By Rory Lewandowski, Extension Educator Wayne County
Recently I have gotten some questions about rental of livestock buildings, specifically dairy facilities. Typically, callers want to know a charge per square foot or a rental rate based on a per head basis or, for a dairy facility, based on number of free stalls. The reality is that there is no one right or correct answer.
Several methods or approaches generate a dollar figure for rental. However, view that number as a starting point in a rental negotiation. There are additional factors that affect the final rental rate. Those factors include the age and condition of the building, location of the building, the functionality or obsolescence of the building, the demand for rental of this type of building and the character and personality of the parties involved in the rental agreement.
The simplest and most direct way of calculating a building rental rate is to use a commercial rate, a known market. While these types of figures are available for grain storage and some equipment storage markets, they are not available for livestock building rentals. We don’t have a commercial livestock building rental market. A second method is to use survey data. Survey data is commonly used to provide rates for custom farm work and cropland rental. The reliability of those numbers is dependent upon getting significant numerous responses. The issue with livestock building rental surveys is that there are a very limited number of surveys and those surveys generally have a small number of responses, so use results with caution. You can get an answer that is fast, easy and very wrong for your situation. The most recent farm building rental survey that I know of is a May 2014 document by the North Central Farm Management Extension Committee. It is available on line as a pdf document at http://tiny.cc/farmbldgrentalsurvey. The number of responses for dairy building rental varies between three and nine.
The best method to determining a rental rate for livestock buildings is to actually calculate some building ownership costs and use those figures as a starting point in coming to a rental rate agreement. There are two basic categories of building ownership costs, variable and fixed. Variable costs are dependent upon building use and the level or intensity of building use. Those costs include utilities, use-related repairs and maintenance, and possibly costs of additional wear and tear beyond depreciation. Often variable costs increase as the number of animal units or production level in the building increases.
Fixed costs are incurred regardless of the level of building use. Fixed costs remain even if the building sits empty. The fixed costs of building ownership include depreciation, interest, repairs (maintenance not related to building use), taxes and insurance. The low end of any building rental agreement must cover at least the variable costs of using the building. There must be some way to measure these costs, especially costs such as electricity, fuel, and water. However, the building owner realizes no gain until at least some portion of the fixed costs are included in a rental agreement.
The North Central Farm Management Extension Committee publication “Rental Agreements for Farm Buildings and Livestock Facilities” (http://tiny.cc/NCFMfarmbldgrental) contains a good worksheet to help building owners estimate ownership costs. A basic starting point for determining ownership costs requires an estimate of the current value of the building to calculate depreciation. One method commonly used is to determine a replacement cost for the current building along with an estimate of the useful life, generally in the 15 to 25 year range. Next, determine how many years of useful life remain in the current building. Depreciation is the replacement cost divided by useful years of life remaining in the current building. If the building is under loan, then the interest cost is the actual interest payments on the building loan. With no loan, calculate interest costs as a return on investment by multiplying an annual interest rate times the current value of the building. The interest rate used could be the current rate to borrow money, the rate for invested dollars or possibly an average of the two. The county auditor’s office can provide the building tax rate. Use the actual insurance policy for insurance costs. Alternatively, multiply the current building value by 1.5% to get an estimate of tax and insurance costs. The most accurate way to get cost of building repairs is from farm records. According to an Iowa State University publication entitled “Computing a Livestock Building Cash Rental Rate” (https://www.extension.iastate.edu/agdm/wholefarm/html/c2-26.html), a value of 2% to 4% of the replacement (not current) value of the building provides a reliable estimate if records are not available.
For example, let’s say I investigate and find that it would cost $325,000 to build a new free-stall dairy barn of similar size, function and with comparable technology and features to what is currently present on the farm. That building would have a 20-year life. My current building is 8 years old, so I have 12 years of useful life remaining, equivalent to 60% (12 divided by 20) of the building replacement value. The current value of my building is therefore $325,000 x 0.60 or $195,000. The annual depreciation cost is $325,000 divided by 12 (years of useful life left) equals $27,083. Note that in some cases, buildings may still be serviceable after their useful live and so depreciation expense could be zero. For this example, assuming no outstanding loan on the building, I am going to calculate a conservative return on investment using an interest rate of 3% times the current value of the building ($195,000) equals $5,850. To calculate taxes and insurance costs ideally I use actual values, but in this example I will use 1.5% times the current building value equals $2,925. Next, I need to estimate repair costs. I will use 3% times the replacement value ($325,000) equals $9750. My total estimated fixed cost of building ownership is the sum of these calculations or $45,608 annually.
Knowing the fixed costs of building ownership can guide a rental negotiation. The ideal situation is that the building renter, in addition to paying all the variable building costs, will cover the fixed costs as well. In most markets that may not be realistic. The next best-case scenario is that the cash costs of building ownership are covered after building variable costs. Those costs include taxes, insurance and repairs. In our example, those cash costs equal $12,675. From a purely economic point of view, if an empty building can’t generate enough rental income to cover cash expenses in the foreseeable future, it is reasonable to consider demolishing the building.
I have found a couple of spreadsheets available on-line that can help to calculate building costs and potential rental rates. They are available at https://www.agmanager.info/ksu-building-cost-rent, and https://dunn.uwex.edu/agriculture/farm-management/farm-lease-information/. Click on “Lease Payment Evaluators”, then “Building Rental Evaluator”.
The most important piece of any building rental is a written lease. The lease spells out not only the rental rate but also specifies dates of rent payments, what happens if rent is late, and how the rental agreement is renewed or terminated. The lease contains provision about how repairs are handled, how water and utilities are paid for and maintained, limitations on modifications to the building, how many livestock can be housed, rights of entry and inspection and even how manure will be handled and where it will be applied. The North Central Farm Management Extension Committee publication “Rental Agreements for Farm Buildings and Livestock Facilities” contains a sample lease agreement that can serve as a starting point.
Finally, the characteristics of the potential renter are another consideration in a lease agreement. Things like how they care for property, personal habits, reliability, honesty, temperament, how you get along with them, can all matter and might influence the rental price either upwards or downwards.