Alternative investment structures in rural land: the rise of the 'sale & leaseback' - July 2018 - EY
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018
Preface
There has been a well-publicised increase in the value of agricultural
land in recent times, with record high commodity prices, strong
demand for Australian produce and investment focus on the sector.
So why has this market not followed other property markets in
providing a range of ownership and capital structures?
Because of the increase in land values EY believes alternative
operation and ownership structures will become more prevalent
in line with other investment grade real estate sectors and attract
institutional investment. There are some recent examples in the
rural market that show a shift towards realising capital from land
whilst continuing the management of farming operations, however
the potential available to the sector is huge.
This paper investigates recent trends in the sale and leaseback of
rural property and why it has the potential to be a more common
form of transaction structure.
2 | Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018
Background
Leasing is a common form of tenure in the Australian property market, and is highly prevalent in the
commercial, retail and industrial sub-markets (collectively Commercial Property). The ownership of
Commercial Property is also highly institutionalised, with owners including pension funds, insurance
companies, wholesale investors, private equity funds, and Australian Real Estate Investment Trusts
(REITs). The trend towards lease procurement in Commercial Property sectors has been supported
by government and corporate tenants who prefer to lease rather than own their real estate for a
range of reasons including business flexibility, the efficient use of capital, professional outsourced
management and tax benefits. This trend is likely to continue as the financial services sector grows.
Land tenure of rural land in Australia is predominantly held under Crown Leases in terms of area.
Crown leases normally interpolate restrictions on land use (e.g. for grazing) and place requirements
on the Tenant to maintain the land via specific conditions. Crown leases are prevalent in central
Australia where vast tracts of land are subject to pastoral leases. Leases over freehold rural land are
not common as most farms are owner-operated, and it is leases over freehold land that this paper
explores.
Whilst the leasing of Australian rural freehold exists, research by EY indicates there is no detailed
database kept on the exact levels of leased freehold land in the rural property sector. Anecdotally
however, the prevalence of leased rural freehold land is low relative to other investment grade real
estate sectors, particularly in dryland cropping and grazing, which covers the majority of rural
land use in Australia. Leasing is more common in production forestry (for example woodlots);
horticulture (for example almonds and olives) and dairy. Of the parties surveyed for the purpose of
this paper the agents and valuers were aware of medium to long term, commercial structured rural
lease transactions occurring for dryland cropping and grazing land, though these were recurring
examples involving several key market participants such as Westchester and Rural Funds Group.
A significant difference between rural property and other property types is that the majority of
Australian rural property is held intergenerational for the purpose of being farmed by the owner.
There are currently few institutional investors of rural land relative to other real estate asset classes,
although the number has been growing in recent years.
As an alternate to leasing, the rural sector tends to favour share farming and agistment. A share
farming agreement is an arrangement whereby a landowner or person in possession of land grants
a farmer the right to cultivate the land. The profits and/or produce derived from the farmer’s
cultivation are shared between them in proportions agreed between the parties.1 A share farmer is
neither an employee nor a tenant of the landowner, so the legal relationship between the
share-farmer and the landowner will be quite different from that between a tenant (or lessee) and
the owner.2 Agistment is seasonal occupation undertaken by way of a licence and are generally
short term (per week/month or seasonally based).
1. Source: http://www.rurallaw.org.au/handbook/xml/ch02s03.php.
2. Source: http://www.rurallaw.org.au/handbook/xml/ch02s03.php.
Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018 | 3
Why does leasing rural land make sense?
Since the wool boom of the 1950s farmers have Given low long term commodity price growth overlaid with
experienced a long-term downturn in rural commodity high proportion of ‘small farms’ that exist in Australia,
prices.3 During this period there have been upturns, for leasing can play a role in releasing income for asset heavy,
example the past 3 years, but overall the long-term trend is cash light operations.
down. Farmers have reacted to the downward pressure on
Further reasons advocated for leasing include:
commodity prices and upward pressure on input costs by
either turning to other means of employment or expanding For Land Owners:
the size of their operation. • Growing age of landowners, less ability to operate farm
This is demonstrated in the number of agriculture business
businesses over time; the number of businesses in • Predictability of income
Australia has gone from approximately 200,000 in the
1950’s at an average of 2,400 hectares per business4 • Decrease exposure to commodity risk
to 85,681 as at 30 June 2016 at an average of 4,331 • Revenue earned can be reinvested into the asset to
hectares per business.5 create more efficiency
Despite the increase in average farm size, small farming For Tenants:
operations still make up the majority of farms in Australia.
