THE world of agricultural land makes the commercial property market look like a sane and rational place. Investment decisions are often made on the basis of lifestyle and sentiment rather than discounted cash flow or rate of return.

"There are certain landowners who measure their wealth in acres rather than pounds," says Mr Peter Clery, managing director of Lands Improvement Holdings, the agricultural property company which made its stock market debut this week.

Official statistics show prime farm land currently yields about 5 per cent. But many buyers are willing to accept far lower returns because they have a sentimental attachment to an estate. But if many buyers of farmland ignore investment fundamentals, the fundamentals themselves are difficult for many mainstream property investors to grasp.

While commercial property is loosely tied to the economic cycle, land prices are driven by factors such as grain prices and the level of the green pound - the rate at which EU subsidies are translated into sterling.

Forecasting these variables is difficult indeed. Three years ago, land prices were lower than in the mid-1980s because the green pound was strong and grain warehouses were relatively full.

Yet, last year land values raced ahead by 20 per cent as grain prices soared - due to a worsening world shortage of wheat, exacerbated by poor weather and the weakness of the green exchange rate.

Against this background most big institutional investors have given up on agricultural land as a bad lot. Institutional capital poured into farm land in the mid-to-late 1970s, driving yields down to a low point of 2.2 per cent in 1980. By the late 1980s, though, institutional cash was being withdrawn against a background of falling values, with prime estates changing hands at yields of 6 per cent or more.

Specialists such as Lands Improvement and the Church Commissioners are now left to plough a lonely furrow, with pension funds and life insurers making only occasional purchases.

Mr Clery says most fund managers did not understand the nature of the asset and did not work hard enough to squeeze value from their estates. Lands Improvement, he says, buys estates with one eye on the quality of the soil and one eye on the potential for development. It aims to increase its yield by selling some acres for housing, warehousing or roads.

The difference in value between farm land and housing land is such that even relatively small deals can have a big impact.

In the early 1990s, Lands Improvement sold 90 acres of land in Kilmarnock, to the south of Glasgow, to a housebuilder for £15,000 sterling per acre. As farm land, it was valued at only £700 per acre.

Government forecasts of demand for housing also imply that demand for housing land will probably increase over the next decade. However, it requires a very large portfolio indeed to be sure of achieving a steady flow of these deals.

With 27,000 acres in its charge, Lands Improvement can be fairly sure that it will sell a few parcels of development land every year. It is even hopeful of developing a natural gas field on one estate.

Critical mass also allows Lands Improvement to exploit the imperfections in the land market. Last year it acquired 19,500 acres from Royal Insurance in one of the largest transactions seen in British agriculture The company has since sold all but 6,500 acres, mostly in small lots, taking ad vantage of strong demand from private investors and farmers themselves.

This policy of "buying wholesale and selling retail" is not new to commercial property investors. But the agricultural land market provides a rich seam of opportunities.

Last year's deregulation of farm tenancies also offers big investors a chance to squeeze additional value from their agricultural as sets. Until last September, farm tenants enjoyed lifetime security of tenure and rents which were kept below free market levels by regulation. For this reason, land let to tenant farmers has historically changed hands at around half vacant possession value.

New Farm Business Tenancies are more flexible. Landlords and tenants can now freely negotiate agreements for any period, with rents decided by market forces.

There is a parallel with the housing market, where regulated tenancies - replete with rent controls and security of tenure - are gradually being replaced by unregulated assured shortholds.

While it is too early to say for sure how the new rules will affect the market, rents being struck under farm business tenancies are up to twice as high as under the old system.

Big landowners can also strike relatively short-term deals with farmers which cover, say, a few weeks for a single crop of lettuces. At the end of the period the landowner can simply take back the fields for a different crop or a different tenant.

The overall lesson is that decent returns can be earned from agricultural land if investors are willing to invest on sufficient scale and devote sufficient resources to the active management of their estates. Even more than in the commercial property market, it is not enough to simply buy an estate and accept a steady 5 per cent rental yield.

Mr Clery certainly believes the outlook is bright. He points out that even after the spectacular gains of last year - when agricultural land was the best performing UK financial asset - land values are still well below the levels of the I980s in real terms.

The shape of the land cycle from here on depends on unpredictable variables such as the green exchange rate and world grain prices. The long-term impact of politics on the price of agricultural products, which are largely determined by the Common Agricultural Policy, is equally a matter for informed guesswork.

These uncertainties - combined with the bad experiences of the 1980s - probably mean that the case for farmland will have to be exceptional before most investment institutions consider ploughing cash back into the agricultural market

But this probably suits Lands Improvement, which carved its profitable niche in the 1980s when fund managers were selling out.