pe 7 The Hawaii Farm

Chapter Seven The Hawaii Farm

WHEN THE BIG FIVE CORPORATIONS first came to the Hawaiian Islands, they got the title to vast amounts of land. At first, they used this land to raise tropical crops for American markets. They needed people to do the labor and wanted the cheapest workers they could find. They went to China and found large numbers of people willing to work for almost nothing. Most of their workers came from China.

The Chinese wanted rice to eat and the islands had no native rice. The companies allowed the workers to bring seeds from China and plant the rice on land wasn’t suitable for the crops the companies wanted to raise for export.

In the 1950s, the big five corporations became the owners of large amounts of land in Central America. This land was much closer to their markets in the United States and shipping costs were far lower, so they moved their agricultural operations to Central America. They sent the Chinese workers in Hawaii back to China and began converting the farmland that had raised tropical crops to other uses, mostly as sites for condominiums, homes, golf clubs, and resort facilities.

The bogs and the swamps where the workers had raised rice weren’t very desirable properties for just about anything and the companies basically ignored them so they could focus on other parcels with greater potential to generate revenue.

Rice kept growing on these lands, but humans didn’t harvest it. The rice was left for other animals.

Frances has been looking for land that former officials of the company had ignored but that the company could use to generate revenues. She found a parcel of land that the company had ignored where rice grew. This parcel is 1,500 acres in size, the same size as the Pastland Farm. As of the early 21^st century, chemical contamination from genetically modified hybrid rice (which needs chemicals to grow) was spreading throughout rice-producing lands all over the world. Wealthy consumers wanted uncontaminated rice and were willing to pay more for it. By the time our group took this trip, the uncontaminated rice was getting very rare, because contamination was spreading very rapidly. As a result, the price of uncontaminated rice was much, much higher than the price of standard rice: by the time Frances did her study, pure, uncontaminated, organic rice was selling for nearly ten times the price of standard rice. Since rice was never a common crop on Hawaii, the hybrids that needed chemicals had never been brought to the islands. The rice that grew in the bogs was pure, uncontaminated, totally organic rice which would sell for ten times the price as standard rice.

Several years ago, Frances began putting together an operation so that the company could generate revenue from this land. She hired a professional farm management company to monitor the land, determine when the rice was ready for harvesting, call a harvesting company and get the rice brought to market, and arrange for replanting so it will produce more rice next year. Each year, the farm produced 3.15 million pounds of organic rice.

Organic rice was selling for $1 a pound, so the land produced $3.15 million a year in revenue. (The same as the Pastland Farm.) All of the workers and suppliers that the management company hired to take care of harvesting and replanting submitted their bills to the management company, which then submitted a single bill each year to Castle and Cooke. These bills totaled exactly $700,000 a year. The company paid these operating costs out of the operating revenue and was left with $2.45 million a year, called the ‘gross operating profit’ of the Hawaii Organic Rice Farm. (This is the exact amount of the gross operating profit of the Pastland Farm.)

The management company didn’t work for free. Each year, it submitted a bill to Castle and Cooke for $50,000, the cost of the management services it provided.

After Castle and Cooke paid this bill, it had $2.4 million of the money from the sale of the crop left over.

This was the free cash flow of the farm. This is the amount of money Castle and Cooke got each year from the land. Note that this is the exact same free cash flow as the Pastland Farm.

Different Ways to Privatize Land

Frances has a Ph.D. in the field of land tenure design.

She designs land tenure systems, including leasehold ownership systems.

She is not a rice farmer, she has no interest in farming, and has no time to devote to analysis of rice farming. Her department deals with thousands of different kinds of properties. Most of the properties her department deals with are residential, commercial, and resort facilities, like hotels, condominiums, shopping malls, and housing developments.

Her department has ONE rice farm.

Often, the management company taking care of the Hawaii Rice Farm has questions: it needs to know what Frances wants done with the waste straw and other plant materials generated from farming, how to deal with birds and pests that eat the rice, and other details.

Frances has a lot of properties to deal with. She can’t deal with the details of every single property. This one is taking up too much of her time. She needs to get someone else involved with the property, preferably someone who will have very strong incentives to make the decisions that would be in the best interests of Castle and Cooke, take care of the land, keep it productive, and improve it if this is possible.

She has a kind of standard leasehold system that she often uses for properties that generate free cash flows. This works for residential properties, commercial properties, resorts, golf courses, restaurants, and just about any other property she wants under private control. In this system, she sells the rights to the property in a way that causes the great bulk of the free cash flow to flow to the company in the form of a leasehold payment.

Some of the free cash flow will be available for the buyer of the leasehold to keep. Because the buyer will be buying the right to some free money, the buyer will be willing to pay a price. Frances wants this to happen because if a buyer has to put up large amounts of her own money in the property, she will have incentives to make absolutely sure that she follows all of the rules and makes the leasehold payment as promised. (If she doesn’t do these things, her rights to the property may be cancelled ‘without recourse,’ meaning that she won’t be able to get back the price she paid. People don’t want to lose money. They will pay their leasehold payment and follow the rules to avoid this loss.)

She looks over her portfolio and finds a golf course that the company offers through leasehold ownership. The golf course charges people to play golf. They charge a lot because a lot of people move to Hawaii specifically to play golf: the weather is perfect there almost all year long. They use part of this money to cover the cost of maintaining the facility. The rest of the money is the free cash flow.

This particular golf course generates a free cash flow of $2.4 million a year. Frances created a leasehold on this property and sold it under these terms: the buyer of the leasehold would have to turn over $2 million of the free money to Castle and Cooke each year as a leasehold payment. This would leave the buyer with $400,000 a year in free cash. Interest rates were 4% at the time so the buyer wanted to buy on terms that would generate a 4% return on the money they invested. (If you pay a price for a document that grants you rights to a golf course, you are investing your money.) They realize that if they invest $10 million, they will get exactly a 4% return on their invested money. ($400,000 is exactly 4% of $10 million.) Frances found a golf course operating company that really wanted this particular course added to their portfolio. (Hint: the company name starts with the letter T, ends with P and has um in the middle.) The company thought that, with its brand, it could charge more to get people to play and make lots of money.