• Avoid high entry costs, specifically the cost of
Small farms, defined by ABARES as farms with a total
acquiring land
value of sales of less than $450,000, account for 70 per
cent of Australian broadacre and dairy farms.6 Small farms • Flexibility to increase and decrease the scale of
are mostly family owned and operated, typically with a operations without high entry or exit costs
total capital value of less than $5 million. Off-farm income • Use of capital can be used for the property itself,
from wages, salaries, investments and other non-farm research and development, employment of staff, plant
businesses often accounts for more than 50 per cent of the and equipment etc.
disposable cash income of farm operators.7
Why consider a sale and leaseback?
For Purchasers/Lessors: • Freeing up capital — Capital ‘locked away’ in asset(s) can
be made available for the vendor/lessee to redeploy back
• Exposure to sector without management risk — investors
into the business or elsewhere.
can invest into agriculture sector without the need for
operational knowledge or risk of production volatility • Reduce Debt — Capital realised from the sale can be
• Predictable income — leases provide steady income often utilised to pay down debt; careful consideration should be
with annual increases had to annual lease payments vs debt facilitation costs,
however generally lease rental charges are struck at an
• Lessee knowledge of the asset(s) — purchaser/lessor can
equitable rate to both lessee and lessor to ensure the
have comfort that lessee understands the potential of the
rent can be paid year-on-year, where finance expenses
assets and no ‘scaling up’ of business required
may not be structured in this way.
For Vendor/Lessee
• Knowledge of the Assets — The vendor/lessee
• Asset Improvement — As part of the transaction i.e. understands the assets intimately meaning the there is
through incentives (see further details on incentives later no time required for ‘scaling up’ operations, identification
in this paper) or utilising money raised from the sale, of deficiencies and taking advantage of asset-specific
capital can be reinvested into the assets to enhance the opportunities.
efficiency of operations or to change operations utilising
more modern farming techniques, for example modern
drip irrigation infrastructure vs traditional flood irrigation.
3. Successful Land Leasing in Australia — A guide for farmers and their advisers
4. Dr B. Fisher — ABARE — address to the 24th Biennial Animal Production Conference.
5. Food, Fibre & Forestry Facts 2017 Edition A SUMMARY OF AUSTRALIA’S AGRICULTURE SECTOR
6. ABARE, Australian Farm Survey Results 2014–15 to 2016–17
7. ABARE, Australian Farm Survey Results 2014–15 to 2016–17
4 | Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018
Who is driving the activity? Case Studies
There has been significant increase in agribusiness
investment interest from corporates, investors and
offshore groups in recent years, with a sale and leaseback
Camm Agricultural Group
proposition allowing land owners to realise capital gains
without giving away the operational business and attractive Camm Agricultural Group (Camm) is a family-
to buyers searching for investment platforms without owned, vertically integrated cattle farming
operational risk. business. It operates approximately 400,000
hectares of prime breeding, backgrounding
and farming land across nine properties.
Additionally, the group owns a feedlot with
1,676
1,658
1,633
2,000
Foreign owned land (million ha)
a capacity of 9,100 SCU and has a farming
1,412
1,500 division which grows various summer and winter
crops, both for feedlot ration and for sale to the
1,000
market.
720
703
EY acted as the lead adviser to the shareholders
566
546
500 of Camm. Various structures were explored,
232
154
with a view to bringing on board a capital
10
17
10
partner to support the future growth of business
8
0
NSW Vic. Qld SA WA Tas. NT operations, whilst ensuring the Camm family
2010 2016
retain significant involvement post-transaction.
Source: ABS 7127.0 A sale and leaseback transaction of the group’s
breeding and backgrounding properties in
Northern Queensland was completed with
Australia’s appeal for investment can be attributable to a Rural Funds Group (RFF). The transaction
multitude of factors, including: included sale and leaseback of properties plus a
• Natural comparative advantage across a diversified mix performance fee and significant capital to invest
of farm commodities due to scale in farm improvements.
