By Chris Zoller and Barry Ward et.al
Thousands of Ohio crop acres are rented from landowners by farmers. While the most common is likely a cash agreement, the flexible lease may be worthy of consideration for some farmers. This article will provide a broad overview of the flexible lease option, including advantages, disadvantages, and strucutre.
The information provided here is only a summary from the Fixed and Flexible Cash Rental Arrangements for Your Farm published by the North Central Extension Farm Management Committee. Anyone interested in learning more about flexible leasing arrangements is encouraged to read more about this topic at this site: https://aglease101.org/wp-content/uploads/2020/10/NCFMEC-01.pdf.
What is a Flexible Lease?
Because of uncertainties with prices, yields, and input costs, some farmers and landowners are apprehensive about entering into a fixed long-term cash rental arrangement. From the perspective of the farmer, the concerns include poor yields, commodity price declines, or sharp increases to input prices might impact cash flow if there is a long-term fixed arrangement. In times like we are experiencing now, landowners want to capitalize on high commodity prices or high yields.
Therefore, the operator and landowner may turn to the use of a flexible cash rent of one kind or another. The idea of a flexible cash rent usually pertains only to the rent charged for cropland.
Advantage of Flexible Leases
- Flexible cash rent enables the landowner to share in the additional income that results from unexpected increases in the prices of crops considered in the rent-adjustment clause. If the cash rent also is flexed for changes in yields, the landowner will benefit from above-normal yields regardless of the cause.
- For the operator, risk is reduced. Cash-rent expense is lower if crop prices or yields are less than normal.
- Calculating flexible cash rent requires more communication from both parties.
Disadvantages of Flexible Leases
- For the landowner, flexible cash rent increases risk.
- Windfall profits that may be realized by the operator from unexpected price increases are reduced.
- If cash rent is flexed according to yield, the landowner becomes more concerned with the level of crop yields as well as the accuracy of reported yields. Yields must be verifiable and segregated for each land unit in the lease.
- If cash rent is flexed according to yield, the operator may give up part of the benefits from higher yields resulting from managerial input, thus possibly reducing incentives to maximize profits.
- Calculating flexible cash rent requires more management from both parties. There must be agreement on how to verify the factors that are used to set the rent each year.
Methods of Flexible Leasing Arrangements
Crop Price Only - Rents that flex only on price increase risk substantially for operators. A short crop that leads to higher prices and higher rent may leave the operator with less ability to pay.
Yield Only - With some commodities crop yields are highly uncertain. In other cases, the crop that is grown may only be fed to livestock, so no relevant market price exists. In such cases producers may prefer to negotiate a flexible lease agreement that bases the annual rent solely on the actual yield achieved.
Flex for Price and Yield - This method requires the operator and landowner to agree on a base cash rent tied to a base yield (average or expected yield) and a base expected price for each crop being considered. If only one crop is grown, this is the only crop considered. If several crops are grown and all are considered equally important, all crops may be considered in determining the current year’s cash rent.
Flex for Change in Cost of Inputs - The cost of variable inputs can change significantly from year to year and cause large swings in profitability. Incorporating a factor that reflects a ratio of the base year’s cost of inputs divided by the current year’s cost of inputs will help stabilize the bottom line for operators.
Put the Agreement in Writing - If it is decided to use some form of flexible cash rent (or any form of rental agreement), the details of how the rent will be determined should be clearly specified in a written lease agreement.
Source : osu.edu