California agricultural land values have enjoyed an impressive run in recent years. Due to limited supply and increasing global demand for specialty crops, this trend is likely to continue in the long term.
In Rabobank’s recent California Agricultural Land Value Outlook, published in October, research shows how agricultural land values have risen at a pace far exceeding historical trends, posting double-digit annual gains between 2010 and 2015. This upward movement in values has been broadly shared across many agriculture regions in the state.
Over the past 12 to 18 months, however, values in some areas have come down as tree nut prices have fallen dramatically off their peak prices. Our forecast calls for another moderate decline in land values in the Central Valley in 2017.
The North Coast vineyard market, on the other hand, remains in a world of its own. Continued growth in demand for premium wine has driven grape prices steadily higher and pushed land values in the area to new peaks. Early in the recovery, there was strong demand from winery buyers for established, producing vineyards. Demand has now spread to plantable land and vineyards outside “core” Napa and Sonoma appellations, all of which have seen values increase at a compound annual growth rate of 8 percent to 10 percent in the last five years.
While demand for wines from the North Coast is growing at a healthy clip, global supply conditions are only adding to the price pressure on the regional grape crop. As grape harvest tallies from the Northern Hemisphere are summed up, supply from EU nations is expected to drop 3 percent to 4 percent in 2016. Add to that the poor harvests in notable Southern Hemisphere producers, such as Chile and Argentina, and wine production from “new world” countries may be off by more than 10 percent combined.
Though global wine supply and demand may not directly correlate to vineyard prices on the North Coast, the fact that wine demand is growing while supply is declining will help keep upward forces in place, particularly as supply constraints may be structural. Weather played a key role in 2016’s global harvest volume, but investment in new vineyards has been at a low ebb in many producing countries, as weak profitability has truncated appetite for investment.
Despite rising grape demand, producing vineyard acreage here on the North Coast actually declined in 2015. Figures from the U.S. Department of Agriculture show vineyard acreage decreased last year in all but one North Coast county — Lake — albeit by small percentages. The lack of suitable plantable land in premium growing regions likely will not allow supply to catch up to demand at current growth rates.
With a backdrop of limited supply and growing demand, what factors would curtail growth in North Coast vineyard values? Most likely, macroeconomic shocks dramatically would impact interest rates and change the general direction of the economy. Although growth in the overall U.S. economy has been below desired levels, our regional economy has been performing well, and slow growth and low inflation conditions have kept interest rates at historically low rates.
However, economic forecasting got a bit more uncertain on Nov. 8. Not only is Donald Trump the president-elect, but also Congress remains in Republican control. The expected path for fiscal and monetary policy under the new administration was outlined by Trump as a candidate, as he called for broad fiscal stimulus spending and sizable tax cuts. Further, during the campaign, there was virtually no discussion of controlling entitlement spending, which had traditionally been central to the Republican platform. A combination of spending, tax cuts and no reduction in entitlement spending could push up the public debt, and that would likely lead to higher interest rates.
At this writing, the markets have already responded by bidding up the 10-year U.S. Treasury by more than 30 basis points since the election. Higher rates may temper vineyard-value appreciation, just as years of very low rates have helped support their value by boosting leveraged returns. On the other hand, real estate assets as a class are often favored when investors expect inflation, and a fiscal stimulus paid for by debt is a recipe for inflation.
Though economists will debate the impact of fiscal policy, a trade war could hurt the U.S. economy. Trump’s claim that he would impose certain protectionist measures on large trading partners, such as China and Mexico, raises the specter of retaliatory measures that could escalate to a full-blown trade war. Wineries with significant export volumes could suffer if tariffs are imposed on U.S. goods. But the largest impact on the industry would be a recession brought on by a protracted conflict.
While the political climate creates ever more uncertainty, the fundamentals remain in place for continued vineyard appreciation. After years of very solid growth and prices reaching lofty heights for high-profile properties, it would be tempting to call a peak. We expect that appreciation rates may moderate somewhat, but the elements clearly remain in place for long-term value growth.