'*>*&? Division of Agricultural Sciences UNIVERSITY OF CALIFORNIA %gm m?- fyfrAcd ^cti ^AciM^Cncm Mctd A. D. REED J. H. SNYDER CALIFORNIA AGRICULTURAL Experiment Station Extension Service CIRCULAR 491 Revised CAECAG491 1-8 (1973) This circular aims at helping tenants and landlords in drawing up mutually satisfactory leases. The farm lease worksheet sample (see center insert) may he torn out and used to help you deter- mine an equitable rent for your individual lease situation. MARCH, 1973 THE AUTHORS: A. D. Reed is Extension Economist, Agricultural Extension, and Associate on the Giannini Foundation, Davis. J. H. Snyder is Professor of Agricultural Economics, and Agricultural Economist in the Experiment Station, and on the Giannini Foundation, Davis. WHAT YOU SHOULD KNOW ABOUT FARM LEASES Tenants operate approximately 13 per cent of California farms, but 63 per cent of the land is leased. Included are all types of agricultural enterprises. Rental rates and leasing arrangements vary widely, depending on type of enterprise, productivity, size, location, and the like. Leasing arrangements must be tailored to each individual case but should be based on a mutual feeling of trust, a sat- isfactory potential income for tenant and landlord, a rental rate equitable to both parties, and a written lease using clear, understandable words, farm leases In short, good are periodically reviewed to deter- mine if they are equitable, are based, if necessary, on some form of sliding-scale rent (described herein) to reduce undue risk to ei- ther tenant or landlord, provide for an automatic renewal unless terminated by either party, are in writing — to protect you, your heirs, and your tenant. WHAT TO INCLUDE Legal advice will help prevent subsequent difficulties. In general, every lease should contain at least the following: Date of lease. Names and addresses of all parties con- cerned. Description of the property — Location as to county and state, Legal description, Acreage, Specification of parcels of land or buildings being retained by the land- lord. Terms of lease — Dates of start and termination of the lease, Provision for automatic continuation on a year-to-year basis unless termi- nation notice is given by either party before a specified date, Rental rates for each enterprise, Expenses to be borne by each party concerned, How, when, and where rent is to be paid, Management practices to be followed for: Acreages of crops Rotations Numbers of livestock Improvements, Provision to reimburse tenant at ter- mination of lease for improvements made at his expense and not fully used up, Provision for settlement in case of death, Provision for arbitration in case of disagreement. Signatures of all parties. LEGAL REQUIREMENTS A lease is a contract, a promise enforce- able by law. A valid contract must meet certain legal requirements. Among them are: Consent of the parties. All parties to be bound by the contract must consent positively. Lack of a negative answer cannot bind a person to a contract. Parties competent to enter into con- tract. Persons under 18 generally do not have full legal capacity to make con- tracts; neither do insane persons, intoxi- cated persons, and convicts. Corporations, by their charter, may have limited con- tracting power. Consideration is the price which one party pays for another's promise. The price need not be in terms of money but is essentially the conduct, or the promise of conduct, of one party given in ex- change for the conduct, or promise of conduct, of the other party to the trans- action. Purpose of the contract must be legal. Contracts which cannot be performed within one year must be in writing to be enforceable. L nder California law, leases of land for agricultural purposes for a period longer than 51 years are not valid. DETERMINING THE RENT Rent, being the price for the use of land or other productive factors, is determined by demand and supply. There are, how- ever, many reasons why it is difficult for tenant and landlord to arrive at and to maintain a rental arrangement fair to both. Rents often become established at a "customary" rate. But there are situa- tions where no customary rate has been established, such as for enterprises which have not normally been rented, or for new enterprises developed in an area. But also in situations where customary rates have been established, tenants and landlords will do well to constantlv reap- praise the existing rates, or they nun find themselves at a disadvantage. Rental rates should respond to changes in cost-price relationships, introduction of new ma- chinery, development of higher-yielding varieties, production shifts from one area to another, increasing farm size, need for greater managerial ability, and others. This circular cannot, of course, de- termine the rent for you. This is your job to be done by individual bargaining. This circular, however, presents to you a method that will assist you in arriving at equitable rental rates. An equitable rent, as usually defined, is one where landlord and tenant share the gross income in the same proportion as they contribute to the costs of pro- duction. To