Excess Farm Indebtedness: Not a Sustainable Practice

“Farmers should not depreciate their soil biological capital, nor their financial capital.”
-A New Jersey Farmer

moneyfallWhen farms fail, causes usually include financial resources, as well as the natural resources that farms depend on, like water and soil. It often goes unrecognized that farm financial resources and natural resources are intimately linked; both contribute to and are required to sustain a healthy farm. Excessive debt and resource degradation are both unsustainable practices. Of the two, resource degradation is widely discussed and investigated. However, historically indebtedness has been our country’s leading cause of agricultural sustainability failure.

All Farming Resource Costs & Market Prices are Distorted

How does society value farms and farm products currently. On one hand, we know farms provide local food, open space, beauty, ground water recharge, freedom from sprawl, and wildlife habitat. However, these public benefits are never included in the prices we pay when purchasing farm products or selling farmland. Likewise, public policies often ignore and distort economic externalities. Economic externalities are the hidden long-term costs of farming resource degradation (e.g., sprawl, large lot development, soil erosion, over-grazing, or ground water depletion). We don’t factor these into the market prices we pay for farm products either. Consumers expect the farmer or the environment to absorb these costs. In this manner, all farming resource failures are, at their root, economic.

Urban fringe farms, as isolated islands of production located on expensive land with higher regulatory burdens and production costs, are less able to absorb these hidden costs. The urban fringe farmer needs to be especially skilled in debt management. An astute farmer said, “You can’t express a sustainable farming vision from an empty checkbook.”

Farming Endeavors Don’t Mix With High Debt-To-Equity Leverage

Debt-to-equity ratio is a quick measure of financial leverage risk, helping to assess a farm’s long-term viability. Farms frequently use owner equity plus borrowing to finance farm acquisition, long-lived improvements, operating expenses, or equipment. Debt-to-equity ratio is simply total farm liabilities divided by farm owners’ equity (measured differently than for public companies, which might only factor long-term debt liabilities and shareholders equity). Borrowing has multiple benefits when farming returns on debt far exceed costs. Modest debt enables farmers to use their farming resources efficiently. For example a farm may need to construct direct marketing building improvements or to buy conservation tillage equipment; both are long-lived expenses that improve using a farm’s resources.

What Lesson Does Sustainable Farming History Teach Us About Debt?

While there are no firmly established rules for acceptable debt-to-equity leverage, successful farms operate with very low debt. This is revealed in Table 1, which shows how leverage risk changes dramatically with just modest debt changes. Farms with debt exceeding 60-65% of capital (that is, leverage of 1.8:1 or above) are less viable over the long-term. They are not resilient when facing the five resource risks buffeting farms: Production, Economic/Financial, Markets, Human, and Legal. Yes, human management and a predictable legal framework, like property rights, are essential farming resources too.

Table 1: Leverage Changes Dramatically With Modest Debt Changes

% Debt % Equity Debt-to-Equity Leverage Ratio May be found in:
110+ -10+ Incalculable Wall Street & Investment Banking
100 0
97 3 32:1
95 5 19:1 Beginning homeowner or consumer. Hopefully not a beginning farmer!
90 10 9:1
80 20 4:1
75 25 3:1 Beginning or established farms. Main street enterprises.
65 35 1.8:1
60 40 1.5:1
50 50 1:1
25 75 .33:1 Farms & enterprises on durable path, able to withstand uncertain risks.
10 90 .11:1
0 100 0 Rarely seen. Note that eschewing all debt is usually not resource efficient since most businesses require some amount of investment.


Interestingly, farms are far less viable with leverage that non-farming wage earners feel comfortable living with. As shown in Table 1, if you purchased a family home (or farm or farmland) with a 20% down payment and 80% mortgage, you begin with 4:1 leverage. This is more than double the leverage even a beginning farmer should be operating under. What happens if you pay off just 5% of debts–to 75%? Leverage declines from 4:1 to 3:1, a big move. If your family or farm reduces debts another 15%–from 75% to 60%–you cut leverage in half, at 1.5:1. Conversely, if you began with 10% equity instead of 20%–seemingly not a great difference–you farm with double the leverage risk of 9:1. If you bought a house with 5% down, you began your ownership leveraged 19:1! Leverage ratios guide us in lessons about sustainable farming, about life, and even the fate of nations.

How Many Risks Can Any Farm Withstand?

