The Illinois State Board of Investment has fired its longstanding farmland investment manager and plans to sell its $46-million farmland portfolio, citing high management fees and low returns. Though the holding is relatively small for an institutional investment, the exit is notable since the Board, which oversees $15 billion in pension assets for legislators, judges and other state employees, was among a handful of early public retirement funds to venture into agricultural real estate. The Board originally hired specialty manager Cozad/Westchester Agricultural Asset Management¹ in 1990 to invest $50 million in U.S. row-crop land.

The Board’s current “permanent” cropland portfolio includes almond, wine grape and citrus land in California, and wine grape, apple and cherry property in Washington. The portfolio is highly concentrated—by both geography and crop—with 90% of the assets in California and 75% of the assets held in wine grape and almond properties. Through June 30, the portfolio has generated a 5.6% annual net return since 1998, according to an August memo by Marquette Associates, an investment consultancy hired by the Board that recommended terminating Cozad/Westchester. The Board’s farmland return is in sharp contrast to the average 15% annual total return before fees reported over a comparable period for 69 permanent crop properties worth $388 million in the NCREIF Farmland Index. The Index is compiled by the National Council of Real Estate Investment Fiduciaries, an investment manager trade group.

Part of the performance lag comes from Cozad/Westchester’s fee structure, which includes an annual 0.80% investment management fee against the properties’ fair market value, and an annual 1.8% property management fee on gross income from crop sales. Cozad/Westchester also negotiated an incentive fee of 5% to 15% of the two-year average portfolio net income in excess of 5%.

Still, those fees don’t explain the yawning 9.4 percentage point return gap between the NCREIF Index for permanent crops and the Board’s portfolio. Stuart Meacham, Chief Operating Officer at Cozad Asset Management, didn’t respond to multiple requests for comment.

There is a dearth of practical performance data when it comes to tracking farmland investments. Investment promoters are often quick to highlight the compelling returns reported in the NCREIF Farmland Index. For the 15 years through June 30, the Index reports a 13.8% annualized return before fees. At mid-year, the Farmland Index included 539 properties valued at $4.6 billion. That’s less than a 2% slice of the estimated $2.5 trillion U.S. farm real estate sector. In addition, permanent crop properties, which typically generate higher income yields, comprise 34% of the value of the Index while such properties are estimated to make up no more than 20% of the overall U.S. farmland market. And because the Index is calculated at the property level before management fees, it doesn’t reflect the results generated by farmland investment managers.

Farmland Index Overstates Returns

In addition, the NCREIF Farmland Index excludes the typical three-to-seven-year development period required for new permanent crop properties to reach commercial production levels. As a result, NCREIF overstates the Index return and misrepresents the returns that investors can expect to achieve, contends Marquette Associates in its August  Board memo summarizing farmland investment return characteristics and structural challenges.

Scott Richards, a senior portfolio manager at the Illinois Board, notes that private equity indexes do not exclude development periods from their return calculations. “These [NCREIF Farmland Index] returns look so great, but you are losing money those first three to five years, and it doesn’t go into the index,” he says. “To me, it is gaming an index.”

“The index is designed to understand how operating properties are performing,” says Dan Dierking, NCREIF’s chief information officer. “It’s not necessarily an investment benchmark.” NCREIF previously published investment returns for development properties in its detailed report, but ended that practice around 2005 to mask the results of Hancock Agricultural Investment Group, which was then the only manager contributing data on development properties. Though NCREIF continues to collect development property return data and now has multiple managers reporting development returns, it hasn’t resumed publishing the performance results.

The Illinois Board’s initial entry into farmland consisted of a portfolio of 25,456 acres of annual row-crop land in Illinois, Indiana, Ohio, Colorado, Mississippi and California, which was leased to local farmers for rental income. In 1998, the Board turned its attention to opportunistic real estate investments and moved to liquidate the row-crop holdings. The investment wound up in 2002 and generated $28 million in net earnings—a 7% internal rate of return or 4.2% after adjusting for inflation, according a Cozad/Westchester document.

