Lease Negotiations

Annie’s Project

Coweta Oklahoma

February 20, 2007

Cash and share lease agreements

What portion of the income do I receive? What portion of the costs do I contribute? What portion of the risk do I bear? What crop and land management practices will be

followed? What will be the condition of the land and

improvements at the end of the lease?

Cash lease agreements

Tenant pays landlord a fixed amount per acre per year.

May be single or multi-year. Government payments go to tenant. Can add flexible component.

Cash lease advantages

Landlord More stable income Payment can be scheduled for

any time of year Eliminates or greatly reduces

cash expenditures Reduced management

responsibility Shifts risk Fewer potential conflicts about

sharing and marketing crops

Tenant Total managerial freedom Fewer chances of conflict

over decisions Receive all benefits of a

“good year” and superior management

Eliminates time and effort associated with dividing crops and input purchases as well as the related record keeping

Cash lease disadvantages

Landlord Can become inequitable due

to changes in prices, costs and technology

Fewer opportunities for income tax management

Will not realize benefits of good price and/or yield years if the agreement is not flexible

Greater chance of soil depletion, neglected improvements

Tenant Must shoulder all the price

and yield risk if the agreement lacks flexibility

Large capital requirements for inputs

May be required to pay part of the rent early in the year before the crop is planted

Landowners may attribute above average yields to soil rather than management

Adding flexibility to the cash agreement Can reduce need for frequent adjustments Distributes more of risk

Price risk adjustment Multiply base rate by actual price/estimated price

Yield risk adjustment Multiply base rate by actual yield/estimated yield

Share lease agreements

Landlord and tenant share proportionally in costs and risks of production, then share benefits accordingly

May be single or multi-year Government payments shared in same

proportion as crop

Share lease advantages

Landlord Receives benefits of good price

and/or yield years Land and improvements are

more likely to be maintained Relieved of some operational

decisions Easier to establish “material

participation”

Tenant Less capital may be required Less experienced tenants can

benefit from the landowner’s managerial input

Share price and yield risk with landowner

Share lease disadvantages

Tenant Need to discuss

management practices with landlord on a continuing basis

Joint decisions result in more opportunities for conflicts

Must share benefits of a “good year” and superior management

Must maintain records of shared expenses and divide crops

Landlord More variable income and

increased risk Need to discuss management

practices with tenant on a continuing basis

Increased capital requirements associated with share of cash expenses

Must maintain records of shared expenses

Increased responsibilities More possibilities for conflicts

with tenant

Put the agreement in writing!

Encourages understanding by both parties Serves as a reminder of terms agreed upon Legal resource and guide for heirs

Consult with a lawyer.

Terms that should be specified in all agreements

Parties to lease and description Date the lease is entered into Names and addresses of the landlord and tenant Legal description of the leased property Binding to heirs Signatures of the landlord and tenant

Terms that should be specified in all agreements

General terms Beginning and ending dates of the lease Rental amount, respective shares When and how rent will be paid and penalties for late

payment Who will carry insurance on the property and crop Statement that no partnership is intended Conditions under which the tenant may or may not

sublease the property Records to be kept

Terms that should be specified in all agreements

Termination When and how the lease may be terminated Requirements for notice of termination Acts of the tenant that would constitute default of the lease Reimbursement provisions for crop nutrients, lime and/or

completed fieldwork upon termination of the lease Tenant’s rights if the property is transferred or condemned

during the lease period. Reimbursement provisions for a crop in the ground when

the lease is terminated.

Terms that should be specified in all agreements

Operation and maintenance Desired or prohibited farming practices, including types of

chemicals that may not be used on the property Process of measuring and maintaining soil fertility and pH

levels Which party is responsible for controlling noxious weeds Which party is responsible for maintaining fences Whether the tenant has the right to make improvements

and be compensated for improvements, terms for reimbursing tenant

Terms that should be specified in all agreements

Operation and maintenance (continued) Stocking rate Whether the tenant has the right to utilize improvements

made by the landlord. Provisions for soil-conservation practices. Statement regarding the existing environmental status of

the property and responsibility to minimize activities that may cause contamination.

Use of non-cropland, garden plots, trees, buildings, grain bins, pasture or other areas not rented for cropland.

Terms that should be specified in all agreements

Landlord rights and government payments Landlord's right to enter the property for specific purposes

(entry, hunting and fishing, harvesting pecans) Landlord's right to a security interest in the crops or other

provisions for ensuring payment. Statement of which party will participate in federal farm

programs, including responsibility for eligibility and receipt of payments.

Nature of landlord participation in management (may impact income and self-employment, taxes, social security payments, and estate planning)

Terms that should be specified in all agreements Arbitration of differences

Provision that any amendments must be in writing and signed by both parties.

Procedure for resolving disputes, including the applicable state statutes.

Terms that should be specified in all agreements Crop-share provisions

Sharing of crops and tenant's contribution of machinery and labor.

