HISTORY OF TIMBERLAND INVESTING
Even though landowners have made money from timberland since the earliest sawmills were built, this asset class received little attention from institutional investors until 1974. This was the year Congress passed the Employee Retirement Income Security Act. Before this law was passed, pension funds and endowments were invested mainly in equity and fixed income instruments. The new law encouraged these institutional investors to diversify their portfolios to include other investments like real estate holdings, which included timberlands. Changes in the tax law in 1986 increased the amount of institutional investment in timberlands even further. The new law did not allow U.S. forest product companies to take advantage of capital gains tax rates for timber harvests. With the loss of this tax advantage, many forest product companies began to sell their timberlands to tax exempt investors like pension funds, foundations and endowments.
From 1986 to 2007, most forest product companies realized they did not need to own large amounts of timberland to provide their mills with a steady and reliable flow of wood. They decided it would be better financially to monetize the timberlands and use the capital for investment into wood processing facilities and to improve their balance sheets. During this 21 year period, the total investment in timberlands by institutional investors increased from less than $1 billion dollars to over $60 billion dollars.
The millions of acres of timberlands sold during this period were purchased by several entities. The largest buyers were pension funds, university endowments, charitable foundations and high net worth individuals. The majority of these timberlands are managed by Timber Investment Management Organizations (TIMO). TIMO’s assist the investors in locating and purchasing timberlands and also manage the timberlands for their clients. There are approximately 17 different TIMO’s in existence today. The four largest TIMO’s are Hancock Timber Resource Group, Forestland Group, Campbell Global and Resource Management Service. These four TIMO’s manage over 15 million acres of timberland for their investors.
Instead of selling their timberlands, some forest product companies moved their timberland holdings into Real Estate Investment Trusts (REIT). REITs have better tax advantages than holding the lands in a C-Corporation. The four largest REITs today are Plum Creek, Rayonier, Weyerhaeuser and Potlatch. Together they own over 17 million acres of timberlands.
WHY INVEST IN TIMBERLAND?
Historically, timberland returns have compared favorably with stocks but with much less risk and volatility. U.S. timberland investment performance is measured by the NCREIF Timberland Index. This index is published by the National Council of Real Estate Investment Fiduciaries. Over the last 20 years, according to this index, returns from timberland have been almost equal to returns from equity investments as measured by the S&P 500. The rest of the story, however, is timberland investments had less than half the volatility of the equity investments. The volatility of timberland investments over this time period was equal to 10 year treasury bonds. This demonstrates the low risk nature of timberland investing.
Timberland is an excellent addition to an investor’s portfolio for two other reasons. First, timberland is a hedge against inflation. Historical data on timberland returns and inflation show there is a positive correlation between the two. Second, because timberland returns typically move counter cyclically with other asset classes, it provides overall portfolio diversification, which lowers portfolio volatility and risk.
Another favorable characteristic of timberland is trees continue to grow in volume, and thus value, regardless of what is going on in the current economy. If timber prices are unfavorable, the timber can be stored on the stump and allowed to grow until prices become favorable again. This cannot be said for other investments like stocks or gold. While waiting for stock prices to increase, the number of shares of stock owned are not increasing. With gold investments, while waiting for the price of gold to increase, the ounces of gold owned is not increasing.
There is one more unique difference between investing in timberland verses other more traditional investments like stocks, bonds or gold. Timberland is a tangible asset that can be enjoyed while owned. One cannot go hunting or horseback riding on a share of IBM stock or a gold brick. Timberland ownership, however, allows the investor to have a place to enjoy and create memories that will last a lifetime. To many timberland owners, this is the most important characteristic of the asset.
Along with the upside to timberland investing, there are a few negatives. Unlike investing in the stock market, investors in timberland must have long term investment horizons. As witnessed over the last several years with the recession and housing market crash, there is also market uncertainty. Another negative is the fact that timberland is a fairly illiquid asset. It may take 6 to 18 months to sell a timberland property. Timberland investments are also subject to damage from fire, wind, insects or disease. Geographic diversification of timberland properties, timber age class diversification and good forest management, however, can lower these environmental risks.
