Leasing land

How leasing works

The tenant (lessee) pays the farm owner to use their land, buildings, and infrastructure and possibly dairy company shares to run their own farming operation independently of the lessor. The lessee is also responsible for the upkeep of the farm assets to an agreed standard for the duration of the lease.

This is not a partnership with shared responsibilities as is the case for sharemilking and equity partnerships. The lessee keeps all revenue and pays all costs associated with the farming operation and upkeep of the land. The lessor’s income is generated through a pre-agreed rental payment, usually paid monthly, and subject to periodic review. The rental paid may be either a fixed rate (12 equal monthly payments) or a variable rate that changes depending on milk price.

Entering and exiting a lease agreement

• The duration and the terms and conditions of the lease are open to negotiation. While templates are available from organisations such as Federated Farmers each agreement defines the terms differently.
• A lease duration of three to five years with a right of renewal for a further period, subject to rental renegotiation, is typical.
• From the lessee's perspective, given the investment in cows, plant and equipment, and staffing, there is a requirement for a reasonable tenure.

Advantages for the lessee

• Full control over the management of the dairy operation and therefore profitability of the dairy operation, assuming they are meeting their obligations.
• They can take control without having to borrow to purchase land, allowing entry with lower equity.

Advantages for the farm owner/lessor

• May suit farm owners looking to exit from the day-to-day running of the property but still want to retain land ownership.
• Provides options to receive a secure income independent of production and milk price through a fixed rate rental, or to introduce a little risk and reward through a variable rate rental.
• Removes the need to deal with a business partner.

Setting the rental rate

Determining a realistic and fair rate will help both parties feel they are meeting their objectives. The lease rate can be calculated in different ways.

Fixed lease rate

A fixed lease rate is agreed and paid annually, usually in monthly instalments. This provides predicable cashflow to the owner/lessor.

The most effective way to establish the lease rate is to go to the market and invite potential lessees to tender for or negotiate a lease. Other possibilities include:

• Using average debt servicing levels for the area as a percentage of gross farm income. This provides a starting benchmark.
• Using a percentage of capital value. This can however be difficult as capital valuations are influenced by factors outside of productive value.

Variable lease rate

In some cases, a lease agreement will be structured around a rate that varies based on the milk price, but not on milk production. This means the owner/lessor gets to share some benefit from high milk prices and the lessee is less exposed at low milk prices.

Calculating a variable lease requires:

• A market rental to be agreed, based on an assigned level of milksolids production reflective of the history of the farm. This is used to set a base lease rate per kilogram of milksolids.
• A reference milk price that represents the expected milk price for the period of the lease.

The actual rental can then be calculated in a couple of ways:

• Indexing directly to milk price. Dividing the base lease rate per kgMS (B) by the expected milk price (C) provides a rental index. Let’s say this equals 20%. The final rental the lessee will pay will be 20% of the actual milk price multiplied by the reference level of production (A). In some cases, a floor milk price will be specified to guarantee the lessor a minimum income.
• The lessor and lessee can agree on levels in milk price at which an increased share of the milk price is paid to the lessor. In this case, the base rate sets the minimum to be paid to the owner but as milk price increases above the reference milk price (C), there is an associated increase in rental payments.
  For example, if milk price is $0.50/kgMS to $1.50/kgMS above the reference milk price (C), the lessor may be paid an extra $0.10/kgMS across the base production (A), and if milk price is more than $1.51 above the reference price they may be paid $0.20/kgMS across the base production (A).
  Note that changes in production volume are not factored into these calculations as this will be valued in a market valuation of the base lease.
• Top-up payments can be made At the end of the year or through the year as milk price changes are announced. The simplest option is to maintain payments at the base rate until the final milk price is known when a single top-up payment can be made.

Keys to success

Although the lessor and lessee are not in partnership the lease arrangement still needs to work for both parties. Making it work requires a fair rental rate and clarity during the development of the lease agreement. Farmers tell us the key issues to be addressed include:

• The lease must specify conditions of “good farm husbandry” practice that the lessor expects the lessee to meet. This may include conditions around fertiliser to be applied, weed management, minimisation of pugging in susceptible areas, and expectations of repairs and maintenance.
• The lessee takes on the responsibility of the landowner for the duration of the lease. This may require them to carry out a range of regulatory duties including complying with environmental obligations. These must be identified and documented in the lease agreement.
• Having the above expectations monitored regularly by a third party will help reduce the potential for misunderstanding and allow any issues to be addressed in a timely fashion.
• The condition of assets at the end of the lease can be a source of conflict. Documenting this at the start of the lease is critical and should be carried out by an agreed third party. The lessee is required to look after the assets, but allowance is made for fair wear and tear, the interpretation of which is best done by a third party.
• Rent review dates and methods (CPI, market, agreed percentage) are typically included in the lease. This is more challenging as you can’t really go to the market if the lease is not on the market. A variable rate agreement will reduce the need for reviews.
• Houses on the property can be priced into the lease or excluded from the lease and rented separately or excluded.

Beyond this, the landowner must be aware that the lessee has full management control, and the right to quiet enjoyment of the property during the term of the lease, provided they are meeting their obligations as set out in the agreement. This type of agreement may not be suited to an owner who wants to maintain a level of involvement in operations.

Next steps

• Ensuring the lease is well-written and obtaining professional advice will help both the landowner and lessee understand expectations, obligations, and responsibilities.
• Use a current lease agreement and work alongside your farm advisor. You can find more information on support and advisors on our website.
• If you are a member of Federated Farmers you can access legal advice and purchase land lease agreements through them.

Who can help and further advice

Involving an experienced farm consultant, accountant and lawyer who have experience in lease farm arrangements is important when looking into any leasing agreement. They can provide advice on lease rates and establishing a fair and reasonable legal lease contract.

You can find farm consultants on the NZIPIM website.