Flexible Cash Lease Arrangements: Flexing On Cost Of Production

By Kim Dillivan

A flexible cash lease is a contractual arrangement between a producer and landowner in which the final rent payment is determined after the crop has been harvested. Depending on the type of flex lease, the rental payment is a function of crop yield, price, revenue, or cost of production. Often, a flex cash lease requires that the landowner accept the possibility of lower rent payments in poor production years in exchange for the opportunity to receive higher rent payments in good production years.

Flexible leases have gained popularity in recent years and these agreements offer both advantages and disadvantages to landowners and tenants. An advantage of a flex lease compared to a fixed cash lease is the avoidance of committing to a fixed rent amount prior to the determination of most market and production variables. However, flex leases are usually more complicated than fixed cash leases and this complexity adds additional risk for both parties.

Advantages of Flex Lease Contracts

• For the tenant, some production and marketing risks are shared with the landowner (similar to a crop-share lease).
• For the tenant, the amount of rent paid may be lower (compared to rent in a fixed cash lease) in years when crop price is low, yield is poor, or production costs are high.
• For the landowner, the amount of rent received may be higher (compared to rent in a fixed cash lease) in years when crop price is high, yield is good, or production costs are low.

Disadvantages of Flex Lease Contracts

• For the landowner, some production and marketing risks are shared with tenant.
• For the landowner, the amount of rent received may be lower in years when crop price is low, yield is poor, or production costs are high.
• For the tenant, the amount of rent paid may be higher in years when crop price is high, yield is good, or production costs are low.
• For both parties, contract complexity is greatly increased.

Flexing on Production Costs

In this arrangement, landowners and tenants agree to flex rent based on a ratio of input costs. This arrangement allows landowners the opportunity to share with the tenant the risks associated with cost variability. To flex lease on production costs, both parties must first agree on a base per-acre rent and a base per-acre cost of production (before land charge). The procedure to calculate annual cash rent is as follows:

Base Rent multiplied by (base input cost/actual input cost) = Current Year Rent

Two examples of flexing on production costs:

1. Assume a corn lease contract specifying a base rent of $190 per-acre, a base input cost of $500 per-acre, and assume that the actual production cost per-acre is $480. Then, the annual rent paid is $197.92 ($190 x 500/480).
2. Assume a soybean lease contract specifying a base rent of $175 per-acre, a base input cost of $320 per-acre, and assume that the actual production cost per-acre is $335. Then, the annual rent paid is $167.16 ($175 x 320/335).

Flexing on cost of production shifts some risk from unexpected increases of input costs from the producer to the landowner. This method also allows the landowner to benefit financially should the cost of inputs be lower than expected. This type of arrangement requires the tenant to keep accurate and verifiable records regarding production costs.

Setting Rent Payment Parameters

Compared to a fixed cash lease, flex leasing may result in higher rent payments in good performance years but lower rent payments in years when performance disappoints. As a result, many flex lease contracts specify a minimum rent payment and a maximum applicable rent payment regardless of crop price, yield, or input costs. Landowners and tenants should carefully consider whether to establish minimum and maximum per-acre rent amounts for their flex lease contracts.

Source:SDSU