicago Mercantile Exchange) futures options, USDA LRP (Livestock Risk Protection), or other pasture and rainfall insurances offered from USDA. The tenant could use the USDA-RMA (Risk Management Agency) subsidized Livestock Risk Protection product on the day cattle are placed on grass to insure against a drop in price.
“One of the benefits for the person renting pasture is that he/she can defer some of those higher costs until a later day when they have more income. The benefit for the landlord is that it helps ensure having a long-term renter who won’t go out of business. Renting pasture tends to be location-specific; there are usually a limited number of people who could potentially rent that land,” Dennis said. If you have a good renter you’d probably prefer to stick with that person even if some years you get less income.
The two parties can decide what the limits would be—with a floor and ceiling; the pasture rental rate can’t go above or below specific amounts. “This is helpful for both parties—cost control for the livestock producer and income protection for the landlord.”
Communication beforehand is important. “The rental agreement always starts with a conversation. There are benefits for both the landlord and the person renting the pasture, but they need to start that conversation to see the possibilities and what they want to agree upon that would be satisfactory to both parties,” he said.