Since the golf course operating company would be buying the right to $400,000 a year in free money, it could afford to pay $10 million for the rights to the golf course. Frances wanted this because she knew that, if the company had $10 million invested, it would never be late on the yearly payment of $2 million. If it was late, Castle and Cooke could cancel the leasehold ‘without recourse,’ meaning the operating company would lose $10 million. No one would try to come up with excuses for missing a payment of $2 million knowing that they might possibly lose five times this amount ($10 million is five times $2 million), so Frances was sure that the golf course operating company would never miss its payments and never violate any of the rules that Castle and Cooke put in place to protect the land.

You might intuitively realize that Frances could set up many kinds of leasehold ownership systems that work differently. She could ask for an extremely high leasehold payment (even higher than $2 million), transferring more of the free cash flow of golf course to Castle and Cooke. But if she did this, the buyer would be buying less of the free cash flow and wouldn’t pay nearly as high of a price. For example, if she asked for $2.39 million, rather than $2 million, as a leasehold payment, the buyer would only be buying the right to $10,000. At a 4% interest rate, the most the buyer could pay for the price of the leasehold would be $250,000. (Why is this the most she could pay? If she invests $250,000 to buy the right to $10,000, she will get exactly a 4% yield on her invested capital. She can’t pay more because if she paid more, her yield would be less. For example, if she paid $1 million, her $10,000 yield would only be 1%. Since she can get 4% in the market, it doesn’t make sense for her to accept only 1% and Frances will not be able to sell the leasehold if she asks $1 million for it with a leasehold payment of $2.39 million.)

Her company sells a lot of leaseholds and it has a division that makes calculations to show what combinations of prices and leasehold payments would work. This division starts with the free cash flow of the land. It calculates how much of the free cash will be left over and buyable at each different leasehold payment that Frances may set. It then determines the price the right to get this ‘leftover free cash’ will bring in the market, at the interest rate in effect at that time.

This division creates a chart so that Frances can see her options for the Hawaii Organic Rice Farm. She can set a very high leasehold payment and therefore get a very high percentage of the free money the land generates but get only a very low price. She can set a very low leasehold payment and therefore leave a lot of free money offered for sale. Or, she can set something in between, a system that will lead to a high leasehold payment and a very high price. Here is the chart this division gives her:

 

Chart 7.1

 

Amount of Leasehold Payment Frances Sets	Price that leasehold will bring in a market, if interest rates remain at current level of 4% on farm loans	Amount of Free Cash Flow Offered for Sale	Percentage of free cash flow that will go to buyer	Percentage of free cash flow that will still be owned by Castle and Cooke
$0	$60,000,000	$2,400,000	100.00%	0.00%
$1	$59,999,975	$2,399,999	99.99996%	0.00%
$1,000	$59,975,000	$2,399,000	99.96%	0.04%
$10,000	$59,750,000	$2,390,000	99.58%	0.42%
$100,000	$57,500,000	$2,300,000	95.83%	4.17%
$1,000,000	$35,000,000	$1,400,000	58.33%	41.67%
$1,500,000	$22,500,000	$900,000	37.50%	62.50%
$2,000,000	$10,000,000	$400,000	16.67%	83.33%
$2,200,000	$5,000,000	$200,000	8.33%	91.67%
$2,300,000	$2,500,000	$100,000	4.17%	95.83%
$2,350,000	$1,250,000	$50,000	2.08%	97.92%
$2,375,000	$625,000	$25,000	1.04%	98.96%
$2,399,000	$25,000	$1,000	0.04%	99.96%
$2,399,999	$25	$1	0.00004%	99.99996%
$2,400,000	$0	$0	0.00%	100.00%

 

She is eventually going to settle on the shaded line in the middle; this give her the best combination of price and leasehold payment. Let’s consider why the other options aren’t optimal to her, starting with the first line.

Frances can decide to sell a leasehold where the leasehold payment is $0. If she does this, she is essentially selling a freehold on the farm, not a leasehold. She is offering to sell the entire $2.4 million in free money the farm generates. If she does this, she will get the price that a freehold on this farm will bring, or the price that this farm would bring if it were sold in a state that didn’t do leasehold ownership, like Texas.

Note that it would bring $60 million.

 

Frances would like to have this $60 million for her company. But there are two reasons she isn’t going to choose this:

First, if she sells the land this way, she is selling a freehold on the land. Castle and Cooke doesn’t sell freeholds: if it sells a freehold, it loses its rights to this land forever. The company wants to keep its land forever. It is not going to authorize her to sell a freehold on this or any other land.

Second, this option doesn’t bring in one dime of revenue for the corporation. Frances works for a company that wants revenue. The more revenue she can generate for Castle and Cooke, the more the company will value her as an employee. Each year, the company shows how much it values employees with bonuses. Very valuable employees get multimillion dollar bonus checks. Frances wants this to happen to her. She wants a system that generates some revenue for the company, so she isn’t going to choose this option.

She could offer a leasehold with a leasehold payment of $1 a year. Note that, if she does, she isn’t going to get as high of a price. She will only get $59,999,975, or $25 less than she would have gotten if she had sold a freehold. (There is a reason for these numbers; they are not made up but come from standard formulas which work for very understandable reasons. See endnote 2, at the end of the chapter, for an explanation.)

This will get her a $1 a year increase in the company’s income. This is better than nothing, but not much better. She can’t expect the company to go crazy with their bonuses when they find she only increased their income by $1 a year from a property that generates $2.4 million in free cash each year.

Socratic Leasehold Ownership

Frances goes down the chart until she gets to the highlighted line. She can sell a leasehold with a leasehold payment of $2 million a year. If she does, her appraisers say she can get a price of$10 million.

This particular leasehold ownership system has a leasehold payment that is exactly 20% of, or 1/5^th of the price paid for the leasehold. We will see that leasehold systems that work to make this happen have certain very special properties that no other leasehold systems have. I will need a name to refer to leasehold ownership systems that sell property rights with a leasehold payment that is 20% of the price, so I can refer to it in discussions. I will call this kind of leasehold ownership ‘socratic leasehold ownership.’