establish a fair rent: FARM LEASE WORKSHEET Owner Tenant Date Farm INVESTMENT EXPENSE Total Investment Landlord Tenant Investment Interest Depreciation Investment Interest Depreciation Buildings Irrigation system Fences Trees, vines, crops Harvest equipment Livestock Operating capital TOTAL DISTRIBUTION OF EXPENSE NONCASH COSTS Interest Total value Landlord Tenant Description Value Description Value CASH COSTS Hired labor (cultural) Hired equipment Dust Seed Fertilizer Spray material Gas & oil Repairs Water or power Harvest Feed Veterinary Supplies Hull & dry Dwelling Other TOTAL COSTS Percent 100 Digitized by the Internet Archive in 2012 with funding from University of California, Davis Libraries http://archive.org/details/whatyoushould49173reed Determine the contributions made by each party, Assign appropriate values to these con- tributions, Establish the share of the total costs contributed by landlord and tenant. List the following contributions in some logical manner. Use of a form like the farm lease worksheet (center insert) may be helpful. Noncash Costs Investment. The capital or investment furnished by each party is made a part of annual costs by including interest on such investments. Figure land at a sound agricultural value. Few agricultural ten- ants can pay a rent which reflects sub- division values. Figure buildings, equip- ment, and other depreciable facilities at current depreciated values, or at about half of the replacement cost. Include only necessary items and only at values which would ordinarily provide adequate fa- cilities. Neither party should include in- vestments of unnecessary or overly ex- pensive buildings and equipment. Figure interest on the total investment of each party at an agreed-upon rate, such as 6 or 7 per cent. Interest actually paid on debts by either party is ordinarily not considered; such outlays are covered by total interest on the investment. Depreciation. The annual decline in value of buildings, irrigation system, equipment, trees, and other capital in- vestments through use or increasing age is a proper part of annual costs. Esti- mate depreciation by dividing cost of each facility by probable useful life. Unpaid labor. Make an allowance for the actual operator and family labor fur- nished by each party at going wage rates and include it in the total costs. Management allowance. This may also be a proper part of total costs; if so, list it under distributions of expenses divided in the same way as the landlord and tenant share in the managerial duties and responsibilities. Management can be valued on the basis of charges made by professional managers — for example, 5 per cent of the gross income for actual management, or 10 per cent where the manager also defrays costs of office fa- cilities, accounting, travel, and other ex- penses associated with management. Cash Costs Credit each party with production, har- vesting, and overhead cash expenses paid by that party. These costs may be esti- mated from previous records, from recent cost studies, or from cost standards, such as enterprise data sheets, available from such sources as the University of Califor- nia Agricultural Extension Service. These expenses are important, so considerable care and local inquiry are justified. Dwelling A dwelling furnished by the landlord and used by the tenant can be included in the investment of the landlord. In this case, interest and depreciation plus cash costs of taxes, repairs, and insurance would be credited as annual costs contributed by the landlord. It is, however, preferable to keep the dwelling completely separate from the contributions of the landlord, and include a provision that the tenant pay a cash rent for its use. This method separates the home from the business, and places a market value rental on its use rather than tying the house rent to the productivity of the farm. The Final Computation After listing the annual contributions of landlord and tenant, add each list and determine the proportion which each party contributes to the total production cost. The percentage contributed by the landlord can be used as the share rent, or it can be multiplied by the probable price to arrive at a cash rent. If the percentage Owner J«^ J/oe FARM LEASE WORKSHEET Tenant A Aof Date Farm f~7i(>c4>sst«.f J^iu^/aes at a« acre /6ss/<> - Uh>d(*~*£ are*^ INVESTMENT EXPENSE Total Investment Landlord J Tenant Investment Interest |^ depreciation Investment Interest £*quipreciation Land Buildings Irrigation system Fences Trees, vines, crops Tractors & trucks Machinery Harvest equipment Livestock Operating capital ) f <?co #<?oo tf*£3 /S /f z. £ / io V7 TOTAL 1 * rt J77 DISTRIBUTION OF EXPENSE NONCASH COSTS Interest Depreciation Unpaid labor Management allowance CASH COSTS Hired labor (cultural) Hired equipment Contract work Herbicide Dust Seed Fertilizer Spray material Gas & oil Repairs Water or power Harvest Feed Veterinary Supplies Hull & dry Taxes Insurance Office expense Dwelling Other < J Total value Landlord Tenant Description Value Description Value ^ A/f *7/ * 77 %9 2? 