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Expanding Your Land Base: The Value of Accurate Valuation

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Author: 
Al Bennett
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For some lucky crop producers, the stars have aligned and the opportunity to acquire additional farm real estate has presented itself. With current land prices, sometimes investing with a partner — or family member — can make the deal more manageable and benefit both parties. While this can be a great experience, and typically add value to the operation, there are some considerations unique to this kind of partnership.
  1. Understanding Valuation. As a lender, one of the key factors we want our clients to have an awareness of revolves around valuation. This concerns how the property is valued. If, for example, what if there's a point in the future where you need to get out of the deal? In that case, having value for the property agreed upon ahead of time is critical.
  2. Hire experienced advisors. There are different ways of determining value. Regardless of the protocol you select, it’s imperative to make certain that the language in the buy-sell agreement is clear and appropriate. And that it has lasting relevance, so it’s applicable both now, and in the future. A great option to ensure this, is to have it drafted by an experienced attorney. Request it gets reviewed, or edited, and interpreted by an independent third party, to see if they read it the same way as the attorney thought he wrote it. Also, it’s important that you — and your partner(s) — understand it, to make sure you are aligned on the intent and that the intent is clearly documented.
  3. Valuation by formula. One method of determining valuation, is by formula. Certainly, if it is by formula, it's got to be a formula that's appropriate for the business and aligns with the earning capacity of the business. You would never want to have a formula for valuation that would put the stability of the business in jeopardy. If you ever decide you have get out of a land deal, you have to be able afford to do so. Without the right formula, you may be unpleasantly surprised.
  4. Valuation by fixed price. Another method used to determine valuation is with fixed price. Generally, there's nothing wrong with having a fixed price for this type of a deal. If you're going to go down that route, you’ll want to make sure there’s a mechanism in place for annual updates. Additionally, have an agreement in writing outlining what would happen if annual updates aren't kept current or if you can't reach consensus. It’s also a good idea to include whether or not the annual updates are binding and, if so, for how long?
  5. Valuation by appraisal. It’s very common to see valuation established via an appraisal. If you are going to have an appraisal to determine value, it could work to have one appraisal prepared by a single appraiser pre-approved by both parties. Sometimes, it makes more sense that the buyer and seller each hire an appraiser. Before the appraisal(s) are done, make sure everyone knows who is paying for what. Typically for one appraisal, the cost is split between the buyer and seller. If two appraisals are conducted, the buyer and seller usually each pay for their chosen appraiser. If two appraisals are done, how far apart can the results be? Our recommendation, obviously, is that you've defined that upfront, that if there's less than 10, or 15 percent deviation perhaps you average them, and that's then the agreed upon value. If it's a broader discrepancy than that, likely it might be appropriate to have language that the first two appraisers, then identify a third appraiser and the mean of those three becomes the binding value.
  6. Discounts. Finally, if this transaction is in a closely held family entity are there discounts? There are sometimes discounts for minority interest and the discounts for lack of marketability. It’s best to consult an attorney for more information on discounts, and include your CPA in this discussion as well. All parties need to understand and agree on any discounts, what they will be and how they might impact the ultimate value of the property. It should also be noted that the decision-makers are working on language to do away with these discounts in the future. All the more reason to consult with your professional advisors before assuming they will apply to your situation.
Keeping your trusted advisors, such as your real estate agent, lender, accountant and attorney an active part of the conversation will help ensure you’re making the best decision for you and your operation. Determining valuation is a solid first step as you work with your experts to design a meaningful, beneficial and professional real estate purchase. For more industry updates, subscribe to our production agriculture e-newsletter.