• Fertile arable land and soil variety across climatic zones — This sale allowed Camm to release capital
particularly in the northern regions and debt from the properties whilst providing
them up-front capital to invest in the portfolio,
• The ability to diversify commodities across multiple planned to be in the form of additional water
regions which allows operations at a geographic scale point infrastructure. RFF receive long term
that far exceeds those of competitors in Western Europe rental income with a lessee that is incentivised
and North America.8 to complete works on the properties who have
• The rise of middle class Asia farmed the assets for multiple generations.
• World population growth
• Australia’s ‘clean and green’ reputation in food
production
8. DRIVING SUPER FUND INVESTMENT IN AGRICULTURE, June 2017
Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018 | 5
Advantages and disadvantages of leasing compared to
other typical structures
Advantages Disadvantages
Share-farming
Landowner • Has say over what happens on the land • Difficult to manage quality of work/produce
output
• Does not need to manage labour
• Continues to benefit from land appreciation
• Shares in profit and risk
Share-farmer • Less up front capital required • Do not have ‘creative control’ over all farm
operations
• Shares risk of operations
• Unprofitable years cannot be recouped
• No share in capital appreciate of the assets
Agistment
Landowner • Flexible in duration (i.e. agistor has no legal right to • Weak lease covenant
the land)
• Generally have to complete repairs and
• Utilisation of unused land, feed, resources etc maintenance
Agistor • Flexible in term (i.e. no obligation to continue to • No ongoing interest in the land
occupy the land, pay rent)
Lease
Landowner • Fixed income paid at regular intervals • No benefit from strong performing years
• No loss in poor years • Loss of primary production status for tax
purposes
• Minimal labour required
• No use of the land other than defined in the
• Maintain capital gains
agreement
• Risk of tenant viability
Lessee • Release of funds of previously owned land (in sale and • Significant fixed cost which must be met
leaseback scenario) irrespective of farm production and income
• Less capital required • Seasonality, commodity price risk sit with the
tenant
• Fixed costs for the term of the lease
• Obtains an interest in the land for the term of the lease
• Costs and investment can be spread over lease term
6 | Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018
Case Studies
Olam Almonds
In November 2013, Olam Almonds Australia Pty Ltd (Olam) entered into a sale and lease-back
agreement for its 12,000 hectares of planted almonds for A$211 million with Adveq Almond Trust.
The transaction involved the sale and lease-back of almond orchard land and trees as well as related
farming and irrigation infrastructure in Victoria for a period of 18 years, which could be extended or
renewed by mutual consent.
The sale transacted on a reported yield (sale price divided by initial rent) of 8.20% in one of the
biggest farmland transactions worldwide in 2013. Adveq’s executive director Berry Polmann was
quoted at the time of the sale saying “institutional investors are attracted to farmland investments
for their diversification benefits and long-term inflation protection, investors require sustainable
performance in an asset class that might be challenging to access”.
This sale demonstrated an appetite by investors for exposure to agricultural real property through
long term passive shareholding that provides a steady annual rental income.
Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018 | 7Typical key elements of a lease
Element Typical Terms Example for rural land
Landlord A person who owns and leases land, buildings Farm owner
Tenant A person who holds or possesses land for a time, usually Lessee
in exchange for rent
Term Varies depending on asset type. For smaller assets Assets < $5m: 3–5 years
generally shorter lease terms because of inferior lease
Assets $10m +: 5–10 years +
covenants offered. For example, individuals or family
businesses woutrger lessees that are financially stronger
and can therefore demand longer term lease terms.
Rent Varying depending on asset type, location, what is See the ’other considerations’ section of this
included in the lease etc. Generally paid per month in paper for examples.
advance based on agreed annual rent.
Rent Reviews Generally includes annual increases, and can include Rent increases 3.00% to 4.00% increases per
market reviews throughout lease term. annum as per standard commercial leases.
Rent reviews mid-way through lease terms generally set
back to market and assessed by an independent property
valuer as stated within the lease.
Outgoings Leases can be ‘net’ or ‘gross.’ A net lease requires the Outgoings vary between property types based on
tenant to pay, in addition to rent, some or all of the council rates and the use of services, for example
property expenses that normally would be paid by the irrigation horticulture vs large scale grazing.
property owner. A gross lease means the outgoings are
included in the rent.
