Leases, like most business transactions, are negotiated with one party wanting the price high and the other low.
Ultimately, a lease must satisfy the conflicting objectives of both parties. In a land lease, the most important component is that it's equitable-value for value.
Income generated from the land should be shared in proportion to costs contributed by both parties. Developing a lease in this manner is called the "cost-contributions approach."
To develop a cost-contributions lease, determine and list costs paid by the landowner and those by the tenant. Then, calculate the percentage of the total costs contributed by each. On a 25/75 landowner/tenant cost contribution crop-share lease, the crop would be divided the same way. Because many landowners don't want to deal with marketing and possibly storing the crop, cash rents are preferred.
The cost-contribution method can also be used to develop an equitable cash lease. Simply convert the crop share to a dollar amount using historical or expected crop yields and prices that the landowner and tenant agree upon. This can be done for a single crop or several crops on a multi-year lease. For example, with a 25/75 landowner/tenant cost contribution, 400 cwt/acre expected yield and a predicted price of $7/cwt, the land owner's revenue would be $700/acre with a crop share lease. But, if the yield drops to 300 cwt/acre and the price drops to $5/cwt, landowner revenue drops to $375/acre.
Land owners receiving cash rent are not subject to yield and price risk. Consequently, cash rent revenue based on a crop share must be reduced to compensate the tenant for assuming all the production and price risk. The "risk premium" will vary by crop with potatoes having a higher risk premium than wheat because of the higher price volatility with potatoes. Risk premiums can range from 5 to 30 percent. By providing the tenant with a 30 percent risk premium, the landowner's lease payment drops by a comparable amount. Using the example above with a 30 percent risk premium generates a cash lease of $490/acre for potatoes (400 cwt/acre x 0.25 x $7/cwt x 0.70 = $490).
However, if price and/or yield exceed what was expected, then a lease could also include a flexible payment. The flex payment can be based on price, yield or both, and can be a percentage or dollar-based. For example, assume the rent on potato land is $490/acre with an expected yield of 400 cwt/acre. Let's say the year ended with a 450 cwt/acre paid yield. The following adjustment would be made: $490 x (450 - 400) ÷ 400 = $61. At the end of the year (or when the crop is sold) the landowner receives an additional payment of $61 per acre.
For a dollar-based flex payment, a fixed dollar amount, say, $1, would be added to the base rent for each hundredweight above the base. In the above example, a $50 flex payment would be made.
The University of Idaho publishes crop costs and returns estimates that can be useful in this process of negotiating a lease as our enterprise budgets provide a detailed list of all the inputs used. We also have an Excel spreadsheet (Idaho Crop Lease Calculator) that can be helpful in helping a landowner and tenant work through this process. Both can be found at http://www. cals.uidaho.edu/aers. Click on "Resources" and then "Crops."
The contributed value provided by a tenant of operating inputs (seed, fertilizer, etc.) is fairly straight forward. The three most difficult issues to deal with in a cost-contribution lease are placing values on the tenant's time, the tenant's machinery and the landowner's land.
Dealing with these will be discussed in next month's column.