Testing the rent review system: report

Chapter 10: Discussion & Recommendations

10.1 Farm Data

10.1.1 Prior to commencement of the survey stage of the project, the Team was clear about the information which needed to be collected to inform a productive capacity assessment. It was also clear from the outset that collection of adequate data required a farm inspection during which the tenant was able to identify the challenges associated with farming there as well as identifying the productive areas.

10.1.2 It was clear from our sample farms that tenant investment had significantly influenced the farming systems employed by the tenant. It enabled farmers to start dairy enterprises, to significantly intensify their existing enterprises and to operate modern alternative enterprises. It was therefore necessary during the inspection, to consider what farming systems were typical to the area and also which farming system the landlord's own fixed equipment would lend itself to. Thus part of the farm inspection was to consider / discuss what would be possible in the absence of the tenant's improvements.

10.1.3 With the physical data collected, thought was given to where farm accounts data would come from. Clearly any data used in a model must be readily available to all, be available with sufficient detail and be produced regularly in the same format to enable years to be compared or averaged.

10.1.4 The Scottish Government's Farm Business Survey ( FBS) Datasets ( http://www.gov.scot/Topics/Statistics/Browse/Agriculture-Fisheries/Publications/FASdata) provide detailed farm accounts at farm down to enterprise account level. The Cost Centre Analysis Tables provided detailed output and input costs for 8 typical farm types, analysed on a £/farm basis. "Detailed Tables" information provides average farm data, available at average, top and bottom quartile level for the same 8 farm types. Average farm size is available with this data set and therefore it was possible to arrive at £/hectare rates. The final FBS data set is the enterprise margin. There is a huge amount of information available here with 9 arable, 12 beef, 3 dairy and 6 sheep enterprises. The information here is produced on a £/hectare basis.

10.1.5 In addition to the Scottish Government's direct information, the SAC Farm Management Handbook is a significant data source which produces annual farm account and enterprise information.

10.1.6 There are other data sources which we considered including Quality Meat Scotland ( QMS) figures, John Nix Pocketbook and current/future price data all of which would be appropriate to use within a model. It was obvious from the research though that restricting a model to the use of one dataset provided for inflexible and often disproportionate results.

10.1.7 The challenge with all of these datasets is making sure that you know how the figure is analysed and therefore how useful it is for a particular analysis and also whether it can be compared with another dataset. For example while using the Cost Centre Analysis Tables we were informed that they followed EU accounting practice and therefore machinery was written down over 5 years and buildings over 10 years. The effect of this is to overstate the depreciation for most farm businesses.

10.1.8 It is clear from the practical application of these data sets to the models that the present format provides challenges. The ability to drill down to a rate per hectare is not possible with some of the datasets and then importing data from other sources could result in double counting or omission.

10.1.9 We would recommend that the productive capacity uses the Output model and/or a budget approach based on 3 years of data (one past, one current and one future). Examples of these models are contained in Appendix 6. Further research is required to justify what range of gross profit (subsequently divided 50/50) should be accepted as being possible from a competent farming system.

10.2 Hypothetical Farming System

10.2.1 The hypothetical farming system was determined by an understanding of the local farming practices adjusted to account for the specifics of the farm and the landlord's fixed equipment. The farming system must be capable of producing a sustainable yield when farmed by a competent, efficient and experienced tenant, with adequate resources. This is the first step for any of the models or for a budget.

10.2.2 Local farming practices are the first step in considering what a tenant's farm business would be. As identified above, some of the farms surveyed employed a farming system which relied heavily on the tenant's own capital and endeavour: a dairy enterprise where the tenant provided the parlour and stalls and a pig farm on which the farrowing and fattening houses were owned by the tenant. Looking at these two examples, the hypothetical tenant on the first would likely have used the farm for a lowland cattle enterprise and on the piggery example the neighbouring farms were all arable. Local farming practices would also determine whether vegetable crops would be included in the rotation and whether there was a market in the area for land available for third party agreements, for potatoes, carrots, turnips etc.

10.2.3 The next step is to consider the fixed equipment provided by the landlord and assess what farming system it would support. The sample farms identified a number of cereal farms where modern grain storage facilities were not present. The Team felt that arable farming today did not necessarily require on-farm grain storage. The presence of grain groups and co-operative storage facilities enables a modern arable farmer to buy space in these stores or indeed to sell his crop off the back of the combine. If no grain storage is present then the prices used in the productive capacity assessment need to reflect this fact either through a lower price or through a deduction for off farm storage costs.

10.2.4 The provision of fences, water troughs and access undoubtedly influence what a hypothetical farming system would be on the farm. The challenge here is to recognise the potential value of the farm and acknowledge that a competent, efficient and experienced tenant would be prepared to invest in the farm to enable a realistic farming system, appropriate to the area to take place. Within our sample there were a number of farms where the tenant had provided much of the fencing and water troughs. In theory without fencing and water troughs, grazing based farming systems could not be employed. Thus, rather than disregarding the presence of the tenant's fencing and water troughs, the Team considers their presence, but as discussed below this needs to be valued out of the farm rent. Such an approach is considered to be a competent, efficient and experienced farmer's approach.