Permanent crops such as nut and fruit trees and grapevines are typically long-life assets that require three to seven years after planting to produce a commercial crop. While NCREIF collects return data on development properties, its Farmland Index omits the results of these non-income producing development years in its published returns. The Illinois Board’s permanent crop investment was a net loser for at least its first six years, according to data obtained from the Board in 2005.

The Board then re-invested half the proceeds in 1999 with Cozad/Westchester to develop a new permanent cropland portfolio dubbed Premiere Partners V. Westchester bought 1,700 acres in California, Florida and Washington and developed the land into the groves, vineyards and orchards that make up the Board’s current portfolio. (A 531-acre DeSoto County, Fla. pasture parcel purchased in 2001 for $730,600 and developed into a 409-acre orange grove was sold in 2006 for $4.85 million.)

The lengthy gap between the Board’s initial investment and when the new tree and vine plantings began producing a commercial crop made Premiere Partners V a net loser through at least its first six years, according to a 2005 Board response to an inquiry by Mercator Research on the portfolio. ■

¹Cozad/Westchester is a legacy partnership of Cozad Asset Management and Westchester Group in Champaign, Ill. Westchester manages more than $3 billion in farmland property, consisting of over 650,000 acres across the U.S and Australia. New York-based asset manager TIAA-CREF purchased an 85% controlling stake in Westchester in 2010.
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Prices for high-quality cropland remain stable across most regions, despite lower prices for many crops compared to year-ago levels. Crop prices had been falling due to early reports of very strong crop yields and expectations for high yields in regions where harvest is just getting underway. However, since early October, corn and soybean futures prices have risen as farmers hold back their crop for later sale. Federal Reserve Districts in Chicago, St. Louis, and Kansas City report very good crop conditions at the beginning of harvest. Chicago and Minneapolis expect large corn and soybean harvests. Drought conditions persist in parts of the Atlanta, Dallas, and San Francisco Districts, but have improved with recent rains. Atlanta, Chicago, Minneapolis, and Dallas note that livestock, poultry, and dairy producers are benefiting from increased output prices and lower feed costs.

Prepared by the Federal Reserve Bank of Chicago and based on information collected through November 24, the Beige Book summarizes comments received from businesses and other outside contacts.

The following is a Fed region-by-region summary of farm sector economic conditions, starting in the Mid-Atlantic and moving west:

Richmond—Agribusiness conditions remain stable. A grower in South Carolina completed peanut harvesting, and one in West Virginia finished wheat and cover crop harvesting. Dry weather in eastern Virginia has delayed tree harvests. A North Carolina contact reports higher year-over-year orders for Christmas trees from big-box stores. Soybean harvesting was half-completed in South Carolina and in West Virginia, where yields are above average. Demand for wood pellets is up. Farmers are reporting lower crop prices and higher poultry, cattle, and swine prices compared to a year ago. Input prices have risen since the previous report. Some growers plan fewer equipment purchases relative to a year ago

Atlanta—Large parts of Alabama and Georgia—and to a lesser extent, parts of the Florida panhandle, Louisiana, and Mississippi—continue to experience varying degrees of drought ranging from abnormally dry conditions to a few isolated areas of severe drought. Although heavy rain in early October delayed peanut harvesting in some parts of the District, harvests in Alabama, Florida, Georgia, and Mississippi were ahead of their five-year average. Alabama and Georgia cotton crop harvests are also ahead of their five-year averages while recent rain in parts of Tennessee has delayed some of their cotton harvesting activities.

Midwest farmers are taking advantage of expanded storage capacity to hold back their crop and push grain prices higher.

Chicago—The Midwest harvest was behind a normal year’s pace even before early snows delayed progress in some parts of the region. Still, yields should set records overall. Corn and soybean prices moved up during the reporting period, driven by the slow harvest, farmers storing much of the crop for later sale, and some shipping delays. Wheat prices rose as well. Milk and hog prices declined from the prior reporting period, but operations remain profitable. Cattle prices moved higher with signs of herd expansion. Weights for hogs and cattle at slaughter were very high, helping boost the supply of meat coming to market.

