8.0 HOW MUCH EQUITY DO FIRST FARM PURCHASERS REQUIRE?
The amount of equity required to purchase a first farm has changed considerably over time. By far the biggest influence on this figure today is land price. However, the milksolids payout and bankers' expectations of how this will behave over the long term, interest rates and farmers' ability to service debt strongly influence the borrowing ability of the individual and thus the amount of equity required.
The size of an economic unit has also increased over time. An economic unit is considered able to support a family and service the debt required to purchase the farm without outside income. In 1972/73 and even in 1992/93, a 40 ha farm was capable of doing this. In 1995/96, this would only be an economic block if it were almost debt free.
It is generally considered by bankers that a farm needs to be producing about 43,500 kgMS (25,000 kgMF) in the Waikato to be economic. At average production levels for Waikato farms, this equates to a 60 ha farm. In the Canterbury region, the situation is slightly different with few smaller farms available for purchase. For this reason, a Canterbury sharemilker moving into farm ownership will be looking at a property which is producing approximately 65,000 KgMS. At average production levels this equates to a 70 ha property.
When looking at lending money, bankers will generally lend up to a point where debt servicing equates to between 25 and 30% of gross farm income depending on the individual. For a competent farmer with good levels of production and relatively low and controlled costs, this translates to a maximum of about 40% of the total value of land and buildings. A prospective farm buyer will also need a herd of cows on top of this to stock the farm.
To get an idea on how sharemilkers or other new farmers fare when trying to purchase a farm today compared with 1972/73 and 1992/93 the 40% criteria has been used in Table 14 to estimate the equity a potential farm purchaser requires.
TABLE 14: Equity Required to Purchase an Economic Farm Unit
| WAIKATO | CANTERBURY |
| 1972/73 | 1992/93 | 1995/96 | 1995/96 |
| FARM PERFORMANCE Average (ha) No of cows wintered Production (kgMS) Production/ha (kgMS) Production/cow (kgMS) |
40 83 17956 449 216 |
40 108 27631 690 256 |
60 168 43848 730 261 |
72 193 65000 903 337 |
| FINANCIAL PARAMETERS Land price ($/ha) Cow price ($/head) |
960 140 |
10349 800 |
18858 850 |
10503 850 |
| CAPITAL VALUE Land and buildings Cattle |
38400 12815 |
413960 88850 |
1131480 153900 |
756216 176801 |
| TOTAL CAPITAL VALUE Number of Cows Required to meet this Capital Value |
51215 365 |
502810 629 |
1284380 1511 |
933017 1097 |
| EQUITY 60% land and buildings Stock NUMBER OF COWS REQUIRED |
23040 12815 256 |
248376 88850 422 |
678888 153900 980 |
453729 176801 742 |
| NUMBER OF COWS ON AVE SHAREMILKING JOB | 138 | 216 | 255 | 390 |
| COWS REQUIRED : AVE HERD SIZE | 1.86 | 1.95 | 3.84 | 1.90 |
The average sharemilker in the Waikato faces a much more difficult proposition today if their goal is to purchase a farm. In 1972/73, a sharemilker needed 256 cows to have 60% equity in the farm and a herd. This equated to 1.86 times the herd size of the average sharemilker at the time. In effect this meant gaining a larger sharemilking job, becoming debt free on the herd, then moving on to farm ownership. In 1992/93, this hadn't changed very much with a sharemilker requiring 422 cows. This was 1.95 times the size of the average sharemilkers= herd. Moving on to a bigger job was still a realistic proposition, although 420 cow jobs in the central Waikato are not that common.
In 1995/96, the equity required to purchase and stock a first farm has increased to 980 debt free cows, 3.84 times the size of the average sharemilking job. This means a sharemilker would require one very large job, or several smaller jobs to gather sufficient capital in the form of cows. This necessitates a change in strategy for the average sharemilker, who is unlikely to be able to acquire a 1000 cow job in the central Waikato. Investment in assets other than cows looks to be a necessary step to attain the goal of farm ownership.