10.2.5 The final step in the assessment of the farming system looks at the farm itself: the size and shape of the fields and all other physical factors which influence the agricultural capability of the land. A good example of how these physical factors influence the farming system was the pig farm mentioned above. Thus, after excluding the tenant's improvements, the local farming practice, soils, drainage and aspect all indicated that the farm would suit an arable farming system. However, after considering field size, shape, shading from field side trees and location of significant drainage ditches and roads it was decided that the farm did not suit modern arable farming practices. Further the location of roads, tracks and ditches meant that it would be extremely difficult to amalgamate fields for arable production. The productive capacity was therefore considered on a lowland cattle and sheep basis.

10.2.6 The hypothetical system on which the productive capacity is assessed therefore need not be the system currently employed by the tenant. The Team believes that an allowance needs to be made for the opportunities which a tenant can reasonably be expected to have access to on signing a lease for the farm and therefore consideration needs to be given to what a competent, efficient and experienced tenant with adequate resources would do.

10.2.7 We would recommend a Statement of Facts defining the specifics of the tenancy and the capability of the holding is produced within the tenant's amnesty timeframe in order to assist rent review negotiations under the new system. Such a process would need to be encouraged via guidance rather than implemented by statute.

10.3 Productive Capacity

10.3.1 The production of a detailed farm budget was considered but the initial focus was on the models and whether there was a way of arriving at a fair rent through a model, using published data.

10.3.2 Whilst using the FBS and SAC Farm Management Handbook data it was clear that very different results could be achieved for the same farming system using different survey data. For example farm productivity could be assessed directly from the FBS Detailed Tables or using the rotation to build up an enterprise based budget.

10.3.3 The differences between the datasets meant that it was challenging to draw conclusions on productivity models. In addition, having to allocate the hypothetical farms into one of eight farm types described, in the FBS and SAC data, was limiting. The Team determined that use of the SAC and FBS data was going to create ambiguity in the rents generated from this method. The clarity of the results was further tarnished by challenges associated with obtaining relevant fixed cost information on an area basis from the survey data.

10.3.4 In terms of the Gross Output approach, the advantage of simplifying the calculation of productive capacity focuses on the output of the farm. The main issue with this system is that it perhaps over simplifies the assessment and may disadvantage one party over another from time to time, perhaps in low margin farm types. The challenge of assessing fixed and variable costs would be avoided in this approach by the use of well established banking principles which consider the profit a competent farm business would generate on a percentage of gross output basis. This could then be split 50:50 before deductions are made for land based tenant's improvements which have not been black patched and deductions for Post Lease Agreements and other unusual lease terms. We recommend further research is undertaken on this model to assess whether it can be implemented in a fair way taking account of different farm types and the margins they are likely to generate.

10.3.5 The concept of an equal share of any divisible surplus is one which inherently feels fair and indeed is one which is supported from arbitrations in England. It is based on the premise that in order for a rent to be generated both the landlord's capital, land and buildings, and the tenant's working capital need to combine to generate a business surplus. We looked to explore this position and feel the following analogy helped us settle on an equal share: in an absolute ransom neither party benefits without the co-operation of each other. Therefore we recommend a 50/50 split of the divisible surplus is used unless there is significant justification otherwise.

10.3.6 Dealing with tenant's improvements by analysing their influence on the rental value has been discussed and agreed within the Team. One way to monetarise this is to consider the cost of the improvement, its value to an incoming tenant, its lifespan and provide an interest charge to represent the opportunity cost of having the tenant's capital tied up in the improvement. Care needs to be taken when dealing with grant improvements and considering how to disregard them in a fair manner. Land based improvements cannot be black patched easily in order to still account for the holdings potential value. A number of approaches have been discussed in this regard and it was considered that a cost and deduction based approach was the fairest means of dealing with non black patched improvements provided a reasonableness sense check is applied to this to prevent the deduction becoming disproportionate. Although a number of scenarios have been tested using various models for deductions, we believe a prescriptive means of deducting improvements would be too restrictive in practice. Any method of deduction needs to be agreed by both parties as being fair.

10.3.7 We recommend the use of the tenant's amnesty to document all tenant's improvements and fixtures so that they can be identified easily at rent review with their relevance to the holding agreed by both parties. Such a process would simplify all future rent negotiations and minimise the opportunity for dispute.

10.3.8 In the previous chapter we considered measures which the Team felt were important for Dispute Avoidance - in particular the Statement of Facts. This would play an important role in the assessment of the productive capacity. A cornerstone to the success of this option would be an honest, transparent and reasonable approach taken by the parties. Partisan positions could not be tolerated and facts based on market research a prerequisite to two parties reaching agreement.