Capital Generally the responsibility of the landlord. These items Any replacement of capital intensive items or
Expenditure are stated in the lease and generally relate to large agreed projects at the commencement of the
capital items. See the ‘examples in the market’ section lease.
for an example of agreed capital expenditure.
Tenants fixtures, for example shedding or other items
affixed to the land, generally treated in the lease
agreement, i.e. make-good clauses.
Maintenance Varies depending on the lease; if the lessee is responsible Minor items such as stock fencing would
the lease is known as a ‘triple net lease.’ generally be responsibility of the lessee, larger
items like the service of irrigation systems would
be the lessor’s responsibility.
8 | Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018Case Studies
Macquarie and Costa Group
In November 2016 the Costa Group and Macquarie Agricultural Funds Management (MAFM)
entered into an exclusive non-binding arrangement to investigate mergers and acquisitions in
farmland, biological assets, water and infrastructure assets.
In December 2016 Costa Group and MAFM paid about $50 million for the Avocado Ridge orchards
and packing operations in central Queensland. MAFM purchased the farms and entered into a
20-year lease with Costa to operate them. Costa Group have stated publically this model would be
replicated at other sites across the country.
This is an example of an investor and operator jointly going to the market with a pre-agreed
purchase and lease structure.
Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018 | 9Other considerations
Rental Pricing therefore cannot access tax advantages, which include but
aren’t limited to averaging income across financial years
Different market participants have differing opinions on
and claiming specific capital works expenditure deductions.
how leasehold rental payments on agricultural land should
be determined. Opinions also vary depending on what Owners may also lose access to small business concessions
asset class is being assessed. Below we have explored three and the Capital Gains Tax (CGT) concessions which are
ways rents can be calculated. available for ‘Active Assets’, being land that is farmed not
leased.9
1. Rate per land area
There are tax benefits for leasing and renting commercial
• The most common approach in assessing market rent properties therefore professional tax advice should be
for small to medium size operators sort by the lessee and lessor before entering into lease
• Based on a rate per hectare or acre per annum
agreements in order to determine the most tax efficient
• Generally the primary approach for less complex
structure.
property types, such as grazing
• Rates vary between asset class and location, and key Incentives
terms of the lease (term, responsibility for outgoings,
Lease incentives are some form of inducement or benefit
maintenance liability etc)
• Generally based on what a lessee is willing to pay, granted to a tenant in return for entering the lease. These
‘rules of thumb’ for that district are normally expressed in percentage terms and calculated
by reference to the equivalent number of month’s rent free.
2. Return on land value
For example an 18 month rent free incentive over a 10
• More common for larger corporate owners and year lease equates to a 15% incentive.
investors where annual returns are a critical
consideration There is a range of alternate structures which are possible
• This approach is accepted throughout the valuation to agree between landlord and tenant, including:
industry • The property may be in need of upgrades such as water
• Quantum of rent can vary dramatically with small infrastructure; fencing; buildings; improvements to the
variation in adopted percentage return land such as levelling and clearing which the vendor may
• Terms of the lease will also have material impact on be willing to undertake and/or pay for in return for a
rate adopted higher rent payment by the tenant.
• Generally rates are between 3.00% and 8.00%
depending on asset type and responsibilities under the • Operational cost savings in the early stages of the lease —
lease The tenant may prefer to delay costs in the early setup
3. Rate per productive capacity phase of the business to ease the case flow burden and
may seek a rent free period to coincide with, for example,
• Uncommon approach to valuing leasehold interests the end of the first crop cycle. As per above, the landlord
• Rate based on per adult equivalent for grazing may be willing to do this in return for a higher rent
properties, tonnage for cropping, viticulture or payment by the tenant.
horticulture
• Generally not an accepted leasehold valuation • To achieve a higher sale price of the asset — vendors
approach and therefore rates are not uniform often seek to maximise the face rent by agreeing a lease
incentive with the tenant in return for offsetting the cost
The rental amount needs to be equitable for landlord and
of the incentive through a higher purchase price to the
tenant which can be difficult given the high volatility nature
of the agriculture sector being subject to commodity buyer. Purchasers regularly pay a proportionally higher
prices, impacts of weather etc. There are examples in the contract price for a property on account of the higher
market where clauses are being included in agricultural face rent being paid by the tenant. In a transaction
land leases linking the rent to commodity price thresholds, involving incentives in the lease the vendor and the
for example farmgate milk prices for dairy. purchaser agree to who pays them out and the sale price
is adjusted accordingly.