In Canterbury on the other hand, with land selling at $8,300/ha less than in the Waikato, and with larger sharemilking jobs available, on average the sharemilker needs 742 cows to provide sufficient equity to purchase and stock a farm. To a Canterbury sharemilker, this represents about 1.90 times the size of their herd. This is 32% less equity than is required in the Waikato.
The issue of shares in the dairy companies and Dairy Board, and the requirement on new entrants to purchase those shares in order to supply milk, will also impact on the capital required by new entrants to purchase a farm. For example, share proposals currently in front of the New Zealand Dairy Group's suppliers would see new entrants having to front up with $2/KgMS prior to supply.
How the rural real estate market will deal with this is at present still unclear. The two main options would be to:
- deduct the value of the shares off the asking price of land;
- ask new entrants to pay current land prices with the share price as a cost over and above purchase price.
Under option two, a first farm purchaser looking at an average sized farm would require a further $87,700 in capital. This represents a further 103 cows, or 4.25 times the average sharemilkers= herd size in the Waikato.
Disregarding the share issue, as it is still only a proposal and has yet to be ratified at the time of writing, the economic farm surplus from Table 7 can be used to estimate the period of time it would take a sharemilker to accumulate sufficient capital to purchase a farm. Assuming the sharemilker starts with only 50% equity in their livestock, Table 15 illustrates how long it will take for sharemilkers to achieve farm ownership.
TABLE 15: Estimated Period Required to Accumulate Equity for Farm Purchase
| WAIKATO ($) | CANTERBURY ($) |
| Current equity (half ownership of stock) | 107,000 | 166,000 |
| Equity required (land and stock) | 832,788 | 630,530 |
| Debt servicing [ Interest cost at 13% of debt servicing on half of livestock value .] (interest on half of stock) | 53,000 | 82,000 |
| Difference | 778,788 | 546,530 |
| Annual earnings post tax [ Estimated as EFS - $30,000 drawings - Tax (28% of EFS) .] | 31,213 | 27,750 |
| Years required to attain equity [ Assuming annual earnings are invested as an annuity at 10% pa .] | 13.1 | 11.4 |
In the Waikato it is estimated that it will take the average sharemilker 13.1 years to gather the equity to purchase a first farm, compared with 11.4 years in the Canterbury region on the average sized sharemilking position. For the average sharemilker who enters the industry at age 28, this would mean they would be about 41 in Waikato before they purchase a farm or 39 in Canterbury.
This is a slightly artificial scenario as it is highly likely that the sharemilker will move on to larger jobs as a further stepping stone to farm ownership.
If a Waikato sharemilker were to purchase a farm in Canterbury they would be able to gather the equity in 10.6 years. Conversely, it would take a Canterbury sharemilker 14 years to accumulate the capital to purchase a central Waikato farm.
While it would not make sense for a Canterbury sharemilker to purchase in the Waikato, a Waikato sharemilker may stand to gain through purchasing in Canterbury. They would be able to purchase a farm almost two years sooner than they would be able to do so in the Waikato and would be able to purchase a larger property.
Using the MAF Farm Monitoring model for both centres, the EFS and return on capital can be calculated to ascertain whether or not it would be a good investment for a Waikato sharemilker to purchase a first farm in Canterbury. This is outlined in Table 16.
