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Percentage Leasing

This new system of leasing introduced by yours truly has caught the dairy industry's imagination and is being used frequently. It was initially established around 25% based on a $4 payout and a $1 for rent. Oh how times have changed! The market is indicating 22% + or – to be a more realistic figure. It allows the land owner to share in the increase in payout.

Under the fixed price lease all the benefits of an increased payout goes to the lessee or the tenant. This model has been in existence for many years and of course the landlord is unable to get an increase in rent until the rent review date. More than that, it may not give an equitable return to the land owner on a rising payout. Let's review some of the examples and how they work:

a) Fixed Price Lease

100 kg milk solids, 110 hectares say, including shares @ $1,200/ha yields $120,000

Rent reviewed every two years, lessee to pay all outgoings. So the net rent to the owner is $120,000
In this case the rent is fixed for the remaining period of the lease which is two years under normal lease agreements.

b) Variable Rate Leasing fixed to the Payout

With the rapid rise in payout, those on fixed price leases are unfortunately stuck to the rental waiting for the review. Given that farm leasing is an emerging tenure, the rental needs to reflect a fair return to the owner, and a realistic cost to the tenant. If you take 20-22% of gross dairy cheque as a fair rental then the figures are as follows:
100,000 kg milk solids x $8/milk price yields $800,000. 22% of this = $176,000 rental

So, how did I get to the 22% rental??
22% seems to be a realistic cost to capital allowed by banks and financiers. That is the amount of income that you could reasonably expect to go toward debt servicing, interest and lease costs.

This percentage could vary slightly up and down depending on circumstances. For example, if it is a high cost operation with expensive irrigation and wintering off, then the percentage could come back a little. If it is an all-grass easy operation with outstanding facilities, then the percentage could rise.

Ratchet Clause

This clause sets out the minimum rental that the lessee will pay no matter what the circumstances. It is very important to have this in the lease so that if things go wrong, then you know exactly what your minimum income is.

Point of Sale

A big issue around getting money for anything is to get it at point of sale. Rather than the lessee receiving all the dairy cheque and then paying the lessor as per an agreement, it could be set up with Fonterra or the point of source, where 22% of the dairy cheque goes to the landlord and 78% goes to the tenant. In this model the tenant is not actually handling the landlord's money; it is being paid direct to the landlord by the dairy factory thereby avoiding any arguments later.

Getting your money at point of source under any circumstances is vital for good relations. Under this model there can be no missed payments or misunderstandings. The owner's rental is pegged and paid at point of source. It also means that the rental is paid in line with the Fonterra payments. That means if there is a low income month then both parties share that reduced payment. The same applies in reverse on a high payout month, like during bonus time then both parties benefit from that.

A "dairy only" clause could also be inserted in to the lease, specifying the farm is exclusively for dairying. This clause could set out the number of replacements (female cattle) that can be retained and maximum/minimum of cows.

It could be argued that this may be a disincentive for the lessee, but existing fixed price leases have been at that 22% of dairy cheque on a gross basis for some time now. This is not a 22/78% agreement where the owner pays 22% of feed costs either. That is a tenant cost.

For the landlord it may sound too good to be true and there may be some hooks in it. Lessees are relatively happy to have a variable rental in line with their income too. It is along the lines of a 50/50 agreement, but it avoids all the unhappiness, bitterness and interference that can come with a 50/50 sharemilking agreement. It is important to get an independent person to assist with the correct clauses . The Federated Farmer lease document has stood the test of time and is ideal.

In summary, moving from a fixed price lease to a variable lease which is tied to the milk payout has really caught on. The benefits are to both parties and would encourage the parties to work together to increase production on the farm. It also ensures the landlord is paid at point of source rather than the money going through the tenant and then him choosing whether he is going to pay the landlord or not.


 

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