10.3.9 A Statement of Facts would be agreed to set out the physical factors of the farm. This would be carried out in open correspondence and therefore available for scrutiny by the Tenant Farming Commissioner or Land Court should agreement fail to be reached. Any scope for dispute would be narrowed.

10.3.10 With a farm budget approach it would be possible to be more precise with a budget rather than using the survey data. With this precision comes greater scope for disagreement and dispute.

10.3.11 Whilst a share of gross output appears to be a fair and workable basis of a productive capacity based rent review, the Team believes that a sense check should also be allowed for. A sense check could be with sitting tenant rents on comparable holdings agreed and set in the last three years as it would seem fair that similar holdings pay similar rents.

10.4 Surplus Residential

10.4.1 The assessment of surplus residential accommodation is determined by the hypothetical farming system and the SAC Handbook's SLR. The Team is advocating rentalising any accommodation, excepting any residential property the tenant is living in themselves, which would form part of the surplus residential property. The preference for this model was that it was scientific and avoided a threshold based approach.

10.4.2 The threshold based approach would need to rely on a set of rules to determine what the threshold would be. In other words a second house would be required for a farming system when the SLR was greater than 1.5, for example.

10.4.3 From our experience, the Team believes that the SLRs overestimate modern labour requirements and would recommend that they are reviewed to ensure that a fair appraisal of the labour required for a farming system can be carried out and thus fairly assess what residential property would be deemed surplus.

10.4.4 The use of comparable evidence and the challenges with analysing it were one of the main reasons for agricultural rental reform. The legislation provides for a market evidence based assessment of surplus residential accommodation. The challenge is that many of the farm cottages we saw had a lot of tenant's capital invested in them. With the Repairing Standard defining the minimum standard that a property must be before it can be let, there will be next to no unimproved, very basic properties available to let. Therefore comparable evidence will be thin. The Team's view is that comparable evidence is sought for properties matching the properties unimproved condition so far as possible with rents adjusted to reflect the tenant's improvements as and when they need to be taken into account in order to assess the market rent. Tenant's improvements which are required to meet the Repairing Standard should not be black patched and should be accounted for in terms of cost whether they are in place or not. Improvements such as central heating, new kitchens and double glazing should be black patched unless taken into account in order to assess comparable evidence.

10.4.5 The question of whether a rent should be attributed to surplus properties occupied by retired employees and family members if there is a prohibition on sub-letting needs to be determined. We would suggest where there is third party occupation, the landlord has been aware of such occupation and the property is surplus in terms of the SLR then it should be considered as surplus.

10.4.6 The legislation as it stands excludes any house occupied by the tenant being assessed as surplus and the property's rental value is effectively included with the land. Whilst there is an argument to support the inclusion of a house with the land in remote parts of the country, there is equally a fairness question which arises if a farmhouse is included with a very small acreage in a location where alternative accommodation is available. The Team suggests that this could be accounted for in the 'all of the considerations' part of the Act.

10.4.7 During debate on valuing out non black patched improvements within the Team, it became apparent that different approaches were required to adjust the rent of surplus residential accommodation and non-agricultural property compared with those improvements required to determine the productive capacity of the holding. The former two components of a farm rent are to be assessed on the basis of open market rent whilst the farm land is assessed on the basis of its productive capacity.

10.4.8 Surplus residential and non-agricultural property's non black patched improvements need to be considered on an annualised current cost basis. This removes the challenge of assessing the value of a non-agricultural improvement to an incoming agricultural tenant and avoids the potential of undervaluing the improvement due to the differing legislative obligations.

10.4.9 The current cost basis proposed for deducting non-agricultural improvements ensures an inflationary element is present in the analysis of the cost of the improvement which compliments the market rent analysis. As generally accounting for these improvements will relate to costs expected in order to meet the repairing standard or be able to analyse comparables reference to interest rates would not be relevant.

10.5 Non-agricultural / Diversified Income

10.5.1 The property diversified from agricultural use is identified as the property used by the tenant for that diversified use. The rental value of this property is then defined as what a tenant would pay for it. The hypothetical tenant need not be an agricultural tenant. The use of the property need not be the same use to which the tenant is using it for but it would need to fall within the same planning use class.

10.5.2 From the Team's experience and from the farms visited, it is clear that diversifications can be very specific to both tenant and location. What is clear is that the skills and expertise of a tenant should not underpin the value of a diversification. There are diversifications which rely almost solely on a tenant's skills and expertise and that is why we need to be careful in promoting a budgetary approach or sense check for diversified income. On the other hand there are opportunities which are created naturally by the landlord's fixed equipment and its location and a budgetary approach, with suitable adjustments, would make a sensible check in the absence of relevant comparable evidence as a method of assessing rent.