Tax
As long term commercial leases are somewhat rare in the
An owner who leases out land and no longer undertakes Australian agriculture sector, the knowledge of the type
activities associated with primary production may lose and level of incentives are more uncommon. With more
their status with the Australian Tax Office (ATO) and investor and corporate participation there is likely to be
more of these agreements offered in the market.
9. Successful Land Leasing in Australia
10 | Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018Concluding comments
Leasing agricultural land can provide mutual benefit to
EY’s agribusiness team provides professional,
lessee and lessor, with other property sectors utilising this
structure to best suit expertise and use of capital. multi-disciplinary advice throughout the transac-
tion lifecycle from pre-acquisition planning, optim-
Sale and leaseback transactions allow land owners to isation to divestment. We can advise on the impact
realise capital for investment back into the business, into of
capital works programs on the property or pay down sale and leaseback transactions on your business
debt. This allows the lessee, former owner of the land, to through the lens of:
continue to operate the business where they have deep
knowledge of its potential. • Deal origination and transaction management
EY believes the interest in agricultural investment is due • Identification and mitigation of transaction risk
to increasing land values driven from historically high • Key commercial considerations and metrics
commodity prices and demand for Australian-grown
• Vendor and/or purchaser due diligence
products, and sale and leaseback transactions provide a
structure for indirect, lower risk exposure for investors • Tax accounting
with a tenant who understands the property they farm. We
see a future in these structures as agricultural investment
sophistication matures and landowners/business operators
seek more efficient use of their capital.
Alternative investment structures in rural land: the rise of the ‘sale & leaseback’ July 2018 | 11About EY Transaction Advisory Services About EY
EY is a global leader in assurance, tax, transaction and advisory services.
EY | Assurance | Tax | Transactions | Advisory The insights and quality services we deliver help build trust and confidence
in the capital markets and in economies the world over. We develop
How you manage your capital agenda today will outstanding leaders who team to deliver on our promises to all of our
define your competitive position tomorrow. We stakeholders. In so doing, we play a critical role in building a better working
world for our people, for our clients and for our communities.
work with clients to create social and economic
EY refers to the global organization, and may refer to one or more, of the
value by helping them make better, more-informed
member firms of Ernst & Young Global Limited, each of which is a separate
decisions about strategically managing capital and legal entity. Ernst & Young Global Limited, a UK company limited by
transactions in fast-changing markets. guarantee, does not provide services to clients. For more information about
our organization, please visit ey.com.
Whether you're preserving, optimizing, raising or in- © 2018 Ernst & Young, Australia.
vesting capital, EY’s Transaction Advisory Services All Rights Reserved.
combine a set of skills, insight and experience to de- APAC no. AU00003307
liver focused advice. We can help you drive compet- IN1831527
itive advantage and increased returns through im- ED none
proved decisions across all aspects of your capital This communication provides general information which is current at the time of production. The
information contained in this communication does not constitute advice and should not be relied
agenda. on as such. Professional advice should be sought prior to any action being taken in reliance on
any of the information. Ernst & Young disclaims all responsibility and liability (including, without
limitation, for any direct or indirect or consequential costs, loss or damage or loss of profits) arising
from anything done or omitted to be done by any party in reliance, whether wholly or partially, on
Selected Contacts any of the information. Any party that relies on the information does so at its own risk. Liability
limited by a scheme approved under Professional Standards Legislation.
Richard Bowman ey.com
Partner
EY Real Estate Advisory Services — Melbourne
Tel: +61 418 321 634
Michael O’Donoghue
Manager
EY Real Estate Advisory Services – Melbourne
Tel: +61 428 310 438
James Mahoney
Director
EY Mergers and Acquisitions – Sydney
Tel: +61 413 402 209
Merv Burton
Senior Manager
EY Tax – Adelaide
Tel: +61 499 075 338
Angus Blackwood
Partner
EY Transaction Advisory Services – Brisbane
Tel: +61 413 744 562You can also read
