Beef Cow Rental ArrangementsFor Your Farm

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North Central Farm Management Extension Committee

Beef Cow Rental Arrangements

Kevin DhuyvetterDepartment of Agricultural EconomicsKansas State Universitykcd@ksu.edu -- 785-532-3527

AGRICULTURAL ECONOMICS

Damona DoyeDepartment of Agricultural EconomicsOklahoma State Universitydamona.doye@okstate.edu -- 405-744-9813

Ag leasing resources… www.aglease101.org

(lease-related information developed as part of a North Central Region project)

NCFMEC-01 – Fixed and Flexible Cash Rental Arrangements for Your FarmNCFMEC-02 – Crop Share Rental Arrangements for Your FarmNCFMEC-03 – Pasture Rental Arrangements for Your FarmNCFMEC-04 – Rental Agreements for Farm Buildings and Livestock FacilitiesNCFMEC-06 – Beef Cow Rental Arrangements for Your FarmAll bulletins include examples and fillable forms and in some case reference supporting spreadsheets that are available.

Beef Cow Rental Arrangements For Your Farm (NCFMEC-06) and KSU-BeefCowLease.xls spreadsheet

Identifies questions to answer, discusses factors impacting equitable arrangement, and includes examples of leases and worksheets that can be used for individual operations.

Basically does all the math behind the worksheets shown in NCFMEC-06

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Background

• Leasing assets (land, buildings, machinery) is common in agriculture and is a form of risk management

• Leasing breeding livestock is simply a form of borrowing/getting access to capital

• Can be a “win – win” situation for both the owner and the operator

• Owner and operator need to have mutual trust and confidence in each other – good, open and honest communication is a critical part of this

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Breeding Livestock Share Leases

Advantages to livestock operator:• Makes use of working capital without tying up capital

for breeding livestock• Share the risk of the operation with the owner• Obtain capital over and above the limits of credit

agencies• Borrowing of capital at a fair rate of interest

(assuming the lease is equitable)• Permits an increase in the volume of business• Helps the beginning operator get started in livestock

production• Provide return to labor if the operator is

underemployed

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Breeding Livestock Share Leases

Advantages to livestock owner:• Can maintain a breeding herd even though labor

is not provided

• Provides a source of rental income

• Provides an opportunity for returns on capital investment

• Means of transferring ownership over a period of time

• Possible income tax and social security advantages

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Advantages to livestock operator:• Generally operator has full control and responsibility for

management decisions• Benefits from above average prices and production

Advantages to livestock owner:• Provides a fixed income without any operating expenses• Possible income tax advantages

Often viewed as easier than share leases, are they?

Breeding Livestock Cash Leases

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Determining the terms of a lease ...

How are cash lease rates or the terms of livestock share leases established?

Short answer is “the market” determines an equilibrium priceThat is, the terms of a lease are determined by Producers (demand) negotiating with Cattle owners (supply)

S

D

P

Q

Cattleowner

Producer

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Ways to find equilibrium price/share…

Whether we are talking about land, buildings, machinery, or cattle, the parties involved often claim to want a share or cash lease rate that is “fair” to both parties.

Economist’s definition of “FAIR”

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Ways to find equilibrium price/share…

• Whether we are talking about land, buildings, machinery, or cattle, the parties involved often claim to want a share or cash lease rate that is “fair” to both parties.

• Because the word fair does not exist in an economist’s vocabulary, we use what we call an equitable approach in determining lease rates.

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A good crop share lease should follow 5 basic principles

1. Yield increasing inputs should be shared

2. Share arrangements should be adjusted or re-evaluated as technology changes

3. Total returns divided in same proportion as resources contributed

4. Compensation for unused long-term investments at termination

5. Good landlord/tenant communications

Is the list really any different for leasing beef cows?

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Determining equitable shares…

1. Identify all costs to be included

2. Identify the costs contributed by each party and the costs to be shared

3. Calculate the percent of total costs contributed by each party

When all three factors are determined, the owner and operator should share income in the same proportion as they contribute to the operation.

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Other factors to discuss…1. How will replacements be handled?

2. What about pasture, crop ground, machinery and equipment, buildings, etc.?

3. What is acceptable death loss and how will death loss be documented and shared?

4. Condition of cows when returned, breeding and vaccination programs to follow.

While there is no right answer that fits every situation, it is generally recommended to keep replacements and other assets out of the cowherd lease.

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Other factors to discuss…

• Quality and usefulness of contributions

– Owner may have buildings and equipment that served him or her well, but are of little value to the new operator’s management plan.

– Quality and value of assets can vary considerably (e.g., genetics, age, and condition of cows)

– Negotiation and communication skills are essential to resolving disagreements of the value of such contributions

– Is management considered a contribution, who provides it, and how is it valued?

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0

4

8

12

16

20

24

28

32

36

0 100 200 300 400 500 600 700

Annu

al h

ours

/cow

Number of cows in herd

Estimated labor requirements for beef cowherds

Source: USDA ERS, EIB #73, McBride and Mathews, March 2011

Basic Principles

• Economies of size: What costs should be used to value contributions?

If labor is valued at $8, $10, $12, $14, and $16/hr, respectively, labor costs/cow are $247, $232, $177, $168, and $99.

