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James C. Barnett |
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What's the Monetary Value of Your Premerchantable Timber?
Steve
Bullard and Tom Monaghan
Premerchantable timber stands may be highly valuable
for commercial uses in the future, but what is their monetary value today? This
important question often arises in buying and selling land that has
premerchantable timber, in making damage estimates, and in allocating value
between land and timber for tax purposes.
There are two broad types of monetary value—market
value and investment value. Market value is the price for which an asset would
sell on a competitive basis, and investment value is the value of an asset to a
particular investor. Appraisers use various methods to estimate these values.
Market value, for example, can be estimated using: the cost approach—an estimate
of the cost of replacing the asset; the income approach—an estimate of the value
today of the asset’s projected income; and comparable sales—information on
prices paid for similar properties.
Most appraisers prefer to use comparable sales
information to estimate the value of an asset, particularly when estimating
market value. In some cases, however, sales information isn’t readily available
for properties with “comparable” site and stand characteristics.
In this article we describe a few of the methods
used to estimate the value of premerchantable timber stands. The methods
estimate investment value, and they can help in estimating the market value of
premerchantable timber where comparable sales information is not available. Note
that these methods estimate the value of the premerchantable timber only. To
estimate the total value of a forested tract, land value should be added to the
value of the premerchantable timber. Traditional Methods Two traditional methods of estimating premerchantable timber value are: (1) Compounded Costs, and (2) Discounted Revenues. Because these methods are often used, forest landowners should understand their basic rationale and application. Both of them ignore some important parts of premerchantable timber value, however, so they are not recommended for use in estimating investment value. Compounded Costs
A common method of estimating premerchantable stand
value is to “compound” all of the timber’s production costs to the stand’s
current age. “Compounding” is the process of accounting for the time value of
the money that has been invested in the stand. To do this, compound interest
formulas are applied to site preparation, planting and other costs incurred in
establishing and maintaining the stand.
Example. Consider a pine plantation that was
established for $150/acre eight years ago, and assume that 7% interest is the
owner’s guiding rate of return. Using the compounded cost approach, the
investment value of the eight-year old stand is:
$150 x
1.078 = $257.73/ac.
The compound interest formula used to calculate the
$257.73 is the same formula used by banks to determine account value. That is,
if the $150 had earned 7% each year in an interest-bearing account, the account
would have $257.73 after eight years.
Compounded costs are sometimes referred to as
“seller’s value,” in this case reasoning that $257.73 is the minimum amount a
seller would accept for the trees if he wanted to earn 7% interest on the site
preparation and planting investment. Others, however, prefer to call compounded
costs “buyer’s value,” reasoning that $257.73 is a relatively low estimate of
value, and thus the amount a buyer would offer as appropriate using 7% interest.
In this example, note that the $257.73/acre
estimated stand value does not include the value of the land. The estimated
value is for the premerchantable timber only. In general, the younger the stand, the more accurate the investment value estimate will be using compounded costs. This method, however, typically yields relatively low estimates of stand value because it underestimates the actual costs involved in producing a stand. The money tied up in land, for example, is part of a landowner's cost of producing timber, yet this cost is ignored in the compounded cost estimate of premerchantable timber value. Discounted Revenues
Another method of estimating the investment value of
premerchantable timber is to “discount” the timber’s projected (future) revenues
to the stand’s current age. “Discounting” is the process of accounting for the
time value of the money that is expected from the timber in the future. To do
this, compound interest formulas are applied to the expected timber harvest
revenues.
Example. If the pine plantation in the previous
example is expected to be harvested at age 20 for pulpwood, what is the value of
the stand at age eight to an investor who would like to earn 7% interest? If we
assume the stand will yield 45 cords/acre of timber at age 20, and if we assume
a future price of $50/cord, the expected harvest value is (45 cds./ac.) x ($50/cd.)
= $2,250/acre. Using the discounted revenue approach, the investment value of
the eight-year old stand is:
The formula above simply “discounts” the $2,250/acre
projected revenue for a 12-year period using 7% as the expected rate of return
on the investment. Why was 12 years used? Because if the timber is purchased
today (at age eight), revenue from selling timber won’t be received for 12
years, when the stand is 20 years old. This approach calculates “present value”
(value today) by “discounting” the value expected for the timber 12 years in the
future. Note that if other harvest options are considered, their discounted
value can also be calculated. The value of the premerchantable timber to a
particular investor would be the highest value he obtains using his expected
rate of return as the interest rate.
