Last time, we talked about the working capital burn rate (WCBR)–a measure of how many years of losses a producer can sustain before they exhaust their working capital and have to either refinance their land to withdraw equity, or take some other drastic action. This time, I want to discuss the land equity burn rate (LEBR). The LEBR measures how long a producer can continue to take those drastic actions before all of the value of the farm is gone.

The LEBR is calculated by dividing the amount of equity the farm has in its land and buildings, i.e. their market value minus debt owed on them, by the annual loss. There are a couple of points to understand about the values used for this calculation. First, use only the equity in land and buildings–these are assets that have clear collateral value and lenders will readily lend against. Second, use the current market value of these assets–not what they were worth in 2013. Third, instead of using taxable profit use cash flow–ignore depreciation and amortization, but add in both family living expenses and debt payments, this is a better approximation of the health of the operation.

Going back to the same groups that we used last time from FINBIN, we calculated the LEBR for the three least profitable quintiles.

The least profitable quintile has an LEBR of 7.5, meaning that at the current rate of losses, there are only 5.1 years of equity left in the operation. The second quintile is in a much better situation at 11.4 years, while if the 76 years in the third quintile ever becomes relevant, there are bigger issues in the economy to worry about. Turning our attention, though, to the first quintile, these are operations with an average of 1/2 of a year of working capital, i.e. they’ve already run out of cash, and they only have 5 years left of these conditions before the farm must not only be sold, but there will be almost nothing left over after the sale. These numbers also assume that these asset values are still current. If we reduce these asset values by 10%, as might be reasonable based on changes in the past year, then the LEBR for the lowest quintile drops to only 4.4 years. On the other hand, Dave Kohl suggests ‘stress tests’ based on 25% declines in land values(!), which would drop that lowest quintile LEBR to only 3.25 years.

That is why these ratios are potentially so powerful–they put a farm’s situation in a very easy to understand single number. In an industry in which one of the primary goals is pass this operation on to the next generation, knowing how many years they can keep going ‘business as usual’ can be powerful, and powerfully upsetting.