57 S7 3 3 •» 2. £ 4 /s- AT // // 23 33 -xo 2.0 >s- /C / 7C /TO /7 '7 /9 /? TOTAL COSTS / WVsr * M * #S7 Percent 100 "- 9« of the costs furnished by the landlord is loo far from the usual or "customary" share, and it is desired to use the cus- tomary rate, some of the contributions may be shifted from one party to the other to make the percentages fit the local rental rate. Changing the contribution from oik 1 party to the other may also equalize the risks borne by the landlord and tenant or contribute to more efficient use of some resources, e.g., where ferti- lizer cost is divided between the parlies. This method does not determine what the exact rent should be, but provides a guide as to what the rent might be. The exact rent must be determined by bar- gaining between the parties, considering prevailing local rates. A Sample Worksheet The worksheet for a tomato lease shown above illustrates the procedure that can be used to determine an equitable rent of 16 per cent. Although this rate is the pre- vailing one, current rents range from 15 to 20 per cent, depending primarily on what the landlord furnishes. Sliding Scale or Flexible Rents Many landlords and tenants find a slid- ing scale or flexible rent desirable. Under these arrangements, the amount of cash rent or the percentage of share rent varies with price, yield, or income. In some cases, the rent varies in direct pro- portion to the change in price, yield, or income; other arrangements include some arbitrary deviation from the direct relationship. Usually, rent variations ac- companying changes from a direct rela- tionship between rent and price result in the landlord assuming a larger share of the risk associated with price or yield drop than would otherwise be the case. The landlord is able to stand this risk because a larger proportion of his con- tributions to the business is noncash. Sliding- scale cash rent. Under this sys- tem, the cash rent is usually set to vary with the price of the product. A basic rental rate is usually established at some stipulated selling price. Then provisions are made for set increases or decreases in the rent as prices rise or fall. The actual rent is determined only after the com- modities are sold and the actual selling price is known. Where several marketing outlets are available, it may be desirable to base the rent on some established and well recognized market quotation for the product rather than on the actual selling price. This protects the landlord from poor marketing practices by the tenant, and gives the tenant the advantage when he does a particularly good job of mar- keting. The amounts of rent actually paid under these systems do not necessarily change in direct proportion to the changes in price. In many cases they are set up so that proportionately less rent is paid at low prices and higher rent at high prices. Sliding-scale share rent. Since the ac- tual rent collected by the landlord under a share rent agreement varies proportion- ately with the yield and with the price, there is not a great deal of interest in a sliding scale share rent. However, this method is used in some areas of relatively high risk. A sliding-scale share rent is based on price or on yield. If based on price, the share rent is established at some given price, and goes up or down with the ac- tual price received. For example, the 16 per cent rent in the tomato example given on page 6 might be established at a price of $30 per ton. If the price increased to $32, the rent might be 17 per cent or, if the price dropped to $15, the rent would be 15 per cent. There is periodic interest in this type of rental rate but very few actual leases are drawn up on this basis. A sliding-scale share rent based on yield is more common, particularly in areas of rather frequent near failures of the crop. Usually the tenant pays no rent if the yield drops below some predeter- mined level, and the share rent gets pro- gressively higher as the yield increases. A variation to the above is where no rent is paid below a certain yield level, but above this point the rent is higher than that indicated by the method of de- termining equitable rents. Sliding-scale share rents have to be based on some arbitrary agreement, be- cause these arrangements are a deviation from the equitable rent which would be obtained by using the method described earlier. These arrangements can be de- fined as equitable only in terms of easing the burden of the tenant under conditions of low price or low yield. They represent protection against unusual, but potential- ly disastrous, income hazards. DEVELOPMENT LEASES The method which we have described for determining annual rent can also be used to determine the rent under a develop- ment lease. The inputs of the landlord and the tenant can be accumulated during the development period, after which they be- come a part of the contribution during the rent-paying period with depreciation and interest being charged over the rent- paying period of the lease. Co-operative Ex.en.cn work In Agrfc-hur. and Home Econor.es, Kj*n of ^gj-nj *^e^ co-operating. Distributed in furtherance of the Acts of Congress of May 8, and June 30, 1914. George B. Aicorn, uirecio , LOw 3,'73(Q7993L) PAD