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) NWSWNCEState Wheat Alfalfa Grain Sorghum Native Pasture Bermuda Other Pasture Source: OSU CR-216 and CR-230, 2005

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 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.

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 sharedLandlord’s share Crop1/3 Gov’t. payments, other income1/3 Expense items shared SeedNone Fertilizer1/3 Pesticide1/3 (or none) Chemical applications1/3 (or none) HarvestingNone Lime application1/3 IrrigationNone (or 1/3)

Tenant’s Share of Herbicides Source: OSU CR-230, 2005

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 tenant ½ 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 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

To do Develop written agreements Review agreements annually in advance of the renewal date Update, modify agreements when the operating environment changes significantly