Again, this method uses the same formula used by
banks to calculate account value—if you placed $999.03 in a 7% interest-bearing
account, after 12 years the account would have $2,250. Discounted revenues are
sometimes referred to as “buyer’s value,” reasoning that $999.03/acre is the
most a buyer would be willing to pay for the trees today if he wanted to earn 7%
on the timber investment, and if $2,250/acre in 12 years is a reasonable
expectation of future revenues. Others use the phrase “seller’s value” for
discounted revenues, however, because the estimate is relatively high.
As with the other methods for estimating stand
value, note that the $999.03/acre estimated value is for timber only. Land value
would need to be added to estimate the value of land and timber together.
In general, the older the stand, the more accurate
the investment value estimate will be using discounted revenues. As noted above,
however, the discounted revenue method often yields relatively high estimates of
the investment value of premerchantable timber. Trees grow on land, and the cost
of the money tied up in land is not accounted for in the above calculation of
discounted revenues. The ROI Method
The “ROI” method for estimating premerchantable
stand value involves calculating and using the overall return on investment (ROI)
for the land and timber combined. This annual interest rate represents the
owner’s rate of return on the money invested in land and timber during the life
of a stand. The ROI method for estimating premerchantable stand value is more
involved than most forest landowners can calculate “by hand,” but computer
programs and other aids are available for those with further interest in this
important issue. [See the inset box titled “For More Information.”]
Example. If $150/acre was invested in stand
establishment, and a final harvest revenue of $2,250/acre is projected at stand
age 20, what is the stand’s investment value at age eight using the ROI method?
For this example we’ll assume the value of the land was $400/acre when the stand
was established eight years ago, and we’ll assume the land value is expected to
be $600/acre when final harvest of the timber occurs.
For this example, the three steps in the ROI method
are:
1. Calculate ROI:
The owner of the timber stand invested
In this example the value of the land is projected to increase from $400/acre when the stand was established, to $600/acre when the final harvest is projected. The land and timber investment is projected to earn 8.75% per year, so in the first year the land cost or "rent" is $400 x .0857 = $34.28/acre. The value increases each year, however, as the land value increases. In this example, the land increases in value by about 2% per year, so the land increases at a similar rate.
Table 1 shows the estimated land
rent for each of the stand’s first eight years (assuming land value starts at
$400/acre and increases at 2% per year). In step 3,
Table
1. Land rent for each of the stand’s first eight years
3. Compound all timber production costs to the
stand’s current age, using ROI as the interest rate.
$468.66 + $685.54 =
(Land)
+ (Timber)
Summary
Many things affect the investment value of
premerchantable timber. Revenues projected from the future sale of timber, for
example, are affected by expected prices and estimated yields of merchantable
products.
Traditional methods of estimating premerchantable
timber value may understate or overstate investment value because they leave out
some important costs. Table 2 shows the value estimates for land and timber that
resulted using these approaches in our example. The ROI method accounts for
expected costs and revenues from the timber, and it considers the “time value”
of the money invested in planting and management practices, as well as the money
invested in the underlying land.
Considering the “time value” of money involves the
use of compound interest formulas, and the ROI approach is most easily applied
by using a computer program prepared for that purpose. One program that is
available to forest landowners is FORVAL for Windows. This program was developed
at the Forest and Wildlife Research Center at Mississippi State University for
evaluating forestry investments in general. It has a section that applies the
ROI method for estimating the investment value of premerchantable timber.
Forest landowners may find that their
premerchantable timber has a relatively high value. This is particularly true
for pine stands in areas with relatively high prices and good yields. In most
cases, a professional forester should be consulted in estimating volumes and
values of timber stands. In cases where total tract value is being estimated
(land and timber combined), forest landowners should be sure to add the value of
their land to the investment value of premerchantable timber.
The
following articles have information that relates specifically to estimating the
value of premerchantable timber:
Chang,
S.J. 1990. Comment II. Forest Science 36(1):177-179.
Foster,
B.B. 1986. Evaluating precommercial timber. Forest Farmer 46(2):20, 21.
Foster,
B.B. 1986. An alternative method for evaluating precommercial timber. The
Consultant 31(2):29-34.
Klemperer, W.D. 1987. Valuing young timber scheduled for future harvest.
Appraisal Journal 55(4):535-547.
Straka,
T.J., and S.H,. Bullard. 1996. Land expectation value calculation in timberland
valuation. Appraisal Journal 64(4):399-405.
Vicary,
B.P. 1988. Appraising premerchantable timber. The Consultant 33(3):56-59.
Dr.
Steve Bullard is a Professor in the Department of Forestry at Mississippi State
University.
------ Approved for publication as article number FO 106 of the Forest and Wildlife Research Center at Mississippi State University. |