A well-managed and financed farm is able to withstand adversity from one, maybe two, of the five risks at once. When two or more risks bear on a farm at the same time, only the lowest indebted will remain viable. It is unstable stewardship to saddle farms, buffeted by volatile short-term biological and resource uncertainties, with long-term, “time certain” financial liabilities. Excessive leverage prevents farms from adapting to changing farming technologies or markets. Like any enterprise, leverage subjects a farm to rising interest payments during periods of rising rates. But, farms are additionally subjected to unpredictable natural calamities like hail or flood, drought or frost, unpredictable declines in prices from surpluses, sudden loss of markets, and other failures. While higher leverage is beneficial in predictable enterprises, it is a key association with unsustainable farms.

Implications For Starting Your Commercial Urban Fringe Farm

An observation from successful low debt-to-equity farms is that a sound path to starting farming includes training for a higher earning non-farming profession first. The future farmer saves a “grubstake” to begin their farming vision with equity, not debt. Many aspiring farmers and ranchers are anxious to gain their hands-on internships first, because farming skills must be learned from apprenticeship experiences. However, as essential as practical “how-to-farm” vocational experiences are, they should remain a secondary training avocation for the aspiring farmer until farming investments begin. There is no path to farming sustainably when saddled with high debt.

Another observation from successful low debt-to-equity farms is that the beginning farmer may do better leasing land rather than purchasing a farm. Land costs in New Jersey, despite all the legislative efforts to stabilize them, continue to rise relentlessly. The average value of improved farmland in our state is $15,346 per acre while the national average is $1,892. Farmland sales prices have two components: the farming value plus the speculative value for alternative uses. On the urban fringe, the speculative value of farmland far exceeds the farming value. When purchasing land to farm, speculative value can represent 80% of the price per acre, making farmland purchases prohibitive to many aspiring farmers. Due to our extraordinarily high urban fringe farmland prices, the future must include policies “taking farmland equity off the table’” since this is a barrier to entry for a younger new generation of farmers. The next generations of urban fringe farmers, and farmland owners, must design alternative leasing arrangements so beginning farmers can start on rented farmland, with longer-term 10-20 year incentive leases. These leases must not overly dictate farm management practices. Leases should offer flexibility and freedom for wildlife damage control, constructed investments, pest management, and associated needs.

Don’t Farm-Away Your Urban Fringe Land Equity

Urban fringe farmers have experienced decades of rising land values. Some farmers were tempted to increase their borrowing based on the value of their land rather than farm profits. Those farmers who did not raise sales per acre, improve marketing efficiency, and increase repayment ability, became known as “equity farmers.” Their farmland assets, appreciating faster than the farm was losing money, masked underlying problems…for a while. When land use policies changed, like down-zoning or regulatory takings, and reduced their equity value, their debt-to-equity ratio became excessive and the farm was no longer financially viable. Inter-generational transfer of the farms was weakened by excessive debt. Further, the exit strategy of selling the farmland for alternative uses was often removed without compensation. Sound business practices are a requirement for sustainable urban fringe farming.

The Bottom Line

  • Excess debt and resource degradation are both implicated in unsustainable farming.
  • The public benefits and real costs of farming are not fully included in farm product prices at the present time. This is a hidden financial burden for urban fringe farms.
  • A debt-to-equity ratio can quickly help measure a farm’s ability to withstand adverse conditions and remain viable.
  • A farm with debt exceeding 60% of total capital is significantly less viable over the long term.
  • Debt adds risk to farms already operating with unpredictable risks from natural calamities, markets, and changing technology.
  • Successful farms operate with debt-to-equity ratios far lower than other business endeavors.
  • Indebted urban fringe farms have difficulty with inter-generational transfers.

What You Can Do

  • If you plan to enter farming, train for a good job first and save money to start your farm.
  • Farm part-time until you have sufficient equity to launch full-time farming.
  • Start acquiring used equipment before you buy a farm. Learn how to operate and repair it.
  • Operate on long-term leased farmland until you can afford your own. On rented land, a farmer can begin farming with as little as $25,000 to $80,000.
  • If you are an agriculture or land use professional, get involved with the policy need for “taking farmland equity off the table” as a cost barrier to entering urban fringe farming.
  • Avoid excess indebtedness. Adhere to conservative borrowing practices found on successful farms.
  • Farmers with the best balance sheet get the best loan terms. Keep the farm smaller until you have a proven record of positive net farm income.
  • Borrow for farm growth with longer loan maturities at fixed low rates.
  • Avoid short-term, variable rate loans to finance your farming operations. If you must, keep these loan amounts small.
  • Don’t buy (or inherit) mediocre farmland in a poor location. Exercise patience when acquiring land so that your farm will be as productive as possible. Consider soil, slope, micro-climate, irrigation access, and market access.
  • Once you own land, don’t farm-away your land equity. Borrow based on true repayment ability, not equity value.
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