During the closing months of 2019 we observed a relatively active dairy farm property market in Southland.
We are aware of six dairy farm sales in Southland that confirmed in the last months of 2019 (including a portfolio of three dairy farms). We also understand that this activity is extending into early 2020 with more properties currently under offer or in the final stages of negotiation. This is higher than the volume of sales in the region during the months of December and January historically.
It appears that there has been a reset in the market after a previous stand-off between differing expectations of vendors and the few purchasers active in the market. It now seems that vendors are accepting that they may have to reduce their expectations in order to achieve a sale. As a result, the farms transacting did so at a value some 15 to 20 per cent lower than two years ago.
The buyer profile in Southland largely remains local farming entities looking to upscale, add to their portfolios or position themselves for succession although corporate farming groups still have some presence in the market.
It is becoming apparent that with fewer buyers in the market and values having eased overall, purchasers are becoming particularly discerning when it comes to the physical features of a property.
Farms that are selling and attract interest from the buyers still active in the market tend to be higher quality ‘A Class’ assets. They feature quality soils, a good location and not require major capital expenditure. The more marginal properties, perhaps not suited to dairying, run down or with detracting features tend to be more difficult to sell and may require a lengthy marketing period.
With the prospect of capital gains in the short term looking unlikely, we consider potential buyers of properties will now be influenced by cash return on investment.
As a operating return on investment becomes fundamental, of the farms which will come to market, we consider that the ones with realistic cost structure and strong fundamentals in traditionally sought-after localities will remain the ones that will be still transacting.
The graph below identifies the analysed effective land value per hectare of A, B and C class properties in the region since the beginning of 2015 together with key external influences. ‘A Class’ farms represented in the graph below in yellow, are typically situated in the Central Southland locality or the area to the east of Invercargill, on flat land with good soils and have a good standard of buildings, farm infrastructure and improvements.
Access to capital
Currently, the market for dairy and dairy support farms is being heavily influenced by access to capital. The Reserve Bank of New Zealand has amended the capital requirements for the large trading banks and has identified lending to dairy farmers as a potential risk.
We are aware that some banks are actively trying to rebalance their lending book away from dairy debt, which has led to a severe restriction on the amount of capital available for the purchase of dairy farms.
The Labour led Government’s directive to the Overseas Investment Office continues to stifle overseas investment in New Zealand farmland. Within the current market, the absence of foreign capital has directly impacted on the value of medium to larger scale properties and portfolios offered for sale and the flow on effect of this had subsequently impacted on liquidity for all property classes.
An emerging trend over the past 12-18 months is for international investors to take a minority stake in a dairy farming business. A minority interest of less than 25 per cent does not require Overseas Investment Office approval and still provides international investors with access to the New Zealand dairy market.
The quality of the farms and the management structure in place is important as a high degree of trust is required between the parties in a minority interest scenario.
The presence of syndications in the market is also becoming more prominent together with the emergence of alternate financing options such as the use of finance companies and vendor financing. We are also noticing that larger scale, high value properties are in some instances being broken down into smaller blocks that require a lower weight of capital, in order to achieve a sale.
Increasing environmental compliance is also impacting on market sentiment. The impact of the impending operative status of the Southland Land and Water Plan and the Proposed National Environmental Standards for Freshwater are causing uncertainty; particularly around the effect the tightened rules will have on farming practices.
The Climate Change Response (Zero Carbon) Amendment Act 2019, whereby farms are mandated to reduce biological methane by 10 per cent by 2030 and between 24-47 per cent by 2050, is another challenge for the dairy industry.
Together with the Proposed Southland Land and Water Plan and the Proposed National Environmental Standards for Freshwater, this leads to purchasers now facing a greater complexity and uncertainty of future production.
Overall, we consider one of the key influences on which way the market will trend in the short to medium term is going to be the level of liquidity in the market and the flow of capital due to transactions (or lack of) occurring.
As it stands, with foreign investment constrained for the foreseeable future and banks sending a clear signal to their dairy clients that further consolidation is required, we believe liquidity in the market will remain very tight and only the most desirable and well-located properties with a proven production history and ability to produce a high yield will continue to sell.
The fundamental conditions for optimism in the market do exist, i.e. the dairy payout is looking positive and interest rates are remaining at historic lows, however, with continued cautious sentiment and a smaller buyer pool, it is difficult to see dairy farm values increasing in the short term, with further easing anticipated in the current cycle.
For more information please contact Kate Day.