Partnership Lease Renewal and the Cash-Rent Decision
A 1,200-acre owner-operator is retiring and converting to a landlord. He has three tenant applicants. Tenant A offers a straight cash rent of $310/acre on 1,100 crop acres (100 acres are in a CRP buffer and farmstead). Tenant B offers $285/acre cash plus a 25% share of crop proceeds above a $650/acre gross revenue trigger. Tenant C offers a 50/50 crop-share lease. The operator's machinery is being sold, so he cannot contribute equipment. Local yields are 190 bu/acre corn at $4.50/bu and 55 bu/acre soybeans at $10.50/bu, in a 50/50 rotation. The operator is risk-averse, needs predictable retirement income, and has no operating capital to fund a crop-share position.
1. Which lease structure best fits this landlord's stated constraints, and how do you quantify the trade-off?
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The landlord's stated constraints - predictable income, risk aversion, and no operating capital - point strongly toward cash rent (Tenant A), even though the variable leases offer upside.
Quantify the expected values:
- Tenant A: 1,100 × $310 = $341,000 certain.
- Tenant B: 1,100 × $285 = $313,500 base + expected bonus. Corn gross = 190 × $4.50 = $855/acre; soy gross = 55 × $10.50 = $577.50/acre; average gross ≈ $716.25/acre. Excess over $650 = $66.25/acre × 25% = $16.56/acre on the crop acres. Expected total ≈ $313,500 + $18,216 ≈ $331,700, but with variance.
- Tenant C: 50% of gross ≈ 50% × $716.25 = $358/acre × 1,100 ≈ $393,900 expected - highest expected value but the landlord bears 50% of all input costs (fertilizer, seed, chemical, fuel), which he cannot fund, and full production/price risk.
Tenant A wins on the stated constraints: highest certain income, no capital requirement, no price/yield risk. Tenant C's higher expected value is illusory for this landlord because he lacks operating capital and cannot absorb a bad year. The exam wants you to weigh the constraints, not just maximize expected value.
2. The landlord is tempted by Tenant C's higher expected return. What specific risks and cash-flow mechanics should you explain to him?
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Explain the cash-share mechanics honestly:
- Input cost exposure: In a 50/50 crop share, the landlord pays 50% of seed, fertilizer, chemical, fuel, drying, and often half of the custom hire. On 1,100 acres at, say, $450/acre total inputs, that is ~$247,500 the landlord must front before harvest - money he does not have.
- Timing mismatch: Inputs are paid in spring; revenue arrives at harvest. A capital-poor landlord faces a cash-flow gap and may need operating credit.
- Downside risk: A drought or price collapse cuts his income proportionally. If gross revenue falls to $450/acre, his 50% share is $225/acre - far below Tenant A's $310.
- Landlord labor/management: Crop-share requires the landlord to market his half of the crop and manage the share - a new skill and time commitment for a retiree.
- Tenant quality: Crop-share success depends heavily on the tenant's management; cash rent transfers that risk to the tenant.
Conclusion: Tenant C maximizes expected value only for a landlord with capital and risk tolerance. For this landlord, the certain $341,000 from Tenant A dominates on a risk-adjusted basis. Recommend Tenant A, possibly with a modest escalation clause to capture upside over time.