Monday, March 15, 2010

Problems in Napa Valley

Business Week reports that, "As many as 10 premium wineries and vineyards in the area—home to the nation's priciest grapes—will change hands in distressed sales or foreclosures this year and next, according to an estimate by Silicon Valley Bank." The article explains that many people entered the wine business during the economic boom, buying up very expensive land in Napa Valley and trying to produce high-end wines. While revenue growth for wine had been strong for many years, things have changed with the economic downturn. Fewer people are buying super and ultra premium wines, and more folks are turning to lower-priced, but good quality imports from countries such as Chile, Argentina, and Australia.

What the article does not mention is that the economics of producing high-end wines in places like Napa proves especially challenging because of the long time horizon in the ultra premium wine-making business. First, the firm must make a substantial capital investment to purchase the land and equipment. Second, a long time lag exists between the year in which vines are planted and the point at which aged wine is finally sold to consumers. If a firm purchases land and plants vines today, it harvests the first grapes from those vines three years from now. The winery sells the first aged ultra-premium wine in Year 5, and full-scale wine production does not occur until between Year 7 and Year 10. That's a very long time to wait for a return on a very expensive investment. One has to be very patient, and you have to be able to command a strong price for high quality wine to make the returns attractive. Falling real estate values and high mortgage payments can make it impossible for small wineries to survive, as we are seeing now. Frankly, even with stable real estate values, the payoff for such a real estate investment can be way off into the future.

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