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Almond orchard investments
An analysis of pricing, production, valuations and investment returns
The dynamics behind the growth in almond orchard plantings, almond price cycles, factors that drive almond orchard valuations and the impact of pricing cycles on expected investment returns.
Almond industry background
Almond trees grow best in hot and dry climates. They prefer hot summers and warm dry spring weather with cool (but frost-free) winters and do not grow well in other climatic conditions. As a result, 80% of global almond production is concentrated in California, with a further 6% in each of Australia and the European Union (principally in Mediterranean countries such as Portugal and Spain).
Given California’s dominance of the world’s almond supply, changes in production and almond orchard plantings there have a major influence on almond prices globally. The size, scale, return history and requirement for ongoing production expansion have attracted significant institutional investment into Californian almond orchards. There are a total of 1.5 million acres of almond orchards in California which in 2019 produced a crop worth approximately US$7.4 billion.
Expectations are that almond production and investment opportunities in California will continue to expand on the back of strong demand growth. This has been driven by the use of almonds in baking or plant-based milk (whether as a result of allergies and intolerances, a wish for a healthier alternative to conventional ingredients, or as part of a broader plant-based diet) and as a convenient snacking option. 6.7% annual demand growth over the last fourteen years has been the driving force behind increased plantings and production.
Californian almond production, new plantings and pricing
Almonds, like many other tree fruit and nut crops, are characterized by a long duration between plantings. Almond trees, once planted, live for around twenty-five years, and on reaching full maturity produce a crop every year during that period. Costs of establishment for each planting are significantly higher therefore compared to row crops. At the same time, almond trees do not produce any meaningful crop until five years after planting.
Output in California has steadily grown as new almond orchards have been planted (Exhibit 1). When output is viewed against price, there is in general an inverse relationship between the two. In years when a spike in output occurs, there is usually a corresponding drop in price, a behavior typical of most commodity markets (Exhibit 2).
Given the 25-year investment cycle of an almond orchard, growers cannot respond immediately to price movements by changing their production, meaning that these orchards will produce regardless of the short-term almond price. At the same time, the annual decision of whether to plant bare land with an almond orchard or to replant an almond orchard at the end of its useful life is heavily influenced by the current pricing environment. Exhibit 3 shows that the decision to either plant a new orchard or replant an old orchard is (in the absence of other factors that may affect decision making at the individual farm level) heavily influenced by the almond price - when prices are higher plantings increase, when pricing is lower new plantings slow down.
The delay in almond production relative to when almond orchards are planted not only creates but reinforces a cycle in almond prices. Almond prices have moved according to clearly-identifiable cycles with a peak or a trough in general occurring every ten years, with the ten-year peaks on each cycle shown in Exhibit 4. This corresponds with the peak of a pricing cycle encouraging higher rates of new almond plantings, however, by the time these orchards are producing almonds five years later this leads to supply growth outpacing demand and almond prices falling. Conversely, low almond prices discourage growth in new plantings, perpetuating the pricing cycle.
Despite the price swings from year to year associated with the cycle, there is a clear overall upward trend in almond prices. This leads not only to higher peaks in the cycle but higher troughs as well. Overall almond prices have grown by 3.1% per year on average during the past 33 years.
Almond farmland value drivers
This paper analyses two possible ways to invest in almond orchard opportunities. The first route analyzed is purchasing bare land on which an almond orchard is then planted, and the second is purchasing a mature, income-producing orchard.
The value of bare land in California’s Central Valley, the main almond producing region of the state, can be assumed to reflect the net present value of the cash flows resulting from the conversion of the bare land to an almond orchard and operating that orchard for its natural lifespan.
The value of a mature, income-producing orchard reflects the cash flows due to the purchaser starting immediately. In this way, the cash flows are not reduced by money spent on development.
The main components to determine these cash flows are:
- almond price
- crop yield
- ongoing cost of production
- cost of development, and
- the risk free rate used to discount cash flow to today’s value.
The market’s perception of the almond price component of the cash flows that determine the value of almond orchards (or any land on which a new almond orchard may be planted) appears to be different from the perception of the crop price component of other farmland types. Previously published analysis of row crop farmland values shows that the market uses average historical almond prices to inform income expectations and therefore land values. When using a similar historic almond price methodology to determine the implied value for almond bare land and mature almond orchards, the implied values were significantly more volatile than actual values. Values were often overestimated during periods of strong almond prices and underestimated during periods of weak almond prices.