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Basic Principles

• In competitive industries, Price = Cost(on average in the long run)

– Difficult concept for many to grasp

– Opportunity costs often are not considered

– Even competitive markets can deviate from this principle for relatively long time periods

– Can be multiple year time periods when one party appears to be getting a better deal

Cow-calf profitability drivers…

• Analysis of KFMA cow-calf enterprise analysis returns– 1979-2011 all operations

(examine time effect)

– 2007-2011 operations withat least three years of data(examine producer effect)

• Paper available on web(www.agmanager.info)

19

Source: Kansas Farm Management Association (KFMA) Annual Enterprise Analysis Reports

Average returns are highly variable over time…

20

7981

8385

8789

9193

9597

9901

0305

0709

11

-400

-300

-200

-100

0

100

Do

llars

/co

wReturn over Total Costs

Avg = -$101.34 and Std = $85.91

(top 1/3 = -$8.29 and bottom 1/3 = -$199.09 $190.78)

Why does the cow-calf industry even exist?

Profit Category Difference betweenAll High 1/3 Mid 1/3 Low 1/3 High 1/3 and Low 1/3

Farms Head / $ Head / $ Head / $ Absolute %Number of Farms 91 30 31 30Labor allocated to livestock, % 37.1 47.3 32.1 32.2Number of Cows in Herd 145 191 151 92 98 107%Number of Calves Sold 131 173 137 83 90 109%

Weight of Calves Sold 582 592 580 573 19 3%Calf Sales Price / Cwt $110.82 $112.11 $109.25 $111.17 $0.94 1%

Gross Income $585.86 $628.17 $594.00 $535.15 $93.02 17%

Feed $383.62 $344.13 $382.81 $423.96 -$79.82 -19%Interest $125.94 $106.16 $127.77 $143.85 -$37.69 -26%Vet Medicine / Drugs $20.55 $17.11 $23.99 $20.45 -$3.34 -16%Livestock Marketing / Breeding $14.84 $12.71 $14.05 $17.76 -$5.05 -28%Depreciation $36.75 $26.73 $35.39 $48.18 -$21.45 -45%Machinery $79.70 $58.47 $82.30 $98.25 -$39.77 -40%Labor $120.90 $102.83 $99.82 $160.74 -$57.91 -36%Other $37.66 $28.37 $36.62 $48.02 -$19.64 -41%

Total Cost $819.96 $696.52 $802.74 $961.20 -$264.68 -28%

Net Return to Management -$234.10 -$68.35 -$208.73 -$426.05 $357.70

* Sorted by Net Return to Management (Returns over Total Costs) per Cow

Beef Cow-calf Enterprise, 2007-2011 (min of 3 years)*

Returns are more variable across producers…

26.0%

74.0%

Compared to $191 between top and bottom third years.

21

30.2%14.2%

1.3%1.9%8.1%

15.0%21.9%

7.4%

Beef Cowherd Lease Analysis

Example of equitable shares calculated using KSU-BeefCowLease.xls spreadsheet and costs from KSU budgets.

Note: given inputs entered for share lease, the spreadsheet also calculates cash lease values using various methods as well.

• Replacements purchased or raised outside of the lease

• Owner provides breeding stock (cows and bulls) and portion of misc costs

• Vet, drugs, and supplies shared equitably

• Operating costs based upon MF-266 (KSU)

• Total cost = $1,129Equitable split = 68.0/32.0

Example – avg costs

Example – high costs

• Replacements purchased or raised outside of the lease

• Owner provides breeding stock (cows and bulls) and portion of misc costs

• Vet, drugs, and supplies shared equitably

• Costs based upon MF-266 (KSU) with adjustments to reflect low 1/3 profit group

• Total cost = $1,227 (+$98)Equitable split = 70.4/29.6

Example – low costs

• Replacements purchased or raised outside of the lease

• Owner provides breeding stock (cows and bulls) and portion of misc costs

• Vet, drugs, and supplies shared equitably

• Costs based upon MF-266 (KSU) with adjustments to reflect high 1/3 profit group

• Total cost = $1,030 (-$99)Equitable split = 65.1/34.9

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Determining equitable shares…

So, what is the “right” answer?

1. Average cost operator = 68/32 (operator/owner)

2. High cost operator = 70/30

3. Low cost operator = 65/35

If market is competitive, low cost operators will tend to “set the rates”. The reality is that we can, and often do, see a wide variation in rates within a region for many reasons (some legitimate, others less so)

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Basic Principles

• Competition: We observe owners getting a larger than “fair” share

– Difficulty in accounting for all costs

– Willingness of operator to sell labor and capital at below market rate

– Low cost operators sharing their advantage with owner via higher rent (i.e. it is “fair” rent)

– Local “thin” market conditions

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• Non-Profit Motivations

– There may be motives other than profit that appeal to beef cow-calf livestock industry participants

– Which is it that people gain utility from

• Owning cows vs. Running cows

– Retiring generation may simply want to “help out” the younger generation

If profit is not a motive, do we have a role in helping to determine rental rates?

Basic Principles

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Other Issues/Considerations…

• Written leases are strongly encouraged– More detailed thought process– Reminder and guide– Spell out annual negotiation, termination, etc.

• What is the motivation for the lease?– Is everybody on the same page?

• Communication is key! – Expectations of parties need to be clear and

realistic

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Lease Publications at AgLease101.org

• Fixed and Flexible Cash Rental Arrangements For Your Farm (NCFMEC-01)

• Crop Share Rental Arrangements For Your Farm (NCFMEC-02)

• Pasture Rental Arrangements For Your Farm (NCFMEC-03)

• Rental Agreements For Farm Buildings and Livestock Facilities (NCFMEC-04)

• Beef Cow Rental Arrangements For Your Farm (NCFMEC-06)

AgLease101.org© North Central Farm Management Extension Committee

North Central Farm Management Extension Committee

AgLease 101 was developed with funding provided by the North Central Risk Management Education Center.

Providing leadership in the development of high quality research-based extension programs and publications that anticipate and meet the ever-changing business management educational needs of agricultural producers of the North Central States. Our programs and publications capitalize on the expertise of farm management faculty from throughout the region and country.