Looking to expand? Here's the lowdown on leasing versus buying

Looking to expand? Here's the lowdown on leasing versus buying

Beef News
WEIGHING IT UP: Farm business consultant John Francis, Agrista, talks leasing or buying with producers.

WEIGHING IT UP: Farm business consultant John Francis, Agrista, talks leasing or buying with producers.

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Low interest rates, high livestock prices - expansion is complex

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THE most profitable and least risky pathway for expanding a livestock operation in any cattle-growing or sheep-rearing part of the country has never been clear-cut.

Making things even more complex at the moment is the current mix of low interest rates, high livestock prices, increasing competition for farming land and ongoing uncertainty in global markets.

Farm business consultancy Agrista, in southern NSW, has run comparative analysis on the same scale of expansion which shows the business case is stronger for land purchasing than leasing, so long as capital gains of seven per cent can be maintained.

Agrista director John Francis, however, points out comparisons between leasing and buying is highly sensitive to a range of variables and the only way to make an informed decision is to factor in the specifics of business circumstances.

Lease rates, capital gain, the extent of scale benefits achieved, interest rates over a long-term period and relative production differences all have to be taken into account, he said.

The Agrista work concludes the business case may sway towards leasing if current rates of capital growth decline and lease rates remain competitive and below the cost of debt.

Even with competitive lease rates, the scale required to generate returns competitive with land purchasing is significant - as much as 12 times as great.

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Scenarios 

Under a scenario of expanding a 10,000 dry sheep equivalent operation by 25pc, the net wealth created from land purchasing is $730,000 compared to $327,000 for leasing. This occurs because the capital gain on land generates higher returns than operating returns after costs.

However, a land purchase expansion of 2,500 additional DSE in scale equates to a land lease of 13,800 DSE in scale, assuming the same amount of capital is invested in both. Under this larger scale leasing expansion of an additional 13,800 DSE, the return from leasing increases to $687,000 compared with only a marginally higher return of $730,000 from purchasing.

The reason that returns only double from leasing despite a 5.5 times scale increase is that all the economies of scale that can be achieved with a small scale increase are lost, Mr Francis explained.

Assumptions in the analysis include that expansion opportunities are adjoining, or close by, ensuring efficiencies; and that both types of expansion are funded using debt.

Mr Francis points out in reality, expansion opportunities are rarely that neat, adding weight again to the argument that specific business criteria have to be factored in for informed decision making.

Low interest rates

What the current low interest rates mean is that the amount that has to be earned from the operating side of the business doesn't have to be so high to generate surplus cash after paying interest - thus amplifying the incentive to buy, Mr Francis said.

"But interest rates won't remain this low forever, so producers have to assess the proposition to higher rates to ensure they still have the capacity - and have an exit strategy and know the cost of getting out.

"If you're looking to leverage yourself into agricultural assets, and the last ten years has been anything to go by, at average operating returns you can generate wealth.

"But really understanding your business and having an exit strategy is critical."

Mr Francis said the findings do not mean leasing should be ruled out, but it should be acknowledged that the area required to be equally as profitable is significant and that won't suit everyone.

Increasing this scale also introduces other risks such as operational uncertainty as there is no track record of delivery at such a level.

Leasing, of course, is an option for those without the existing level of equity required to purchase. It can also provide an exposure to the owner that may facilitate a favourable position to buy-in at a future date.

"The bottom line is to be clear on what you're comparing - area with area, DSE with DSE or capital invested with capital invested," Mr Francis said.

"It's never going to be a straightforward one-answer-fits-all. The question of how best to expand a livestock operation has always attracted a nebulous response."

The story Looking to expand? Here's the lowdown on leasing versus buying first appeared on Farm Online.

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