HOW MONEY IS MADE GROWING TIMBER
The value of timberland appreciates in several ways: 1) land appreciation, 2) real timber price increases, 3) biological growth and 4) forest product growth.
Unless the timber property is located in an area of high growth, land appreciation contributes only about 5-7 % of the overall asset appreciation. However, the appreciation of the land can be significant if it is located in parts of the county that are experiencing rapid growth. Many times the timberland will develop a higher and better use where the value of the timber component of the investment becomes secondary to the value of the land component. There are many tracts of land that had a highest and best use for growing timber that are now golf course communities, residential subdivisions and shopping malls.
Real Timber Price Increases
The housing crash of 2008 pushed softwood sawtimber prices down to levels not seen since the early 1990’s. Sixty-five percent of the total demand for softwood timber is from construction and two-thirds of this demand is from new construction. Most forest economists, however, predict the future for timber prices is bright. Several factors should help timber prices rebound and reach new highs over the next 4 -5 years.
First, the housing market will slowly but surely rebound, thereby increasing demand for softwood timber. Housing starts have been at historic lows over the last four years. In order to keep up with future demand for housing, this deficit must be made up. Currently, housing starts are around one million units per year. This should increase to over 1.5 million starts by 2017.
Second, exports to China will continue to increase. The U.S. is currently exporting ten times more wood to China than just seven years ago. Most of the timber being exported to China is coming from the Pacific Northwest.
Third, imported lumber from Canada will decrease because of the devastation of Canada’s timberlands from the mountain pine beetle. The mountain pine beetle infestation has reduced timber volumes by more than half in western Canada. Canada provides the U.S. with one-third of its lumber supply. Less lumber being imported from Canada will result in a greater demand for softwood timber in the U.S. Because it takes 40 to 50 years to grow a tree to sawtimber size in Canada, it will be decades before they can import lumber into the U.S. at the same levels as before the pine beetle devastation.
The combined effect of these three factors will push demand and prices for softwood timber to new highs over the next 4 to 5 years. Because softwood timber is the primary product grown on U.S. timberlands, this will help increase returns from this asset class. The long term outlook for timber prices is even more optimistic when considering worldwide demand for paper and wood products is ever increasing but the number of acres devoted to growing timber is decreasing. Thus, landowners who are investing in timber now will be assured of good markets and high demand for their forest products into the foreseeable future.
Biological Growth and Forest Product Growth
Money is made growing timber due to the biological growth of trees and also due to the change in forest product class as a tree gets larger. When a tree grows, it adds more volume and is therefore more valuable. However, not only does a tree add value over time by virtue of gaining more cubic foot volume, trees grow into higher value forest products as they get larger. For example, in the southeast, loblolly pine trees become merchantable when they reach about 15 years of age. Merchantable means the trees are large enough to be sold to a timber buyer for money. At this time, the trees are approximately 7 inches in diameter. Trees this size are used for pulpwood, which is used in the manufacture of paper products. Pulpwood trees are worth about $7.00 per ton. The value of this 7 inch tree is $1.50. In 7 years, this tree will be approximately 10 inches in diameter and can be used to make small dimension lumber. The value of trees in this forest product class are $14 per ton. The per ton price has doubled from what it was when the tree was 7 inches in diameter. The value of this 10 inch tree is $4.50. Because of the combined effects of volume growth and forest product value growth, the tree increased in value 300% in a five year period. If the tree is allowed to grow another eight years, it will be 14 inches in diameter and be classified as a large sawtimber tree. These size trees can be used to manufacture large dimension lumber or plywood and are worth $30 per ton. The value of the single tree will now be $22.50. That is a 500% increase in value over an eight year period. That is the power of the combined effects of biological growth and forest product value growth in timber. Not only do the trees gain more volume growth over time, the value of those units of volume increase over time as the tree moves into higher value forest product classes. This example did not take into account increases in timber prices. When factoring in economist’s projections of the increase in real timber prices in the future, these numbers could go even higher.