I want you to consider one important reason why this particular leasehold ownership option might appear to be very attractive to Frances:

Let’s say that someone buys a leasehold on this property for $10 million. The buyer promises to pay $2 million a year to her landlord. What if the buyer gets lazy and decides not to collect the rice this year and not make her leasehold payment? If she doesn’t make the leasehold payment, she has violated the terms of her leasehold agreement and her landlord can cancel the remaining term of the lease. She will not get her $10 million back.

If someone buys this leasehold under these terms, you can be very sure she is going to make absolutely sure she always makes her leasehold payment on time and in full, without any need for anyone to notify her or ask for any money. She knows that if she doesn’t make this $2 million payment, she instantly loses $10 million. No sane person would miss a $2 million payment knowing that, if she misses it, she will be out five times this amount of money.

The buyer of the leasehold will make sure the leasehold payment is made every year even if the farm doesn’t produce enough to make it. She has $10 million to lose if it is not made and will sell her personal possessions, if necessary, to get the money. She will borrow, if necessary, to get the money. She will sell her blood to a blood bank, if necessary, to get the money. If all else fails, she will find someone who wants to buy the leasehold and sell it, always making sure the leasehold payment is made. (Note: not all leasehold ownership systems work this way, but the one that Frances set up in Hawaii did work this way.) Frances wants to get this particular property off her back so that she can worry about other things.

If Frances sells the leasehold under these terms, she will never have to worry or lose a second’s sleep about possible problems that might make her drive out to the farm to figure out why she isn’t getting paid. She will never have to do it. In fact, the company will actually come out ahead if the leasehold payment is not made so they have no reason to even send out a notice or ask for it. They might even hope that the leasehold owner forgets.

Why? If the leasehold payment is missed, they can cancel this leasehold and immediately sell another one for $10 million, which is five times the amount of money they missed out on.

There is another reason that Frances likes this option: it provides very, very powerful incentives for the leasehold owner to protect the farm from damage and to repair any damage, at the leasehold owner’s own expense, if it happens. Consider the reason: say the leasehold owner has not taken any precautions against floods and a massive storm floods the farm, doing $5 million worth of damage.

A renter or someone with no money on the line might just walk away. But the leasehold owner is NOT going to walk away. If she does, she loses $10 million. If she can raise the $5 million by any means, and fix the farm, she will still lose, but she will only lose $5 million. If you have ever lost large amounts of money, you will know that it hurts you a lot and the loss will haunt you the rest of your life. People are not going to take this risk if they can avoid it. There are things she can do to protect the farm from floods. She is going to do them. Although she is only doing this to protect herself, her interests are the same as the interests of her landlord in this case. (This is true if the landlord is a giant corporation or if the landlord is the human race, as we will see.) As long as the farm remains healthy and productive, the landlords will get their money. The leasehold owners will make absolutely sure that the landlord’s interests are protected.

If the leasehold owner can’t prevent the loss, the landlords still aren’t going to suffer as long as she can fix the damage for anything less than $10 million. There is very, very little that nature can do to this farm that can’t be fixed for $10 million. The owners of this land (Castle and Cooke, in this case) don’t have to watch the weather forecast and wonder if their land is safe. The leasehold owners will make absolutely sure that no harm comes to the land if they can help it.

We will see that the price plays an important function in leasehold ownership systems. They place this money at risk. They will lose this money if something goes wrong. Frances particularly likes the socratic leasehold ownership system because in this system the price is five times the leasehold payment. (If the leasehold payment is 1/5^th of the price, the price is 5 times the leasehold payment; this is saying the same thing two different ways.) Since the leasehold owners always have five times more money at risk than they have agreed to give to the landlords, they will never leave their landlords hanging; the landlords will always get every cent they have been promised, on or before the due date, and never even one second late.

Even if the leasehold owner should somehow miss this payment, Castle and Cooke (the landlords) still can’t lose. As soon as the payment is missed, they can cancel the leasehold and will again own all rights to the property. They can then sell another leasehold on the same property for another $10 million, getting 5 times more money than they missed out on. The landlords take on no risk whatsoever. Since they take no risk whatsoever, they never have to collect anything, never have to send out notices, never have to bother anyone. They will always get their money. We will see that this is a very important issue when the ‘landlords of the Earth’ are the ‘members of the human race.’ Money will flow from the land, to us, totally automatically, and totally without risk.

Systems Below Socratic Leasehold Ownership in the Chart

Frances goes back to the chart that her analysis department gave her (see chart 7.1, above, for details). She has decided that she doesn’t want to use any of the systems above the shaded line (the one that suggests she sells the leasehold for $10 million with a yearly payment of $2 million). The system at the shaded line has some great advantages. But what about the systems lower than socratic leasehold ownership in the chart? If going down from the top brings ever-greater advantages, why not keep going down, to the bottom of the chart, with the assumption that lower is better?

She looks at options that are lower on the list, below the shaded line, to see if they might be even better than the one that is shaded.

She could get even more as a yearly leasehold payment than $2 million by choosing one of these options. But if she does, she will have to worry about things that she doesn’t have to worry about if her leasehold payment is $2 million. These problems come because the buyers of the leasehold won’t have as much money at risk, and therefore won’t have as much money to lose if they don’t make their payments or if something damages the farm.

To see this, consider the next to last line on the chart. Frances could offer a leasehold on this farm with a yearly payment of $2,399,999. If she does, she won’t be able to get much as a price. The buyer is not going to be buying the right to get the full $2.4 million in free cash flow. She is only buying the right to whatever free cash the farm produces that she doesn’t have to give to the landlord. In this case, she has to give all but $1 a year of the free cash flow to the landlord, so she is only really buying the right to get $1 a year in free cash. The standard formulas show that a person buying the right to get $1 a year in free cash is only going to pay $25 for it, if interest rates are 4%. (This is the price for buying a $1 cash flow that generates a 4% return on the invested money; if you want more information, see notes 1, 2, and 3, at the end of the chapter.)