Sharing of operating expenses. Storage and/or delivery of landlord’s share of crops. Compensation upon termination of the lease. What records are to be kept by whom and how will this

information be shared.

Terms that should be specified in all agreements Miscellaneous

Willingness to sign security agreement Plan to pay property taxes, repairs, insurance on

improvements Compliance with FSA, NRCS, other agency

requirements Mineral rights Other environmental clauses

What is fair? What is not fair?

Fair does not equal legal. Legal does not equal fair.

Everything is negotiable up front.

Determining a Fair Cash Rent

Market approach Landlord’s ownership costs plus return to

equity Residual income method

Northwest

Southwest

East

Northcentral

Oklahoma Farmland Leasing Regions

Average Annual Dryland Cash Rental Rates ($/acre)

NW SW NC E State

Wheat 27.63

10-46

29.93

15-47

34.80

8-50

31.43

10-45

30.21

8-50

Alfalfa 39.62

25-90

Grain Sorghum

25.60

18-45

Native Pasture

7.06

2-15

10.13

5-30

12.15

2-30

10.12

2-30

9.66

2-30

Bermuda 12.55

7-20

13.60

2-30

13.09

2-30

Other Pasture

18.20

10-40

15.87

6-40

Source: OSU CR-216 and CR-230, 2005

Dryland Wheat Cash Rental Rates

2

31

37

20

2

9

05

10152025303540

< $10 $10-19.99 $20-29.99 $30-39.99 $40-49.99 >$50

Rental Rate ($/acre/year)

% o

f R

es

po

ns

es

Source: OSU CR-230, 2005

Determining a Fair Cash Rent

Landlord’s ownership costs plus return to equity Property taxes on land $2 Improvements

Repairs and maintenance Property taxes Insurance Depreciation

Desired return on equity $800 @ 4%

Determining a Fair Cash Rent Residual income method

Returns Grain, government payments, other

Variable costs Seed, fertilizer, chemicals, fuel, harvest costs, labor, etc.

Fixed costs Machinery and equipment depreciation, interest on

investment, taxes, insurance Management fee (e.g., 5-8% of gross receipts)

Review wheat budget

Establish expected returns to overhead, land, risk, management

Determine what each party is contributing.

Overhead LandRisk Management

Determining a fair share rent

Determine the percent contribution of total value of fixed items contributed by each party

Share variable expenses in the same percentage as crop is shared

Adjust share arrangements to reflect the impact of new technologies, improvements, land quality

Share total returns in the same proportion as total expenses are contributed

Compensate tenant at the end of the lease for the unused portion of investments

Valuing fixed contributions

Land “Safe” rate Divide annual cash rent by per acre land value Divide per acre net income by per acre land value

Machinery and equipment Management

Percent of average capital invested Percent of gross farm receipts

Labor

Typical Oklahoma cropland share lease agreements

Source: OSU CR-230, 2005

Income items shared Landlord’s share

Crop 1/3

Gov’t. payments, other income 1/3

Expense items shared

Seed None

Fertilizer 1/3

Pesticide 1/3 (or none)

Chemical applications 1/3 (or none)

Harvesting None

Lime application 1/3

Irrigation None (or 1/3)

Tenant’s Share of Herbicides

0 0

12

41

1

45

05

1015202530354045

0 1-35 36-63 64-71 72-99 100

Percent of Responses

Source: OSU CR-230, 2005

10

0

17

33

30

37

0

5

10

15

20

25

30

35

40

% o

f R

esp

onse

s

0 1 - 35 36 -63

64 -71

72 -80

81 -99

100

Landlord's Share

N=34

Source: OSU CR-230, 2005

Tenant’s Share of Lime Application Costs

Effect of land quality and farm cost on crop-share rental arrangements

Annual yield per acre

Annual operating cost per acre ($)Costs

Least productive land

Most productive land

2/3 tenant½ tenant

Coming to agreement....

Both tenants and landlords should estimate their contributions to production

Use of area standards or traditions may not be in the best interest of either party

Worksheets and spreadsheets are available to summarize contributions and analyze alternatives

Equitable agreements are negotiated

References

http://osuextra.okstate.edu/, choose Department, Agricultural Economics

Oklahoma Pasture Rental Rates, OSU CR-216 Oklahoma Cropland Rental Rates, OSU CR-230 Developing Cash Lease Agreements, OSU F-214 Developing Share Lease Agreements, OSU F-215 Tax Aspects of Leasing, OSU WF-940 Tax Consequences: Cash vs. Crop Share Leases, OSU WF-941 Breeding Livestock Lease Agreements, OSU WF-571  Stocker Lease Agreements, OSU WF-572

Also, MidWest Plan Service website located at http://www.mwpshq.org/

To do

Develop written agreements Review agreements annually in advance of

the renewal date Update, modify agreements when the

operating environment changes significantly