WAYS TO INVEST IN TIMBERLAND
There are several different ways to invest in timberland. The method selected depends on the investor’s total capital to be invested, the amount of liquidity desired and the amount of participation in the management of the timberlands the investor wants.
A way to invest in timberland that offers high liquidity, does not require a large amount of capital to be invested and does not require active management of timberland is to purchase shares of timber related publicly traded stock. Two examples are timber REITs (Real Estate Investment Trusts) and timber ETFs (Exchanged Traded Funds). The difference between the two is when investing in a timber REIT, only one timber company’s stock is being purchased. Timber ETFs, on the other hand, are similar to mutual funds and are made up of stocks from multiple timber companies.
Another alternative timberland investment strategy is the outright purchase of timberland. This method offers low liquidity but a higher level of control. Pension funds, endowments, and charitable foundations who have large amounts of capital to invest and who do not have the desire or experience to manage the timberlands usually hire Timber Investment Management Organizations (TIMO) to purchase and manage their timberlands. TIMOs typically offer two types of products, individual accounts and commingled funds. Individual accounts offer more control of the invested capital but require a much higher amount of capital investment. Minimum capital requirements of most TIMOs for an individual account are around $30 million dollars. A commingled fund is made up of capital from multiple investors and therefore has a lower capital entry requirement. The amount of control over the investment is less with a commingled fund, however these funds usually offer greater portfolio diversity, which results in less risk to the investors.
Another common way individuals invest in this asset class is to purchase timberland and either manage the timber on their own or hire a consulting forester. These investors may own as little as ten acres or thousands of acres. Typically, a property should contain at least ten acres of timber to be able to sell the forest products to a timber buyer at prices that make the enterprise profitable.
There are many characteristics to a property that make it a good timberland tract. If investors are not knowledgeable about purchasing timberland properties, they should hire a forester/realtor to assist them in their search. Some of the most important things to look for when purchasing a timberland property are: 1) the property should be located in an area that has one or more mills nearby that purchase the type of forest product being grown, 2) the property should have productive soils to grow the most profitable timber species, 3) the vast majority of the property should be able to be logged, and 4) most importantly, the property can be purchased at a price that allows for a good rate of return growing timber.
After a timber property is purchased, the forest needs to be managed properly. A well-managed forest will produce much more valuable timber than a poorly managed forest. If the investors do not have expertise in this area, they should locate a competent consulting forester. A good place to start is to contact the Association of Consulting Foresters of America (ACF). ACF membership has a minimum requirement of a bachelor’s degree in forestry and at least five years’ experience. ACF members also have no conflict of interest with timber buyers or forest industry and are required to adhere to the high standards of the ACF Code of Ethics. To be even more confident a consulting forester has the education and experience to manage the timberland, choose one that is also a Certified Forester by the Society of American Foresters. In order to be a Certified Forester, the forester must pass a rigorous competency exam that measures knowledge and skills, complete at least 60 hours of continuing education every three years and also adhere to the Society of American Forester’s Standards of Professional Practice.
This article covered the very basic aspects of timberland investing. Before committing a significant amount of capital to this asset class, the investor should do their due diligence on which timberland investment alternative best meets their goals. The recession of the last six years has created a window of great opportunity for investing in timberland. As the general economy continues to recover and the housing market makes a comeback, wise prudent investments made in timberland now should provide excellent returns.
Bob King, ALC, is owner and broker-in-charge for United Country Land & Lifestyle Realty located in Anderson, S.C. King is also president of King Land Company, Inc., which provides forestry and land management consulting services. He holds a BS degree in Forest Management from Clemson University and has 25 years’ experience in forest management and land brokerage.