In the socratic leasehold ownership system (the one marked by the shaded line) the buyer had to invest $10 million in the property by paying $10 million as a price; the buyer had $10 million to lose if she didn’t make her $2 million yearly payment. No one would ever miss an $2 million payment knowing they would lose $10 million if this happened.

But in the second to the last line system, the buyer only paid $25 for the leasehold. At the end of the year, she will be sitting there with $3.15 million in her hands. She might feel honor bound to pay her workers and suppliers, and if she does, she will be left with $2.45 million. Her contract with Castle and Cooke requires that she give Castle and Cooke $2,399,999 of this money. If she does this, she will wind up with $1, for a year of work with $25 of her own money invested.

What if she doesn’t make this payment?

What if she keeps the entire $2.45 million?

If this happens, Castle and Cooke will cancel her leasehold. She will immediately lose $25.

But why care about this? She has $2.45 million. Perhaps Castle and Cooke will file a suit against her and try to get this money. But she can easily use a pretty standard excuse for people who get money that that doesn’t belong to them: it is gone. She had some bills and spent it. If she doesn’t want to make this excuse, she can simply open an account in Switzerland, wire the money to that account (at the rate of $10,000 per day, to avoid reporting to the IRS, which happens if you wire more than this), and then move to some other state.

Frances realizes that the price acts like a deposit to the buyer of the leasehold. If she offers the rights to the farm under the terms on the second to the last line, the buyer is basically posting a $25 deposit to protect a $2,399,999 million yearly payment. It just doesn’t make financial sense to make this payment if all you lose for not making it is $25.

I consider myself pretty honest, but I would have to think pretty hard about this situation if it were me. Should I keep the full $2.45 million, get myself to Switzerland where I could put the money into a bank and live in luxury on the interest my money will generate for the rest of my life. (At 4% I will get $98,000 a year; since Switzerland doesn’t tax interest for foreign nationals and doesn’t report it to the United States so the IRS can tax it, this will be tax-free.) Or should I be honest and make my payment, leaving me with only the $50,000 that I need to justify the work on the farm and a $1 return on my $25 investment? It is a hard choice. I think a lot of people would be on the next plane to Switzerland.

Frances doesn’t want people to get into a position where they will make more money defaulting on their payments to Castle and Cooke than they would make if they kept their promises. True, perhaps she will get an honest person who will pay. But perhaps not. Why take the chance? She can avoid this problem entirely by choosing one of the other leasehold ownership systems, one that is higher on the chart.

If Frances wants to protect her company’s interests, she is not going to sell with options that are either very high or very low on the chart. The options close to the top don’t get her company enough money over time to make it worthwhile; the options close to the bottom don’t give her company security and safety and don’t give the leasehold owners incentives to work hard to protect the interests of the landlords. The only leasehold systems that make sense are those close to the shaded line on the chart.

In this example, Frances has been in the field for many years. She has sold a lot of leaseholds. She has been studying land tenure systems for her entire life. She manages thousands of leaseholds for Castle and Cooke and knows how they work. She isn’t going to waste a lot of time; she knows what works and want doesn’t. She knows that the option called ‘socratic leasehold ownership,’ the one on the shaded line of the chart, creates the particular set of incentives she wants to create. (Again, don’t worry if you don’t get this now: this is a complicated issue and I just want to introduce it here; we will go over the details in the far simpler system in Pastland, when we sell an identical leasehold ownership there.)

The Sale of the Leasehold

She calls her company’s real estate agent and says she wants to put a listing on the property. She will offer it on these terms:

 

1. Price: $10 million.

2. Leasehold payment: $2 million a year.

 

A Different Perspective

Now let’s change perspective a to see why a person buying a leasehold might like this particular system too:

Imagine that you have just moved to Hawaii and are interested in possibly getting some property. You have some experience in farming and would like to find a farm where you could tinker around a little, be in touch with the land, and possibly make some money.

You decide that you don’t really want a very small farm (one that is only a few acres in size, or a ‘garden farm’) because you are experienced with operating a farm that is 1,500 acres in size. You know how to make things work on a farm this size. You know how to find contractors to bring in the harvest and how to negotiate prices, fees, and contracts. You know how to monitor contractors and draw up contracts that make sure they perform. You know about planting, negotiating the sale of production, and other details of a farm that is this size. You don’t want a few acre ‘garden farm’ because you don’t know anything about putting together the workers and getting things done on a small farm. You are looking for something at least 1,000 acres in size.

You call a real estate agent and she tells you there is a farm that is ‘in the pipeline.’ The agent has put up a notice on internet websites that post farms for sale (most common is Loopnet.com) that a farm will soon be listed but hasn’t listed any details. On the notice, this farm is called this the ‘Hawaii Organic Rice Farm.’ It produces $3.15 million worth of organic rice a year. The farm has operating costs of $700,000 so it makes operating profits of $2.45 million a year. The farm has been under professional management for five years. The current owner, Castle and Cooke, has paid the management company $50,000 a year for its services. In exchange for this money, the managers arrange contractors to do all of the work (the management company doesn’t do any work itself), makes sure production gets sold in a competitive bidding process, takes care of all the paperwork, and has an outside auditing firm come in to make sure that the people who deal with money, equipment, and anything valuable associated with the farm are all being honest and accounting for everything properly.

After all these costs, the company is left with $2.4 million a year. This is the free cash flow of the farm. If you go to any site that offers rights to farms for sale in our world today (on any terms at all) you will see that the free cash flow is a very important number to buyers: most of the ads put the amount of free cash flow the land generates in the headline of the ad.

You drive out and look at the farm. There is no one onsite at the time; you just walk around and look at the land to see if the ad has represented it properly. You call the management company and set up an appointment to examine their books. You find all the numbers are exactly as claimed. You tell the real estate agent that you might be interested, depending on the terms of the deal.

The agent calls you the next day and says that the terms are this: the owner is offering a perpetual leasehold on this property (perpetual means ‘no termination date’). You will have to pay $10 million as a price to buy the leasehold and a $2 million leasehold payment each year you own the leasehold. This particular leasehold has an unusual provision called an ‘option to sell the leasehold back to the seller:’ Castle and Cooke will buy back the leasehold at any time for the full $10 million you paid for it, provided the farm is in as good or better condition as when you bought.