TABLE 16: Estimated EFS and ROC of Waikato and Canterbury First Farms
| WAIKATO ($) | CANTERBURY ($) |
| Gross Farm Income Per hectare |
190,000 3,166 |
242,700 3,370 |
| Expenses Per hectare |
102,000 1,700 |
128,700 1,787 |
| EFS Per hectare |
88,000 1,467 |
114,000 1,583 |
| Capital (land, buildings and stock only) | 1,284,000 | 933,000 |
| Return on capital (%) | 6.8 | 12.2 |
Table 16 demonstrates that the Waikato and Canterbury model farms are both operating at similar levels of profitability with an EFS of around $1500/ha. The big difference is the return on capital gained which is 6.8% for the Waikato and 12.2% in Canterbury. This is due solely to the lower cost of land in Canterbury. Other benefits gained from purchasing a farm in Canterbury would be lower levels of debt servicing, which would result in a higher disposable income and could be used to raise the sharemilker's standard of living and expand the operation. As a straight investment decision, purchasing a farm in Canterbury gives a superior return to purchasing in the Waikato. The future of land values will also play a part in deciding long term profitability through capital gain. Land prices in the Waikato have plateaued over the last 12 months whereas Canterbury dairy land continued to rise in value.
9.0 WHO IS PURCHASING FARMS?
With the rapid rise in farm prices from 1990, potential farm purchasers have required more and more capital to achieve their goal. In order to find out how this has affected farm sales and the type of person purchasing the farm, a search of Valuation New Zealand's database was carried out. Figure 3 below summarises buyer types of all dairy land purchases. As can be seen, existing farmers have dominated the market, and now account for approximately 83% of all transactions. This has been mainly at the expense of new farm buyers, who have dropped from 36% of farm purchasers in 1973, to only 10% in 1995.
FIGURE 3: Summary of Buyer Type in Dairy Farm Land Purchases for 1973, 1993 and 1995
Figures 4 and 5 illustrate trends in buyer types for Waikato and Canterbury dairy farms since 1980. Unfortunately data prior to this was not available on database and had not been categorised by locality.
FIGURE 4: Buyer Type Summary for Waikato and Canterbury Dairy Farms from 1980 to 1996
FIGURE 5: Buyer Type Summary for the Waikato and Canterbury: 1980-1996
The low number of annual property purchases in Canterbury results in a varied distribution of purchasers on a year to year basis. The most noticeable thing over the period is that existing farmers are the predominant buyer type. This is better illustrated in Figure 5. Up until 1990, new farmers were also regular purchasers of farms accounting for approximately one third of the market. Post 1990, the dominance and the value of purchases by existing farmers has increased, while over the same period the number of new farmers purchasing land has diminished to a level where business interests have become the second biggest purchasers of farms in Canterbury over the last five years.
This coincides with the emergence of corporate farm owners such as Applefields and Tasman Agriculture. The effect of these players in the market has probably also been masked by being categorised at various times as existing farmers.
In the Waikato, up until 1990 the existing farmer and new entrant accounted for approximately 58% and 34% of farm purchases respectively. Business interests and other purchasers accounted for the remaining 8% of the market.
Since 1990, the volume of sales has stayed comparatively high and steady compared with the previous decade. The existing farmer has purchased 75% of properties over this period, while the new farm buyer has slid back to 18% of the market. The business and other investors have maintained their market share at around 7%. This coincides with the rapid increase in land prices which started around 1990. At this time, cow prices plateaued and lost their relationship to land prices. Prior to 1990, cow prices held a relationship of approximately 8:1, meaning eight cows equated to 1 ha of land in value terms. By 1995/96, this relationship had changed to 22:1. In Canterbury this relationship changed from 5.1 to 14.1, which closely follows the proportion of change in the Waikato. This is illustrated in Figure 6.
As the sharemilkers= primary asset is cows, and it is the sharemilker who is most likely to be a new farm purchaser, the loss of parity between cow and land prices had all but forced them out of the market by 1995/96. This is demonstrated in Figure 7.
FIGURE 6: Relationship Between Land and Cow Prices from 1973 to 1996
FIGURE 7: Trend in Number of Farm Purchases Since 1990 by Buyer Type
Contact for Enquiries
Rural Affairs Coordinator
Sector Performance Policy
MAF Policy
Ministry of Agriculture and Forestry
PO Box 2526
Wellington
NEW ZEALAND
Phone: +64 4 894 0675
Fax: +64 4 4 894 0745
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