Savills

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UK Cross Sector Outlook 2023: Rural

Emily Norton looks at key market drivers including interest rates and farmland values, energy prices and monetisation of natural capital.

Farming does its best in a crisis. Global conflict, macroeconomic retraction and a protracted recession is causing a headache for investors in all sectors, but farmland has long acted as a haven for wealth preservation. This time around its status as the provider of foundational resources has cemented its post-covid sense of purpose. Inflationary pressures may be suppressing consumer sentiment, but the old “quantity and value” model was already on the way out. As countries urgently move to localisation to contain the impact of conflict in an increasingly volatile world, the regenerative power of food, fibre and fuel from land becomes more prominent and more desirable. Our market forecasts reflect this counter-cyclical sentiment.

FARMLAND

Farmland traditionally responds positively to inflation, outperforming it by 3.2% per annum across the last 30 years. From December 2007 to December 2009, during the global financial crisis, land values rose 29% as investors looked for real assets in a supply constrained market.  Farmland also has a weak negative correlation with interest rates. Investors get wary as income returns from savings look more stable and more attractive than returns from traditional farming, and the impacts of debt drive exit decisions, increasing supply. The early 1990s recession saw interest rates at 13% and a rapid uptick in supply through to 1997. Values briefly responded positively to EU rural development reforms after 1993, but otherwise were depressed during this period. 

 

UP HILL AND DOWN DALE
 
Our prediction for 2023 is that inflationary pressures will be more influential than any tempering effect of interest rates. There are several reasons for this. Supply this year is already at historic lows and interest rates are still comparatively low. Consumer price inflation also is translating into output prices in commodity sectors (even if margins haven’t necessarily improved), and competitive interests for nature-based solutions remain keen. We had expected the agricultural transition to accelerate retirement decisions in 2022, but a rapid uptick in commodity prices in response to the Ukraine conflict means many are hanging on hoping for a bumper couple of years. As such, we anticipate supply to remain constrained for the foreseeable future. Any negative impact of rising interest rates will be tempered by the ongoing supply and demand imbalance. With traditional purchasers of land facing stiff competition from a new era of deep-pocketed nature-positive and impact-motivated buyers, land values are likely to continue to outpace target inflation.
 

YOU'RE THE ONE THAT I WANT
 
Poorer quality grazing land remains our pick for the future. Having increased by 22% since December 2020, demand is likely to continue over the next five years as pressure to re-carbon and re-nature land intensifies. Unlike land that is defined by location, infrastructure or aesthetics, it can be easier to focus the management of poorer quality land on providing valuable services to society. Investors motivated by environmental and carbon targets set by government are well placed to seek natural capital uplift here, either for their own benefit (insetting) or to provide services to others (offsetting).
 

DREAMS DO COME TRUE
 
The value of the global voluntary carbon market nearly quadrupled in 2021. It is no wonder therefore that carbon offsetting is lauded as an opportunity for farmers. However, investors need to be smart about the market value of emissions avoidance and carbon sequestration. Soil carbon markets remain hazy. Above-ground biomass such as hedges and trees ultimately may be easier to monitor and verify. Counter-intuitive value could be found in retiring financially-stressed polluting assets – both carbon and nutrient markets are prepared to pay to reduce pollution permanently. 

Either way, carbon markets should be viewed as a transitional income stream, and revenue reinvested for whole farm resilience. The investor market is still struggling to understand the difference between the natural capital uplift business case, and the long-term income potential of delivering nature-based solutions (including food). Regenerative agriculture majors on profitable income streams, not capital disposals such as carbon offsetting. Within five years, capital values and rent levels should begin to reflect soil health and other regenerative indicators, as a consequence of these enabling market access and farm business resilience.
 

I'LL BE WATCHING YOU
 
The development of private markets for nature-based solutions appears increasingly dependent on location. Divergence in agricultural policy across the home nations will offer a fascinating comparative assessment of the influence that subsidy and private capital has on land values and rents. From an investment point of view, Welsh farmland has scope for increases in capital growth. A supportive new Sustainable Farming Scheme seeks to spread the burden of natural capital uplift through existing farmers across the whole country, which may dampen private market enthusiasm but could make for a good trading framework for profitable farm business. Scotland, in comparison, is overtly seeking private finance into natural capital and values remain highly influenced by natural capital expectations. Based on emerging policy, existing upland occupation models are more likely to be challenged in Scotland than in Wales, such that more supply could be anticipated north of the border. Deep collaboration and partnerships will be key to successful land management outcomes in both.

FRIENDS WITH BENEFITS

Agricultural land provides a host of benefits during economic volatility. Unless capital taxation reforms come back on the table, we expect the inflationary pressures on markets to outweigh interest rate and agricultural transition concerns. Looking forwards, with an increased emphasis on both food security and climate targets, this can only be a good thing for farmland values. Smart investors will look for income value from land, not just capital appreciation, however this year we have a seen prime arable land rise by 8.7% whilst poorer quality livestock has risen by 12.4%. With the exception of poorer quality pasture, national average land value increases have, unsurprisingly, not quite kept up with shock inflation this year. With inflation anticipated to fall in 2023, we estimate GB real value averages for prime arable to increase by 2.5% per year and poor livestock to increase by 6% per year over the next five years.


