Investors and landowners take note: Fundamental changes in forestland values and ownership patterns are changing the ways people look at timberland. Here’s what you need to know as you sort through your investment options.

In the spring of 1998, two large southern forestland deals, which involved forest products corporations selling merchantable forests to private investor groups, sent a current of electricity through the financial and forestry communities.

The deals, each in excess of 70,000 acres, fetched values that caught everyone’s attention: investors, advisors, lenders and landowners. Mostly, however, they drew attention on Wall Street and in industry boardrooms. Already considering land sales as part of an industry-wide restructuring (i.e. sell land, focus on manufacturing), papermakers and their investors noticed these sales and took some bold steps.

Today, more than a year later, there are six major southern land deals (90,000 acres or more) on the market in the southern “Paper Belt,” or Coastal Plain. These deals total over 2 million acres and $2 billion in value. Never before has so much southern forestland been for sale at one time.

And never before has there been so much interest in timberland among new, sophisticated investors. Just about everyone, from industrial managers and high net-worth individuals to Wall Street investment bankers and private landowners, has three basic questions. “Why forestland?” “Why the U.S. South?” And “what does it mean to me?”

Even smaller landowners not interested in doing large deals are following the story because these fundamental market changes could eventually affect how much they get for their land and timber.

BLUE-CHIP FORESTLAND

Why forestland? That part is easy. Over the last 30 years, well-managed U.S. forestland has demonstrated that it can outperform both common stocks and long-term corporate bonds, on a risk-adjusted basis. In these economic boom times, many U.S. investors are diversifying into reliable, low-risk asset classes like forestland, which offers increasingly liquid and tax-advantaged ownership opportunities, plus the amenity values of direct investment.

Why the U.S. South? That’s easy, too. We know from our global experience that teak plantations in Costa Rica sound tempting, but the southern United States remains one of the best places, if not the best place, in the world to invest in private forestland. Strong timber markets, solid infrastructure, state-of-the-science tree farming, a benign operating environment and a stable economy all contribute to this. Relative to risks undertaken, southern timberlands provide superior investment performance.

So, what does it mean to me? This question is a harder one. And we wanted fresh, hard data to back up our answers to it. So, we took a close look at large tract sales in the U.S. over the last three years, and analyzed them to identify current trends among buyers and sellers. Once we identified the trends, we could see where opportunities might emerge in the U.S. South for buyers and sellers.

STRATEGIC DEAL ASSESSMENT

To find out what the trends were, we analyzed 22 recent transactions (between 1997 and 1999) in all three forested regions of the U.S.—the Southeast, the Northeast and the West. These deals totaled 5.8 million acres and were valued at $3.1 billion. We concentrated on large deals. The minimum size of each was 45,000 acres.

We examined each deal for eight separate kinds of data: acreage and value; seller objectives; buyer objectives; seller legal structure and tax status; buyer legal structure and tax status; acquisition currency; presence of a timber supply agreement; and time required to close increasingly large, complex deals.

After assessing them all, we found five current trends. We believe they could signal a historic turning point in forestland values—and ownership patterns—in the South.

Managed Timberland

FIVE CURRENT TRENDS

1) A Marked Increase in Deal Volume. As stated earlier, there are a record 2.25 million acres, or more than $2 billion worth of southern forestland on the market now. If these deals close in 1999, it will be the biggest year for forestland transactions in the history of the region. More forestland will come onto the market in 2000, and prices will probably rise. If these deals don’t close, a possible log-jam will persist.

2) Most Sellers Are Manufacturers and/or C-Corporations (Double-taxed). Most sellers are members of the forest products industry, which is under pressure from Wall Street analysts to improve shareholder performance. In the throes of a major consolidation, the industry is seeing big players negotiate timber supply agreements, sell off lands and re-invest the capital in growing their businesses. In addition, most sellers are C-Corporations, which are double taxed, hence automatically disadvantaged relative to other investment vehicles. For example, for every $1 earned from a timber sale, a C-Corporation shareholder gets to keep roughly 40 cents after taxes.

3) All Buyers Are in Single or No-Tax Structures. In contrast, many of today’s forestland buyers are new investors with single-tax structures, such as S-Corporations, LLCs or REITS, which allow them to keep 80 cents on every dollar earned from timber harvests after taxes. Numerous other buyers are in no-tax structures, such as pension funds and non-profit organizations, which allow them to keep 100 percent of earnings.

4) Merchantable Forests are Fetching Premiums. Merchantable forests fetch premium prices, not only because they contain a greater volume of standing timber, but because they offer immediate cash flow. This makes financial institutions more likely to loan money on forestland, lowering the cost of capital. In the future, merchantable forests will be attractive to private investor groups, LLCs, S-Corporations and publicly traded vehicles, such as REITS, which are just now coming into the market for forestland.

5) Seller Demands are Outpacing Buyer Capacities. Buyer markets have never absorbed this much land at one time, and uncertainty surrounds their ability to perform. Large, complex deals call for buyers who can put together huge sums quickly, handle a mixed bag of assets, pay in ways that enhance the seller’s post-tax value, negotiate timber supply agreements, close in 90 days and meet other demands the seller imposes. Few investment banking firms know forestland well enough to accurately assess all the values in these deals. Few consulting forestry firms know capital markets well enough to structure large deals. As a result, there is a dearth of expert advice and a greater chance that deals will fail to close and go back to the auction block a second time, which is costly for everyone involved.

In sum, timberland is migrating away from “strategic owners”—those who hold timber as inventory for mills—and toward “pure investors” who buy land to reap its unique benefits and look to maximize its long-term investment value. In addition, assets are migrating toward owners with the lowest cost of capital. Taxes add to the cost of investing (or looked at another way, taxes reduce the benefits of investing); hence, assets are migrating toward tax-efficient owners. All of this makes sense. So, while the record volumes of land on the market are indeed extraordinary, and while the forest products industry will continue to own timberland, more industrial land sales should be expected. The pace of all this largely depends on the buyers. Buyer capacity (both in terms of dollars and sophistication) needs to catch up. Herein lies great opportunity.