Have we got an investment for you. It is the perfect addition to that stock and bond portfolio you are so proud of.  Picture this; it has a return of 10 to 15 percent compound interest (or more!) over a 15-year horizon, and a significant portion of the return is tax-deferred and usually reported as capital gains.  It has an historically positive alpha and a negative beta when compared to the S&P 500, and research shows that converting a portion of your holdings to this investment will increase the overall efficiency of your portfolio.  What is this new miracle investment vehicle? Timberland!

If you are already a timberland owner, this description may not make you stand up and shout “Eureka, I’ve found it,” but it has not been all that long since Wall Street investors finally sat up and took notice of the value of timberland investments.  To understand how these sophisticated investors came to understand what timberland owners have known for years takes a short history lesson and a visit to “Wall Street Investing 101.”

Up until the late 1970’s, timberland investments were typically the domain of forest products companies and farmers.  Both had a somewhat similar outlook regarding the nature of their holdings.   The farmer’s main source of income was the cash crops he sold each season from his agricultural land, and the timberland was a hedge or special account he held in reserve for some unknown future need.  Farmers already owned the land and growing timber was all you could do with those acres not suitable for crops.  Many paper companies and sawmills also owned timberland as a reserve or hedge against an uncertain supply of raw materials from the general public.  They, too, made their income from their main investment (plant and equipment), and often their timberland holdings were not thought of as an independent profit/loss center. 

A Counter-Cyclical Hedge

For most farmers and many timber companies, the return on their timberland investment was not important.   In fact, it was not even a major portion of their overall business plan.  It was subsidized by their main business and served only as an asset to support that main business.   During the late 1970’s and into the 1980’s, a number of academic studies looked at the true nature of timberland investing.   These studies were based on evaluating the financial risk and return of investments using CAPM, the Capital Asset Pricing Model, and comparing those returns to the returns generated from S&P 500 stocks.  This is some of what these academic studies found when comparing timberland returns to the S&P 500 Index:

In addition to these benefits, since a significant portion of the return generated from timberland investments is the result of biological growth and increasing value of product classes as pulpwood becomes chip-n-saw and sawtimber, there are no tax consequences related to this return until the timber is sold.  Interest and dividend payments are sources of annual income that are usually taxed at ordinary income rates.  As with growth stocks, most of the return is taxed as capital gain income resulting in favorable tax rates.

For Wall Street investors, the conclusion drawn from these studies is that timberland could be included in their long-term investment portfolio, and when included, the diversity of the portfolio was increased, its risk was reduced, and the return increased or stayed the same.

Today there are many Timberland Investment Management Organizations (TIMOs) pursuing the acquisition of timberland investment for institutional investors across the US.  TIMOs act in a manner similar to stock and bond mutual funds or investment advisors.  They solicit corporate and institutional investors who have pension-fund investments and invest a portion of their assets in one of the TIMOs’ timberland “funds.”  These funds have specific investment criteria similar to the way a company like Fidelity Investments has a small-cap fund or a blue chip fund.  A TIMO may have a “Timberland Fund #1” which is made up of four corporate contributors and is designed to buy loblolly pine plantations;  “Timberland Fund #2” may be totally funded by one client with all types of timberland investments (planted pine, natural pine, hardwood, etc.).  The TIMO may be rounded out with several other funds designed to stakeout a niche in the marketplace or meet the needs of specific clients.

By the end of 1994, TIMO investment in timberland had exceeded $2.5 billion in the U.S.  There are now at least 15 TIMOs operating from Atlanta to Boston to Seattle, and all points in between.   A significant amount of the work that consulting foresters do on an annual basis is for these TIMOs.   TIMOs require analysis of the quality of timberlands offered for sale, stumpage price trend analysis, and future timber market evaluations for upcoming purchases, as well as the day-to-day management services, like timber sales and reforestation, for properties they already own.

Outsmart the Competition

How does all this affect private landowners who already own timberland or individuals thinking about making an investment in timberland?  For one thing, it bodes well for your investment strategy.  If these institutional investors are willing to invest 100’s of millions of dollars each year in timberland, there must be something there in which to invest!  Secondly, these TIMO owners represent a stabilizing force in the marketplace for the forest products industries.  In contrast to developers who subdivide properties and play the real estate market, TIMOs typically retain most of the acquired property for at least 10 to 20 years and manage them as timberland investments.  This helps to provide forest products industries with a reliable source of raw materials, which encourages those industries to make additional investments in the area.  This in turn provides private landowners with multiple timber buyers and a strong marketplace for their timber.

This change in the timberland-investment marketplace, brought about by the increased number of active investors, has several major implications for today’s private landowner.  The first is that the well-managed timberland you own is probably worth more than you think.  This could affect your retirement planning strategy or your estate planning goals.  A second impact is that timberland owners who are trying to increase their holdings are unable to find anything that is “reasonably priced” relative to the investment numbers they are used to using.  If you cannot understand how that “farm down the road” sold for so much, you may need to evaluate what was really for sale.  The $100 per acre bare-land value for timberland not all that many years ago has a $400 value today.  Intensive management practices have reduced rotation length and increased cash flow from timberlands.  That “fool who paid too much” for the tract down the road may have gotten a bargain because he understood today’s markets and values. 

An advantage that TIMOs have over typical timberland owners is the ability to spread risk over a portfolio of land ownerships.  TIMOs manage hundreds of thousands of acres spread over multiple states, whereas, the typical private landowner may have one to five tracts in close proximity to one another.  The TIMO’s diversity reduces the likelihood a natural disaster or local timber market collapse will significantly impact the total investment’s return.  One hurricane or mill closing can have devastating consequences for small private landowners.

Private landowners, on the other hand, have the ability to move quickly when local investment opportunities present themselves.  This local knowledge, together with good investment decision-making can lead to sound long-term returns.  While some degree of risk from natural disasters is inevitable, private landowners can decide to hold timber off the market during downturns in local stumpage prices.  They still maintain the return generated from biological tree growth and the gain as pulpwood becomes chip-n-saw and chip-n-saw becomes sawtimber.   Because timber sales are done infrequently (once or twice during an ownership), the timing of sales for individual investors is critical.  Forest Resource Managers, like Shaw, McLeod, Belser & Hurlbutt, Inc., provide services every day to private investors who are trying to keep up with these changes in the marketplace and make sound investment decisions.

Wall Street investors now know what rural landowners have known for years.  Biological tree growth, plus the increasing value of products as you go from pulpwood to chip-n-saw to sawtimber, plus historical increases in stumpage prices leads to a good long-term investment strategy.  Much of the return is a tax-deferred capital gain, and you get to take the family (or investor-clients) out hunting, fishing or for a nature walk and picnic while you checkup on your investment.   As an added bonus, Wal-Mart may decide that your tree farm is the perfect location for its new distribution warehouse and make you an offer you cannot refuse. 

As the competition for timberland investments increases, coupled with increasing stumpage prices and land values, more sophisticated investment analysis is required to keep up with the competition.  So, check out the latest growth and yield models for timberland in your area, check with your forestry professional and keep your eyes and ears open.  Your next timberland investment could literally be  “just around the corner.”

About the authors:

David E. Anderton, Jr. is manager of Mid-Atlantic Region, Shaw, McLeod, Belser & Hurlbutt, Inc.  He is also a member of Forest Landowner Association, a registered forester in North Carolina and Maryland, and tree farmer in three counties in Virginia.

Charlie Finley is a certified tree farmer in four counties in Virginia and founder of Verbatim Editing, a company now four years old, which provides writing, publishing and editorial services.  He served for 25 years as executive vice president of the Virginia Forestry Association, retiring in 1994.

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