Fair Market Rents and Trust Land Management

PotatoesandOrchard

Rows of potatoes are seen in front of orchard leases on state trust lands.

As trust managers with a fiduciary responsibility, Department of Natural Resources (DNR) leasing staff have an obligation to keep lands productive and generate revenue for the trusts. By law, we strive to obtain Fair Market Rent (FMR) for lease of state trust lands.

Just what is Fair Market Rent (FMR)?

Fair Market Rent is a value based on both parties (lessor and lessee) having reasonable knowledge of the facts of the lease and land, and the price not being affected by stimulus or stress. In their book State Trust Lands: History, Management, and Sustainable Use (University Press of Kansas, 1996), Jon A. Souder and Sally K. Fairfax note, “… fair market value represents the amount for which the lease would change hands between a willing, knowledgeable buyer and a similarly situated seller on the open market.”

Actual rents may be influenced by a number of factors, but looking at three criterion for fair market value rents described by Souder and Fairfax may help folks to understand DNR’s decisions as fiduciary managers:

  1. Is either party (lessee or lessor) “under any compulsion to” offer or acquire the lease?
  2. Is the land being leased for the ‘highest and best use’?
  3. Is the lease being offered on the open market?

Is either party (lessor or lessee) “under any compulsion to” offer or acquire a lease?

It is understood that rent may differ from a fair market rental value when one of the parties is under stimulus or stress that affects the price paid. An example (beneficial to the trusts) is when a lessee is willing to pay over FMR or a pay a large bonus bid to acquire a lease to expand into a new area, or acquire more lands to gain an economy of scale.

Other times, a party may not be compelled to acquire a lease or pay FMR. In the case of state trust lands, the dispersed nature of the parcels acquired from the federal government and their attributes may limit the state from gaining full market value. For example, a small, remote parcel with no legal access may not command the rents of one without these limiting factors.

When possible, DNR land managers pursue options to remove these barriers to acquiring FMR. We can improve potential for leases to command FMR when we acquire legal access to ‘landlocked’ parcels, enforce removal or payment for unauthorized uses, or when we encourage lessee investment in infrastructure that benefits the current or future land uses (adding fencing on grazing leases, or providing irrigation systems on an irrigated agriculture lease). Trading properties to block up lands, and disposing of hard to manage parcels are other options to create an asset base with fewer limiting factors. Funds from the sale of disposed parcels can go to purchase replacement properties with greater revenue potential.

Is the land being leased for the highest and best use?

One of our mandates is to assure lands are put to their ‘highest and best use,’ and when managing lands in perpetuity, this means the use with greatest potential for revenue production to be sustained over time.

In agricultural leasing, protection of soil resources is a big part of keeping lands productive. Resource management requirements assure that our leases are as productive as they can be today, while assuring that the land uses of today don’t impact the productivity of the land for future generations of trust recipients.

For example, we evaluate dryland leases when a Conservation Reserve Program (CRP) contract expires. The soils, location, or topography of the land may lead us to conclude CRP is the best and most sustainable revenue generating use.

Other times, CRP might have been the best option when the lands were enrolled, but dryland farming may now be economically and environmentally feasible.

Direct seed tillage methods have come a long way, and if the lands can now be farmed with minimal soil disturbance and soil loss, and when potential yields and prices are high enough, the return from dryland crop rents may be greater than CRP rents.

DNR also significantly increased numbers of acres farmed and rent per acre when we authorized changes in use from higher water duty crops to those with lower water requirements, which command equal or higher rents. For example, if DNR authorizes a land use change from irrigated row crops to vineyard, additional acres may then be developed with the saved water. While there are costs associated with providing infrastructure to develop new parcels, these investments provide lasting benefits to the trusts. Souder and Fairfax credited large increases in value of both Washington’s trust lands and trust revenues to DNR’s leasing program’s strategically planned investment in infrastructure on agricultural lands. They noted, “Money – in combination with sufficient staff – allowed the WDNR to increase the value of its trust lands.”

Is the lease being offered on the open market?

Widely marketing leases serves a number of purposes in assuring fair market rental values. It allows more parties to learn about and potentially bid on leases, either at re-lease, or when leases are offered through public auction. Increased competition can motivate bidders to place bonus bids in addition to rent, further increasing revenue to the trusts.

Widely marketing leases also allows trust land managers to verify that rents being charged are FMR for a given rental type.* (*State leases are generally triple-net, that is, the lessee pays all operating expenses, taxes, and insurance associated with their use of the land.)

For example, we may hear that lack of water is a limiting factor on a given lease, but if we widely market the lease when it is offered at public auction, and receive bonus bids from multiple bidders, this may indicate that lessees are willing to make needed investments to acquire the lease.

Conversely, if a lease is offered and no bids are placed, we can learn through potential bidders what factors may make a future lease more attractive. Bidder feedback may result in the lease being re-offered with a different rental structure, or a different size through splitting or combining leases, or finding ways to allow the state or lessee to invest in needed infrastructure, when doing so adds value to the parcel.

FMR values also depend on all parties having knowledge of facts about the lease and land. DNR land managers are working to make more pertinent information available earlier to potential bidders and lessees.

By removing limiting factors to achieving FMR, assuring land is leased for the highest and best use, and widely marketing leases DNR land managers meet their fiduciary responsibility to keep trust lands productive, and generate revenue for the trusts, in perpetuity.

By Kathleen Beach, DNR Lease Marketing Manager