If you buy this leasehold and then later change your mind, you can basically return it to the seller and get all of your money back, at any time.

Is this a good deal for you?

There are two ways people can pay the price that they have to pay to purchase property rights. They can pay it with money they already have in their pockets, or they can borrow the money with a mortgage. Let’s consider both options to see how the numbers look. We will start with what would happen to you if you already had the money and could pay cash.

A Cash Purchase of the Leasehold

Say that you have $10 million in a money market fund paying 4%. You get $400,000 a year in returns on this money.

If you take $10 million out of this fund to buy the leasehold, you will no longer be getting the $400,000 a year in returns that you now get. But after you give this $10 million to Castle and Cooke as the purchase price of the leasehold, you will own the right to keep all but $2 million of the $2.4 million free cash flow this farm produces. If it continues to produce as it has in the past, you will wind up getting $400,000 a year, exactly enough to replace the $400,000 in returns you had been getting on this $10 million before.

You will basically break even on this part of the transaction. You had been getting a 4% yield on your money. You will still get a 4% yield on your money, you will just get it from the income of the farm, not from the investment fund.

If you had left your money in the investment fund, you could take it out any time you wanted by selling your shares in the fund. If you put your money into the farm, you can also get it back any time you want by selling your interest in the farm. (Castle and Cooke has agreed to buy it back for the same amount if you ask for it.)

The farm is currently under management. The managers don’t do any physical labor on the farm. They just have a database of suppliers; they monitor the farm and, when something needs to get done, they call the appropriate supplier. They get $50,000 a year for this. If you want, you can leave it under management. If you leave it under management, you will have to continue to pay them.

However, your entire reason for looking for property is that you want to manage it yourself. You intend to go to the farm frequently. You will deal with the contractors yourself. You will take care of selling the rice the land produces yourself. You will write the checks and audit the books yourself. You have experience in these things. If you are working for yourself, you have stronger incentives to make sure you get the best prices than the management company does: the employees of this company don’t really care how much things cost, because they don’t pay the costs. You will pay these costs and you think you can manage the costs much better than the disinterested management company. If you can keep costs down, or do things that drive up revenues, you will get all of the additional revenues. You will also save $50,000 a year on management. This is a lot of money for doing something you already know how to do and which you know will only take a few hundred hours each year.

The real estate agent tells you that there is another way to make money from this land. You can improve it. You saw for yourself, when you went to the land, that the land has never been leveled. There are high spots and low spots, neither of which produce the amount they would produce if they were exactly the right level. You can level the land and production will go up. You can keep all additional money. Quite often, leveling rice land causes production to go up by 20%. If this happens, you may end up with hundreds of thousands of dollars a year in income. Your leasehold payment will not go up: it is locked in and will never change as long as you own the leasehold. You will be able to keep all of the additional money the farm generates.

The real estate agent tells you that if you improve the farm, you can offer the leasehold for sale in the market and it will bring more money. In this system, the amount people are willing to pay for leaseholds depends on the free cash flow. If the free cash flow is 20% higher, and the terms of the leasehold remain the same, you can sell the investment for 20% more than you paid for it, leading to a $2 million gain. (We will look at examples below to show why this is true.)

Here is the bottom line:

If you buy the leasehold on the farm, you can get your $10 million back any time you want by taking advantage of the option to resell the farm. This is really no different than your current deal, with the money in the money market fund.

If you leave the money in the farm, it will generate a 4% yield, the same yield you get on the money market fund.

If you don’t want to manage the farm, you don’t have to: the management company is happy to take it over any time.

If you want to manage the farm, you will make $50,000 a year from this, plus any increases in profits that you can create by driving up production or reducing costs.

If you own the leasehold, you can improve the farm and may possibly wind up with hundreds of thousands of dollars a year without doing any additional work in the future.

If you improve the farm you can then sell it and pocket $2 million, increasing your wealth by an enormous amount.

If you have enough money to pay cash for the farm, this is clearly a very good deal: you get all of the benefits you want, and really don’t have any downside, as long as you take care of the farm and keep it in good condition.

What if you aren’t rich?

If you don’t have the $10 million, you will have to borrow it. At the time, interest rates are 4% so, if you borrow, you will have to sign a loan agreement that requires you to pay $400,000 a year to the lenders as interest.

If you take over management, you will end up with a $50,000 a year income for yourself. If you can cut costs or drive up revenues, you will get more. There is no limit to how much you can make.

If you level the land, your income will go up by whatever extra cash flows you generate. If you drive up production and costs by 20%, you will end up with $500,000 in additional income each year you own. If you decide to sell, you can sell for $12 million. You can use $10 million to repay the loan and be left with a $2 million gain.

Is this a good deal? I hope you can see that Frances isn’t really taking any chances here: someone will definitely buy this leasehold. She added the option to resell the leasehold to Castle and Cooke as an extra attraction: since people know that they can always sell the leasehold for $10 million, they never have to worry about the leasehold to this farm falling in value. Investors love this: it is very nice be offered the right to gain money but be protected from loss. Lenders also love it: they know that, if they should have to repossess the farm, they will be able to sell it for $10 million, so they aren’t very likely to lose any money on this farm.

Everyone wins.

And that is the general idea of this system. It is possible for everyone to win because the world gets richer each year due to the existence of this farm. If Frances sets up the land tenure system right, everyone will win.

Land Tenure Systems

Now that we are in Pastland, Frances is going to be in a position to design a land tenure system for the benefit of the human race. She understands how to align the incentives: to her, the alignment of incentives is a technical task. She can work out the incentives that would exist with each possible land tenure system that she might design. She can figure out the interests of the human race and design a system that has the closest possible alignment between the ‘incentives of the people who control the land’ and the ‘interests of the human race.’ This is what she has done her entire life.