FORESTRY
 
Commercial forestry has been a stellar performer over the last 20 years, but the prospect for the years ahead is more muted. There is still very limited supply, which in turn drives value, and we are unlikely to get to a stage where the market is oversupplied. Sales are largely driven by death (for private owners) or profit crystallisation (for investors), and forest acquisitions are very rarely borrowed against, meaning interest rates have minimal impact on debt related sales. Looking back to the last recession, low interest rates then lead to investors hunting real assets looking for returns. The increase in prices we saw in 2008 as a result will likely not be replicated this time around. The maturity of the forestry market now seems more likely: prospects for capital growth are more closely linked to timber prices, and we are unlikely to see negative growth over the next five years.


FORGET ABOUT THE PRICE TAG
 
The monetisation of natural capital remains the unknown factor, particularly in woodland creation. The acquisition of land to plant new trees has been widely publicised in the media, due to the clamour around the Woodland Carbon Code attracting a new range of commercial investors looking to acquire farmland for offsetting projects. Reacting to this, emerging Welsh agricultural policy places the burden of tree planting firmly on existing farmers, requiring all farms to have at least 10% tree cover. 

The 15,000 hectares of new woodland planted each year is a drop in the ocean compared to the embedded value of the 3.24 million hectares of existing woodland across the UK. In England, 59% of woodland is managed, and the other 41% is likely in a declining condition. Research by the Forestry Commission suggests that for every £1 of private profit generated through the management of forests for timber, £18 of public benefit is generated. Converting the theoretical value of existing woodland into financial returns is key – localised biomass and sawmill infrastructure is needed, and government could do more to stimulate demand-side drivers. 

Monetising positive forest management changes to improve biodiversity is harder than it should be. Whilst management decisions are down to the individual owners and managers, new policies with financial incentives would certainly make the choice easier. This represents a lost opportunity in terms of biodiversity. The Forest Management Certification arguably is seen as a cost of achieving a timber premium, rather than an incentive for better woodland management. One possibility within England is Biodiversity Net Gain (BNG), which will become a legal requirement for development sites in November 2023. BNG compensation can be in habitats of equal or greater value than that destroyed, meaning that woodlands could be used to offset farmland lost to development. Payments for offsite habitat enhancement in woodland areas represents a real opportunity to generate income, even from smaller parcels of woodland. Defra’s new Environmental Land Management schemes would also do well to target public finance to woodland management in the farmed landscape. 

 

RENEWABLE ENERGY 

We are the children of the sun 
In a single hour, the amount of solar energy that strikes the earth is more than the entire world uses in a year. The benefits of solar energy are clear to see, and it is a rapidly evolving technology, with deployment costs having reduced in price by 82% between 2010 and 2019. Questions still remain however over policy, and the current government’s focus on food security over solar deployment. On-shore wind remains under a controversial de facto ban (at least at the time of writing). The role of the planning system in blocking the green energy transition remains under scrutiny. 

What appears to hold back renewables in many instances is the scale and perceived impact that local communities suffer from renewable development. Smaller scale projects do not tend to experience the same levels of scrutiny, and research has even shown communities strongly support development, particularly where they benefit directly from it. Scotland has led the way in community-owned renewable infrastructure. Investors looking at beating the planning system in renewable energy development may be wise to re-scale renewable energy projects to focus on local benefit and self-sufficiency. 

We are young, we run green 
In ideal conditions, 1 kWp of solar power capacity roughly corresponds to 1,000 kWh per year. Due to the nature of solar, it is not as simple as needing 50 kWp to meet the needs of a 50,000 kWh farm or commercial enterprise; firstly, without battery storage, times of lower solar production and high energy needs will require additional energy to be drawn from the grid. Furthermore, factors such  as shade, roof pitch, geographic location and which direction the panel is facing can all impact yield. Actual yields within the UK are more like 675 kWh in the North and 975 kWh in the South, although these can vary significantly.

Modern solar panels for rooftop installations tend to be rated between 300 – 500 watts, with the larger panels being more expensive. This means you would ideally need between 120 and 200 solar panels for a 60Kwp system on a 50,000 kWh enterprise, taking up around 300m2 of roof space. A general rule of thumb for a smaller system such as this is just under £1,000 per kWp, without a battery, meaning for the purchase and installation the total would be around £55,000.

Analysis of our data indicates that for a mid-size dairy farm, this option would have a 4.7 year payback period, and a net profit after 15 years of £112,000, a return on investment of 124% over this period, or 5.52% per annum. High energy prices mean that the returns on investment could be greater and the payback period shorter for small scale solar energy. Between Q2 2021 and Q2 2022 the average electricity price in cash terms (excluding the Climate Change Levy) in the non-domestic sector rose by 45%. There are currently no signs of these prices falling.

Until the house falls down 
For roof mounted solar one important consideration is the lifetime of a building compared to lifetime of PV modules. It is generally considered panels will last at least 25 years, and therefore if you are installing on an existing building this needs to be accounted for, given there will be additional expense if the building is in need of replacement. Planners would do well to ensure that developments are future-proofed through design to maximise passive heating, cooling and solar capture potential. 

A battery is a necessity if looking to maximise the amount of energy available outside the peaks of renewable generation. Though battery storage will lead to higher capital expenditure and longer payback periods, the non-financial benefits, including flexibility and resilience, are substantial and should be considered as an integral part of all new installations.