Room to grow: the big decision to lease or buy

While leasing is not as common here as overseas, a 2019 Rabobank report showed 28 per cent of Australian farmers leased some land.

Leasing was most common in grain-growing powerhouse states SA, at 45pc, and WA, 38pc. In NSW, where a greater proportion of livestock producers are located, only 17pc of farmers leased land.

Rabobank senior analyst Wes Lefroy said leasing was especially attractive when property was hard to find, offered flexibility with the seasons and as businesses changed, and could be a very useful succession tool.

With demand for land expected to continue to outstrip supply, Mr Lefroy said leasing was likely to grow in popularity.

Even so, Agrista consultant John Francis said, the arrangement was still not well understood and the number one myth surrounding leasing was that it didn't require a lot of capital.

"If you're in a livestock business, 75pc of the capital you require will actually be in the livestock," he said.

More land meant a greater outlay on livestock and, at $150-200 a dry sheep equivalent, that quickly added up to a significant investment requiring a lot of security if the money was borrowed, Mr Francis said.

A bigger operation also added efficiencies of scale or inefficiencies, amplified as farm size increased.

"If you can't increase scale with the same skill base and replicate the existing performance, assuming you're already performing reasonably well, your production will decrease, so you would have been better off buying a smaller farm than leasing a larger one," Mr Francis said.

That applied to both productivity and costs, which could change in steps because, as he said, "you can't buy half a tractor".

It had serious implications for a cropping operation looking to invest capital, which, as a rule of thumb, could lease about 12 times the area of land it could buy, Mr Francis said.

"If I'm a cropper leasing say, an extra 1500 hectares, now I need new plant, whereas if I'm just tacking on a 150ha purchase, I can do it with existing plant," he said.

"This demonstrates some of the complexity in a comparison between leasing and purchasing."

It also depended on the view farmers took on farmland price trends.

"If you think capital growth is going to flatline, I would say there's no imperative to get into buying a farm, leasing more scale will give you a greater opportunity," Mr Francis said.

"As soon as you start to pay lease rates of 4pc and above, there's a less compelling case for leasing relative to purchasing if you think purchased land is going to maintain capital growth of around 5pc."

Lease rates pegged at around 5pc of capital value could land tenants in trouble as farmland prices climbed, commodity prices weakened or seasons turned.

"The expectation of return from a landlord's perspective might need to be re-aligned with changes in farmland values," Mr Francis said.

"But really what it comes back to is the tenant doing their homework and saying, 'Can I generate an adequate margin for myself at that price?'. If they can't, they walk away.

"Don't forget, you need a risk premium in there because it's likely that there will be volatility in returns."

Mr Francis said it wasn't the landlord's responsibility to ensure the lease was viable for the tenant but a good agreement delivered profits so the asset could be well managed.

"If you charge a rate where your tenant isn't remunerated for the work they're doing, that's dangerous, in my view, from a landlord's perspective," he said.

The best way to start the process, Mr Francis said, was with an information memorandum even more detailed than those normally used to sell property, so prospective tenants could plan for success.

It should include fertiliser and productivity history, water and other infrastructure maps, enterprise suitability and what's important to the landlord.

"I've had people tell me the truck driving past the house kicked up dust and included that as a term that trucks can't be driven past the house," Mr Francis said.

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