The Monopoly principle

Investments in farm development can be compared to the game of Monopoly, Kerry Dwyer writes.

In Business8 Minutes

Investments in farm development can be compared to the game of Monopoly, Kerry Dwyer writes.

I was recently sitting with some clients who told me about their neighbour who had replaced some K-line irrigation with fixed grid (also called solid set). My clients queried the economics of ditching a functional system and spending a good five-digit a hectare sum for the new one. It may reduce their labour requirement but still has some running costs.

My reply was that the neighbour could be working on the Monopoly principle.

In the game of Monopoly, players buy properties that can earn a base rate from other players unfortunate enough to land on those sites. Site owners can then invest in houses with the expectation of gaining increased income, which depends on the frequency of traffic on the site. After investing in a maximum number of houses, the contestants then have the option to replace the houses with a hotel, at a cost, to gain even higher income.

A base principle of the game is that players make property investment decisions while relying on factors outside their control to gain a return on that investment.

In the New Zealand Monopoly version I have, the highest value property is Queen Street, with a purchase price of $400. Base rental is $50, rising to $200 with one house, $600 with two, $1400 with three and $1700 with four houses. Swapping these for a hotel increases the rent to $2000. Houses and the hotel have a flat purchase price of $200 each.

Doing the maths, the base rental returns the owner 12.5% on investment for every other player who lands there. One house returns 33%, two houses 75%, three houses 140%, four houses 142% and a hotel 143%. The higher the investment, the higher the potential return.

As a comparison, the cheapest property on the Monopoly board is Dunedin’s Stafford Street which yields a base rate of 6%, rising with the various steps of improvement to 30%, 45%, 108%, 133% and 157% for the hotel. I haven’t bothered to calculate the figures for the rest of the board but these may be similarly stepped.

As any Monopoly player knows, gaining those returns depends on the number of players in the game and their luck or misfortune in rolling the dice. The return on investment depends on traffic landing on those sites.

Property investment in New Zealand can be compared to Monopoly, and that includes farm development. What I was saying to my client is that maybe the neighbour had done a detailed plan concerning their investment in the fixed-grid irrigation; or maybe they worked on the principle that the investment would give greater farm profit along with some increase in capital value of their farm. Or maybe they just needed some depreciation to set against their tax problem.

Capital gains

Agriculture has seen the expansion of dairying in the past 20 years. This was largely fueled by the potential capital gains of converting land from sheep and beef to dairying, often doubling land values at a cost of less than that investment. Per hectare returns also increased with conversion, but profit depended on the leverage used for the conversion.

An old adage is to buy the worst house on the best street for capital gain, or you might buy the best house on the worst street and get some benefit. As with Monopoly, you might be best to calculate the odds of the market rising or falling and the amount of traffic passing by.

With the fixed-grid irrigation investment, the key areas to consider would be:

  1. Is there an obvious improvement in pasture growth due to irrigation change? A Google search shows this might be minor – in the range of 5% benefit.
  2. Is there a reduction in annual cost? A similar amount of water is likely to be used, presuming the K-line is well maintained and shifted appropriately. The cost of shifting irrigation daily and maintaining the hardware will be negated, which may come to be upwards of $300/ha/yr if all labour is fully costed and machinery run at today’s cost.

I am basing that on pastoral dairy and sheep and beef costings from my area of North Otago, with sufficient scale to incorporate irrigation with other farm work. There may be an efficiency of scale with fixed grid since labour units mostly come in full units, i.e. having a smaller area of K-line can be inefficient if a whole labour unit has to be available for it, while fixed-grid irrigation has negligible daily labour cost. The fixed grid also has an annual maintenance cost to maintain it in best working order.

  1. Is there additional capital cost for the change of irrigation system? We might assume the pumping system is similar, but that depends on a variety of factors, including how well the original system was designed and set up. The fixed-grid system will require a new system of underground piping and spray stations, which I’m hearing can cost $15,000/ha in today’s world.

Putting that together, a reduction in annual running costs of say $250/ha and an increase of pasture production of 1000kg DM/ha at 20c/kg DM matched against a capital cost of $15,000/ha at 8% a year ($1200/ha/yr) comes to a net annual cost of $750/ha, gives a negative 5% annual return. Note that the figures will be different if you are comparing a startup from unirrigated, or fixed grid versus center pivot or other irrigation systems.

Does the fixed-grid system give capital gain compared to K-line irrigation? Land sales suggest the benefit is negligible compared with K-line, but note that fixed grid is a relatively new system for pastoral farming and the market is more bearish than bullish.

We get back to the Monopoly principle: do all capital improvements you make to your farm return a benefit? As with Monopoly, it depends on the number of players in the game, the amount of traffic, calculating the odds, timing, and a bit of luck.

  • Kerry Dwyer is a North Otago farm consultant and farmer