In our 21^st century Earth, the land tenure systems were not designed to meet the needs of the human race. Most of the land tenure systems were not designed at all: they came to exist after warlords conquered land and used it entirely for the benefit of the warlords (who became ‘kings’ and were eventually deposed by ‘governments’ which took over the flows of value that had gone to the warlord-kings), or they were designed to meet the needs of certain corporations (like Castle and Cooke). In a way, we can be thankful that these companies existed because we can study the tools they used to get private individuals who did not own the land to make truly massive investments in the land they controlled, without having to ever sell any of the land to any of the improvers.

Our group in Pastland can take advantage of these things. As long as the moratorium is in effect, we have a natural law society. Once the moratorium ends, we may create any kind of land tenure system we want, including one that grants partial rights to private buyers provided they agree to rules we have passed to protect the land, and provided they share the bounty the land produces with the members of the human race.

What If You Don’t Pay Cash And Have To Borrow?

If you don’t have the $10 million, you can borrow the money. If interest rates are 4%, you will have to pay $400,000 a year in interest. You will also have to make the leasehold payment of $2 million to Castle and Cooke, so you will pay out $2.4 million of the $2.45 million in profits to others.

If you keep the farm under management, you will also have to pay $50,000 a year to the management company. But, again, in this example, you intend to manage it yourself. If you take over management, you will gain an income from the farm of $50,000 a year. You will have to manage. But it won’t be really a very difficult or time-consuming job for you. You will basically have to make a few phone calls, do a little paperwork, and make sure everything goes smoothly.

You can also make the improvement. If you do, you will gain the same benefit you would have gained if you had paid cash for the farm. Say that you level the land and all the numbers (costs and revenues) go up by 20%. The profits go up to $2.94 million. You will be paying $2.4 million a year as payments ($2 million as a leasehold payment and $400,000 as interest on the loan you took out to pay the price). You will be able to keep the other $540,000 a year in operating profits.

After you improve, you could also sell the leasehold for the same $12 million, leading to the same $2 million gain on the sale.

Either way, you will be able to get a $50,000 a year net increase in your income by buying the leasehold and managing the farm yourself. You can improve the land and will get the same benefits from improvements whether you have cash to pay for the leasehold or have to borrow.

The ending numbers are the same whether you pay cash for the leasehold or borrow, we just get there by a little different way.

Of course, if you aren’t rich, this is going to be a more attractive deal. Why? If you are a multi-millionaire, you may want to dabble a little in the farming, but you aren’t going to really care much about the $540,0000 per year you can gain through improvements. So what? You can already have everything you want. If you aren’t rich, that $540,000 is going to be a huge ‘invisible hand’ pushing you to get the improvements made as quickly as possible. Most people (those who aren’t already multi-millionaires) will stay up nights just thinking about this. They will make the plans as they go to sleep and dream about the workers moving dirt from spot to spot. They will be there before the workers show up in the morning to move the dirt and make sure they do everything exactly properly. Chances are that someone who is not already very rich is actually going to buy this leasehold, because the money that can be made from improvements is going to be a bigger draw for these people. But the point here is that, in the end, the actual incentives are the same for rich people and poor people. They have incentives to take care of the land, to protect it from harm, to make absolutely sure that the share of the free cash flow that belongs to others (the leasehold payment, which belongs to Castle and Cooke) gets where it is supposed to go, and to improve the farm if they can do this.

Frances set up the leasehold ownership system specifically to make sure all of this happened. As we saw earlier, she had a lot of choices. She could have set up leasehold ownership systems that had higher payments to Castle and Cooke but didn’t give Castle and Cooke as much in security. She could have set up systems that gave Castle and Cooke even more security than they had now, but at the expense of lower payments to Castle and Cooke. She chose this one because it was a kind of Goldilocks system, from her perspective: it aligned the interests of the buyer/owner of the leasehold with the interests of Castle and Cooke in a perfect way.

Details Of Socratic Leasehold Ownership

What about the buyback option?

Why did Frances put this option into the system?

We will see, later in this book, that the buyback option is a key provision in socratic leasehold ownership systems. If we, the members of the human race, include it, we will never have to worry about many things we otherwise would have worried about and we will guarantee an orderly and ‘liquid’ market for leaseholds. We will know that they will always sell, very quickly, and will have a reserve of funds that we can use, if necessary, to deal with any problems that may possibly come up in production.

Let’s consider why Frances included this provision:

First, she wanted the leasehold to sell quickly.

If not for the buyback agreement, people may have wondered about the price. Is it too high? They don’t want to pay a price that is more than the market value for the leasehold because, if they do, and they ever want to sell, they may not get their money back.

With the buyback agreement buyers don’t have to worry about this. The market valueof the leasehold cannot go down as long as they keep the farm in at least as good of condition as when they bought. If you buy this leasehold and, a week later, you decide you made a mistake, you can basically return the farm to the seller and get your money back, just as if the farm were an item you bought at Walmart that you decided you didn’t want. Adding in a ‘money back guarantee’ is going to make people realize they don’t have to worry about whether the price might be too high: if they find it is, they can always ‘return’ the farm and get their money back. Since there is no limit on the time for the buyback agreement, they can do this in a year, a decade, or at the end of their life if they want.

The money back guarantee is also going to make lenders far more willing to make a mortgage on the loan. Lenders can lose money if the price of the thing they are lending on falls. In 2007, the housing markets collapsed in large parts of the world and housing prices collapsed. If your house is worth less money than you owe on it, it is better just to walk away: why pay more for the house than it is worth, by continuing to pay the mortgage? Lenders lost trillions of dollars when this happened and the result was a collapse in the lending market (it doesn’t make sense to lend money in a situation like this).

The other reason Frances set up the system in Hawaii with a buyback option was that she wanted security. She wanted to protect herself and her boss.

The socratic leasehold ownership system has a price that is always 5 times the leasehold payment. This system works very much like a rental with a deposit system where the deposit is 5 times the rent. When Frances sells the leasehold, she can’t simply give the $10 million to Castle and Cooke to spend. She may have to give this money back, so she has to hold it in a reserve fund. If the leasehold owner wants the money back, Castle and Cooke must have it available to pay.

