Quick quiz: what’s the best performing Canadian asset class over the last three years?

It’s not residential real estate, no matter how badly one of us has proclaimed there’s a bubble. House prices are up about 15% since 2011.

It’s not the TSX, or S&P 500. They’re up about 20% and 50%, respectively, excluding dividends. I’m not sure how the S&P 500 is Canadian, but I just typed it on a laptop. There’s no take-backsies.

It’s not oil, or gold, or any other natural resource. In fact, both oil and gold have gone down over the last three years, although the decline in the Canadian dollar has helped domestic producers.

Okay, enough teasing. This super-duper performing asset is Canadian farmland. Since 2010, farmland prices in Saskatchewan have gone up about 90%. An Ottawa area farmer interviewed by the Globe and Mail figures the value of his 6,000 acres has tripled since the great recession. Is that enough for a farmland bubble to have formed?

Okay, that’s a huge move. But maybe farmland was just fundamentally undervalued? We’ve all heard the demographic story of how all this land is needed to feed all those hungry babies you ladies keep churning out. World bellies are hungry for Canadian wheat. Plus, crop yields in the United States have suffered from extreme weather over the past few summers, which not only increases commodity prices, but also makes Canadian wheat more important on the world’s stage.

I don’t deny there’s a long term bull case when it comes to farming. I also think there’s a long term bull argument for China to surpass the United States as the world’s true superpower, but I wouldn’t invest a nickel directly in the country. There’s just too many risks – not only with valuations, but also with some, uh, shoddy accounting standards.

There are three main reasons I think there’s a Canadian farmland bubble. I already touched on the first, which is the huge price increases the sector has witnessed. Even between 2003 and 2008, prices across the country were up an average of 6% a year. When you combine the last 10 years together, you’re looking at huge price movements for farmland.

Sure, crop yields have increased, thanks to technology and better crop management techniques. But have yields really increased 200-400% over the last decade? I’m pretty sure that’s not possible. Farmers are increasingly paying huge premiums for land that has only increased production 10-25%. In my world, those numbers don’t add up.

Just like in residential real estate, price increases are fueled by one prevailing factor – low interest rates. Farmers are happy to load on the debt at this point, since borrowing to buy land at 4-5% is a steal compared to interest rates paid in the past.

Plus, farmers are flush with cash. 2013 was probably the best year ever for Canadian crop production. The second best year was probably 2011. Canadian farmers have won the weather lottery, so to speak.

Farmers have short memories, it’s practically a requirement in a business where one bad storm can wipe out a whole year’s work. Most people would throw up their hands and try something new after a couple of bad crop years in the row. It takes a special kind of person to go back and plant another crop.

But this strength can also be a farmer’s weakness. Recent memory is nothing but lollipops and rainbows. Crop yields have been fantastic, interest rates are low, and times are good. Wouldn’t you expand surrounded by these economic conditions? But unlike most other businesses, the weather doesn’t play a factor. Last I checked, we don’t control the weather.

I know a couple that sold the family farm. A recent Chinese immigrant met with them, and offered to buy the whole thing at some silly price. This practice is relatively common these days. The cash was likely put up by other investors in China, while the buyer was used because there are restrictions to foreigners owning Canadian land. This way, everyone gets around the law.

There’s more. Canadian farmers who abandoned the industry years ago to get into better paying jobs are starting to come back and try their hand at farming again. People so bad at farming that they once quit are getting back into it, all while buying farmland at record highs. Yeah, that’ll end well.

The couple that sold the farm? They got well over $500k for it. Immediately, the buyer offered to lease the land back to them for around $15k per year. That’s a cap rate of less than 3% a year, for those of you paying attention.

Farmland is a huge part of the retirement plan for Liquid Independence, who has two quarter sections of the stuff that he’s never set foot on. He has both of his pieces of land rented out to the same guy, who isn’t even paying enough in rent to cover the interest on the mortgage. Uh, I’ll just say that you wouldn’t catch me investing in something like that.

To summarize, we have an asset that’s had a huge price increase, that’s attracting all sorts of new money, is easily purchased because of low interest rates, in an industry that’s had some of the best times ever recently. If you can’t see why I’m skeptical, you should probably go read a different blog. Canada’s farmland bubble is very real.

Tell everyone, yo!