St. Louis—Through early November, the harvest of the southern Midwest-northern Mid-South region’s corn, rice, and sorghum crops was over 90% complete, and the harvest of soybean and cotton crops was close to 80% complete. The region’s farmers will see substantially larger field crop production in 2014 than in 2013. Specifically, the corn and soybean crops will be 7.5% and 15% larger, respectively, in 2014 than in the previous year.

Minneapolis—Agricultural conditions have improved from the previous report. Early estimates of crop production indicate record soybean harvests and a very large corn crop across the region. However, farm incomes continue to be affected by lower crop prices; in contrast, livestock and dairy producers continue to benefit from lower feed costs and high output prices. Relative to a year earlier, prices received by farmers in October were lower for corn, soybeans, wheat, and hay; prices were higher for cattle, hogs, poultry, and milk.

Kansas City—Farm income expectations have fallen sharply since the last survey period as above-average corn and soybean yields are not expected to fully offset low crop prices. Regional contacts report current levels of farm income that are significantly lower than last year despite some expected support from crop insurance, and strong profits in the livestock sector. Although reduced income for crop producers is contributing to a rise in the need for short-term loans to the farm sector, agricultural bankers report that sufficient funds are available for qualified borrowers. Following several years of very strong growth, cropland values have declined slightly in recent months and are holding just above year-ago levels. However, improved profitability in the livestock sector and the potential for herd rebuilding is supporting demand for high-quality pasture and helping fuel moderate gains in ranchland values.

Dallas—Recent rains have improved soil moisture, although drought conditions remain severe in some northern parts of Texas. Harvesting has wrapped up for most spring crops. Yields were generally strong and well above 10-year averages. Improved conditions for cotton allowed for more acres to be harvested this year than in the recent past, although the rains during harvest time have had an adverse effect on cotton quality. Dairy producers have had a tremendous year with good margins, but milk and dairy prices have fallen lately, reflecting shrinking exports and increased world production.

San Francisco—The continuing drought in California has depressed yields for crops such as raisins and almonds. However, tomato production and prices hit record highs. Recent California rains following the close of this report, and the prospect for additional rains are improving growers’ outlook. Washington is seeing very strong apple and pear harvests and an increase in agricultural exports. Idaho farmers report an excellent potato harvest, but late-season rains have damaged wheat and barley crops.  ■

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Florida agricultural land manager and investor Alico, Inc. (NASDAQ: ALCO) appears to be increasing its focus on the citrus sector.

Florida farmland investment company Alico Inc. is increasing its focus on orange groves. In late September, Alico paid $15.5 million for a 1,241-acre DeSoto County grove managed by a unit of TIAA-CREF. More citrus deals are expected.

In late September, the Fort Myers –based company acquired Crossing Grove, a 1,241-acre Valencia orange grove in DeSoto County, Fla. for $15.5 million or $17,837 per productive acre, based on 869 producing acres. The grove has 30 acres of “skips” where trees have been removed, but could be replanted.

The seller is Premiere Agricultural Properties, an institutional farmland portfolio managed by Westchester Agriculture Asset Management, a unit of New York retirement fund manager TIAA-CREF.

The September orange grove deal follows an August pact in which TIAA-CREF agreed to pay Alico $91.4 million for 31,000 acres of Hendry County farmland as the company moved to exit its sub-performing sugarcane farming business. That deal is expected to close this month.

Westchester originally acquired the Crossing Grove tract as raw pasture land in December 2007 for $1.6 million from Orange-Co LP, a private institutional citrus investor based in Arcadia. (Orange-Co was once controlled by heirs of the Ben Hill Griffin, Jr. family, who sold their controlling stake in Alico 12 months ago to a New York investment group that includes hedge fund manager Remy W. Trafelet, and Arlon Group, a private equity unit of Continental Grain.)

In 2007, Westchester valued Crossing Grove at $18.5 million when it transferred the orchard between pension fund clients. The September sale to Alico, represents a 16% decline from the Grove’s valuation seven years ago.

Alico owns approximately 129,100 acres of land in seven Florida counties (Alachua, Collier, DeSoto, Glades, Hendry, Lee and Polk). The company’s existing 8,600-acre base of producing citrus groves is located in Hendry, Polk and Collier Counties and is planted primarily in Hamlin and Valencia oranges for the processed and fresh juice markets. ■

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