What if the leasehold payment is missed? If this happens, the leasehold owner will have violated the terms of the leasehold and the leasehold will simply expire. The (former) leasehold owner will lose all rights. She will not have any right to ask for the $10 million back: as soon as she missed her leasehold payment, she gave up this right. The company will get all rights to the farm back, just as if the leasehold had never been sold. But the company will have $10 million sitting in a reserve fund that it no longer has to hold; there is no longer any chance it will have to use this money to buy back a leasehold, because it already owns the leasehold. This money is just extra.

Before the leasehold payment was missed, this money didn’t really belong to Castle and Cooke. The leasehold owner could ask for it at any time, so it really belonged to the leasehold owner; Castle and Cooke was simply holding it in reserve. The very second the leasehold payment is missed, however, this $10 million belongs to Castle and Cooke.

Let’s say that the contract requires the leasehold payment to be made by 1:00:00 PM on the first business day of November of each year. This money must be paid into ‘the working account of Castle and Cooke’ in cleared funds to be considered paid.

Say that the first of November is a business day. At 12:59:00 PM on November 1, the $10 million is still in reserve; it doesn’t belong to Castle and Cooke. At exactly 1:00:00 PM, the computer checks to see if the leasehold payment is in the working account in cleared funds. If it is, nothing changes: the $10 million must remain in reserve. If the money is not there, the computer realizes that the reserve account has a surplus of $10 million. It has $10 million in the reserve account but will never have to buy back the leasehold to the Hawaii Farm, because the farm is no longer private. The computer transfers the ‘surplus reserves’ to the ‘working account of Castle and Cooke.’

This means that, by 1:00:00PM on the first business day of November each year, one of two things must happen: either the $2 million leasehold payment will appear, as if by magic, in the working account of Castle and Cooke, in cleared funds, ready for the company to spend, OR $10 million will appear in the working account of Castle and Cooke, ready for the company to spend. It is not possible for one of these two things to not happen.

Later, we will look at the idea of using socratic leasehold ownership in our system in Pastland. In that system, we may eventually have billions of private properties. You might think it would be a lot of trouble for us to go through each one and make sure the payments are made as required. But, if we set up our system the right way, we will never have to do this. Our money will come in completely automatically and without any risk at all, just as happened in Hawaii. Frances is never going to send out a notice or bill for her leasehold payment. She doesn’t have to. She doesn’t care if it is missed. In fact, she would be happy if it is missed: if this happens, her company will get an $8 million windfall. (It will get $10 million rather than $2 million.) She may have a dozen, a hundred, a thousand, or even a million separate leaseholds out there. As long as she sets them all up the same way, her company can never not get its share of the value the land produces. It is not possible for this money to not come in.

Selling Leaseholds

Say that you buy the leasehold to the Hawaii Farm. You paid $10 million for the price and have agreed to pay $2 million for the leasehold payment. Note that your leasehold payment is exactly 20% of the price. Your price is exactly 5 times the leasehold payment. (This is saying the exact same thing two different ways.)

If you want to sell the land, you can sell it back to Castle and Cooke for $10 million. You can also offer it to some other party for some other amount. Obviously, it doesn’t make sense to sell it to anyone else unless you can get more than $10 million from it. The leasehold agreement allows you to sell to anyone you want, any time you want, for any price you want that is $10 million or higher. However, if you sell it for more than $10 million, the leasehold payment for the new buyer will adjust upward to be 20% of the price you get, whatever it is. For example, if you sell it for $12 million, the leasehold payment will adjust upward to $2.4 million, which is 20% of $12 million.

Why did Frances put this provision into the contract?

Her company is in this land for the long run. The company has owned this land for more than a century, longer than anyone alive on Earth has been on this world. The company never intends to get rid of this land entirely. It wants to benefit from this land for the rest of time.

 

Frances put this provision into the contract because she wants the company to benefit from the incentives that private buyers of leaseholds have to improve properties. If you buy and improve, you will make money. When you make money, she wants her company to make money too.

It may seem that you are getting the biggest part of the benefits and the company is only getting crumbs. You get a one-time gain of $2 million. The company will only see its income go up by $200,000 a year, and this increase won’t even start until after you sell. But remember that the company is in this for the long run. Over the long run, it will get far, far more benefits from the improvements than you will get. In the next century after the land is improved, the company will get $20 million, or 10 times the amount you got.

If our group in Pastland sets up a system like this, we will have created incentives that lead to improvements. These improvements will not just benefit the people who make these improvements. They will make money but since our income depends on the amount of money they make, the more money they make, the more our income from the land will increase. We don’t have to just use this system for the Pastland Farm: we can use it for any properties we want improved. The buyers of the leaseholds make benefits that seem huge initially and really are huge compared to the incomes most people would otherwise get. But when they make money, we make money. Since our increases in income last for the rest of time, we will always get far more from improvements than any of the private parties involved.

In Hawaii, Frances set up this system for a very specific reason. She worked for a company that was in business to make profits. If she could drive up the profits of the company, she would be seen as a very valuable employee. Castle and Cooke had a long history of rewarding people who can drive up their profits with handsome bonuses. She wanted to help her bosses because she knew her bosses would reward her for this.

Frances is also going to set some common sense rules to protect the land, just as the Forest Service sets rules to protect its land. Frances wants to make sure no chemicals are used on this land so it will remain uncontaminated. (Chemical-free rice sells for five times the price of chemical-dependent rice and the chemical-free rice is getting rarer and rarer, because chemical contamination is spreading in areas where rice is commonly grown.) If she had sold a freehold on this land, she wouldn’t be able to protect it; as soon as the land was sold, the new owner would be in charge. But since she created a leasehold, instead, she can protect this land for the rest of time.

Why Does Anyone Care About Any of This?

We have seen that the societies you and I were born into are diseased societies. They work in ways that allow people to get very rich harming the land and harming other people. The incentives of the individuals in this society conflict with the interests of the human race.

These systems were not thought out. They weren’t the result of scientific analysis. They basically evolved, and they evolved in ways that often made them worse, not better. They started out very dangerous and primitive, and they are just as dangerous, and nearly as primitive now as they were when they were first formed.