It is clear that because of the relatively long life cycle of almond orchards, the market takes a long-term view of almond prices and tends to ignore annual almond price volatility. Rather than using actual almond prices, the market imputes a price that would deliver an acceptable margin above the cost of production in order to generate a reasonable rate of return over the life of the asset. This analysis worked backwards to determine what almond price was implied by historic mature income producing almond orchard values. The market implied an almond price for a mature income producing almond orchard that delivered a gross margin of 43% (Exhibit 7). The margin has maintained a narrow range, although during the most recent price spike in 2014/15 the market demanded a slightly higher gross margin (50%). This has since reverted back to its long-term trend. Although this section of the report has only highlighted mature almond orchards, the same implied margin analysis also can be used to explain the more stable performance of bare land values.
While the almond pricing cycle appears to dictate new planting decisions, the market values of both bare land and developed orchards appear to be driven (in the absence of other factors) by changes in per pound costs of production. Because this in itself is dictated by yield and per acre cost of production, bare land and mature almond orchard farmland values are more stable and far less affected by the annual swings seen in the almond price received by growers. This unique characteristic of almond orchard valuation fits with the methodology that is utilized by both specialist land valuation firms and the way investors approach underwriting an almond orchard. Both agricultural valuers and investors conduct a similar net present value analysis of future cash flows over the life of the orchard using the long-term almond price appreciation as their almond price input each year of their analysis; also largely ignoring the pricing cycle that exists.
Impact of the crop price cycle on the investment returns of developing an almond orchard
When reviewing the NCREIF return profile generated from almond orchard investments, 72% of total returns are derived from the annual income associated with almond production and sales while 28% result from bare land appreciation over the investment period. Despite almond orchard values being determined by long-term gross margin expectations, the almond price cycle still plays a significant role in the return experience. The annual cash flows generated from the orchard play the most important role in determining annual returns. If an investor purchases a California property and develops it to produce almonds, does it matter when the investment is made relative to the almond pricing cycle? Does the holding period impact return expectations? The analysis below underwrote an almond orchard investment assuming that almond prices follow their historic cyclical pattern (Exhibit 8) which incorporates almond prices inflating by 3.1% per annum.
The underwriting model was run using hold periods of 5 years, 10 years, 15 years, 20 years and 25 years. Each hold period model was then run assuming that the investment was made at a different point in the almond price cycle: peak, trough, upswing and downswing. Exhibits 9, 10 and 11 show the results of this underwriting analysis. It can be concluded that the hold period and entry point will have a significant impact on almond orchard investment returns. Longer hold periods are associated with higher investment returns and a reduction in volatility from investing at different points in the almond price cycle. At the same time, it appears that investing at different stages in the almond price cycle can deliver varied return experiences depending on the hold period. The strongest returns are generated when investing during the downswing and the trough of the almond pricing cycle, which at first appears counter-intuitive. However, this corresponds with the fact that newly-developed orchards only start producing income after five years, by which point almond prices are likely to be increasing.
New almond plantings to a large extent are driven by current almond prices, with increased plantings during periods of higher prices and lower plantings during periods of low prices. This behavior creates a cycle in production growth and in turn almond prices. Typically the cycle represents a ten-year duration between pricing peaks.
However, given the long-term view of almond orchard investors, orchard values are driven by expectations of a long-term sustainable margin that can be generated over the cost of production. This leads to significantly less volatility in orchard values relative to almond pricing.
Given a significant portion of the returns from almond orchard investments originate from the annual cash flows generated from producing almonds, the almond price cycle can impact investment returns. Even though investing at contrarian points in the pricing cycle can be advantageous, having a long-term hold period (greater than 15 years) will lead to a higher and more reliable return outcome.
A word on risk
As an asset class, agricultural investments are less developed, more illiquid, and less transparent compared to traditional asset classes. Agricultural investments will be subject to risks generally associated with the ownership of real estate-related assets, including changes in economic conditions, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Nuveen provides investment advisory solutions through its investment specialists.