These systems divide the land surface of the world into entities we were raised to call ‘sovereign countries.’ The leaders of these countries realized that if they could use their armies to ‘conquer’ land, they could then generate revenue from this land in various different ways. They could gain personal wealth and power by creating the conditions needed for wars to take place and then starting the wars.

They hired experts to manipulate the emotions of the people of their countries to make them feel the emotions needed for the war. If the experts the leaders hired could make the people live in fear and believe that the people that they would be asked to fight are horrible monsters worthy only of misery and death, the people would be more likely to make the sacrifices needed for wars and to participate in the wars. The leaders had powerful incentives to find ways to generate hatred, fear, and the strange emotion called ‘patriotism’ that makes people believe that the entity called their ‘country’ provides all wonderful things that exist and is worthy of any sacrifices necessary to defeat the ones the leaders tell the people to hate.

Not all national leaders respond to these incentives.

Incentives are psychological pressures, like an invisible hand pushing people to do certain things. Many people thought the things the incentives were pushing them to do were wrong and refused to do them, even though they could make themselves far better off, gaining both wealth and power, if they responded to the incentives. Not everyone responded, but some did and that is all it takes.

The conditions necessary for war became a reality. Wars became constant.

In these systems, the people and organizations who have control over the world and make day-to-day decisions over the land are notpartners with the human race. The entity we call the ‘human race’ has basically been banished, made to appear that it isn’t even real and has no common interests, by the paid propagandists who work for the individual clans/countries. The only thing that matters is the territorial goals of the clans/countries; those who think of the interests of the human race are traitors to their clans/countries and are often rounded up and disposed of.

These systems are hundred percent ownability systems, meaning that everything is ownable and owned (by some clan, country, corporation, commune, collective, or individual). Nothing is unowned and available for the members of the human race to use to meet the common needs of our race.

If we had anything at all; if any share of the wealth that flows from the land was unowned and available for us to control, we would have some power and some control over the important variables of our existence. But the people who built the societies that were here when we were born didn’t consider the needs of the human race, they considered only their instincts, superstitions, and beliefs about the invisible beings and unseen forces that they thought created a mandate for them to take the land and hold it.

We can’t do anything about the past.

We can’t do anything about the way the world worked when we were born.

But time has passed.

The people who set up this dangerous system are long dead. The people who were in charge are going away leaving new generations. The old beliefs are dying quickly, as technology makes information about objective analysis available to everyone. We can decide to try to keep the old beliefs alive if we want. We can choose to not allow ourselves to look at the world differently than people in the past. We can choose to not allow our children to know they have the right to think about the world the way they want and make it work they way they want.

But we can also make a break from the past. We can accept that there are many different paths that we can take into the future. We can analyze the landscape, figure out where the different paths go, and find one that leads to the type of world that we want to live in, and that we want our children and their children to be able to enjoy.

We are now in a position to do the analysis that the past generations that created this dangerous system were not willing, and not even really able to do. We have tools that include computers and the internet that can help us categorize the old beliefs and instinctual feelings as what they are: remnants of a primitive past. We can accept that we have the ability to set up systems that allow people to buy rights to the world in ways that give them rights to do things that benefit the human race and allow them to get rich if they do these things, without also having the rights to do things that harm our world and put our race and our world at risk.

How do we put such a system into place?

Before we can even think about such things, we have to know this: ‘What system are we trying to put into place?’

You can’t plan a journey until you have first decided on a destination.

We can’t determine the specific steps we need to take to change our societies until we know how we want our societies to work after the changes are complete.

The very first step that we must take is to figure out what characteristics human societies must have in order for them to be ‘healthy’ societies and able to meet the needs of the human race.

I know it is hard to imagine us making a transition from the societies we have now to sane, stable, peaceful, sustainable, and otherwise healthy societies. This is so hard to imagine that most people just want to give up on everything and not think about the issue. It causes real mental pain to think about and we naturally want to avoid pain, so we don’t think about it. But if we don’t think about things, we will never figure them out. We will never figure out how to get to healthy societies if we don’t know what healthy societies look like.

Once we understand how healthy societies work, and we have a destination in mind, we can start to consider what we must change about the societies that our primitive ancestors put into place to get from where we are now to the destination we have in mind.

We will look at the idea of societal change in great detail much later in the book. We will see that if we understand exactly where we want to go and know exactly what we must change to get there, the changes themselves are actually pretty easy. If you know where you want to go and have a map that shows how to get there, it is pretty easy to plan a route.

We must take this project one step at a time. The first step is to understand our capabilities. If we know that healthy societies are within our capabilities, we have taken the first step. We will then be willing to take the second step and do an analysis of the possibilities. We will see that a great many arrangements of human societies are fundamentally healthy. We can narrow down the options by looking for the specific healthy society that is the closest to the societies we have now, and therefore the easiest to get to.

Only after we know where we are going are we in a position to plan the trip itself. This, I believe, is the reason that attempts at societal change in the past have failed: the people who tried them didn’t have a destination in mind, they only knew they didn’t like what they had. (Marx basically said, ‘Kill all the evil owners and bureaucrats and destroy everything they have built; when the evil ones are gone, the good people who are left will figure out something better and put it into place.’ He had no idea about the destination and made entirely wrong guesses about how to get to better societies.)

The Pastland example is designed to make it easy to see that healthy societies really are possible. You and I and the rest of the people in our group are in a position to start from scratch. We can form any kind of society we want. We have incredible advantages, including all of the technology of the 21^st century, the skills of our time, and all information about the things that have been tried over the last iteration of history and the way they worked out. We can take advantage of these things. We are in a position to form any kind of society we want.

We have Frances and other people with skills and talents that can help us. Let’s go back to Pastland and consider what would happen if we decided to intentionally organize our society around a method of interacting with the land that was designed to align the interests of the people who control land with the interests of the human race as a whole. We will see that it is quite possible for humans to live in a healthy, sane, peaceful, prosperous society. Once we know it is possible and we have a potential destination in mind, all we have to do is decide if we want to go there and then make the trip.