Timberland Investment; A look into timberland investing in the Northeast: Part 1

Although investing in timberland is certainly not a new concept, activities on Wall Street and in the pension fund world indicate that it continues to be a popular alternative investment.  It is currently estimated that large institutional investors have over forty-five billion dollars invested globally in timberland as part of their overall portfolios, and indications are for this trend to continue to accelerate.  In the US alone, Timber Investment Management Organizations (TIMOs, managing timberland portfolios for pension funds, university endowments, and high net worth individuals) reportedly manage over 23 million acres of forestland investments representing approximately 7% of total privately-owned timberland.

Investors, whether large or small, institutional or private, have many reasons to consider timberland.  First, there is the value appreciation of both the timber and the land components. There are also periodic cash returns from the sale of timber and land and the potential for annual lease income from other natural resources and recreation.

Investing in timberland offers a good means of portfolio diversification and as a hedge against inflation. Timberland is also a “hard” (physical) asset with a limited supply. There is a great deal of satisfaction in owning undeveloped land with numerous outdoor opportunities including hiking, camping, hunting, fishing and jogging. There are also income and estate tax advantages to owning real estate.

Timberland investments offer many opportunities for appreciation in value. These factors can be broken apart and estimated separately.

Biological growth; As an investment, trees have an interesting attribute – they physically grow. Influenced by species type, climate, soils and other factors, tree growth adds value to trees on a consistent basis.  The United States Department of Agriculture’s Forest Service has developed a series of growth and yield models to accommodate growth predictions in the various regions of the country.

For the purposes of this short paper, we developed growth rates using their growth model called NE TWIGS, which is used to predict actual growth development of hardwood timber stands throughout the Northeast.  To do this, annual growth rates for the major timber species have been estimated by entering timber data collected from almost 200,000 acres of commercial timberland in northern Pennsylvania and southern New York into the NE TWIGS model.  Here is a summary of the resulting estimates of annual growth rates for several of the major hardwood species in the Northeast:

^{(Please note – these are only estimates based on a specific timber resource across a wide geographic area, and are used only for illustration.  Actual grow rates could vary widely based on location, soils, and past management practices.)}

Though highly unlikely to occur in the natural sense, let’s assume for the purposes of illustration that a timberland investment contains an even mix of volumes among this species list; this would result in a composite average annual growth rate of about 3.92%.  In other words, an investment in timberland containing an equal stocking of timber in the species listed above might appreciate at an average annual rate of 3.92% merely because the trees on the property grow at that rate; this creates a “floor” return for an investment in timberland.  Good forestry management and site conditions will improve these annual growth rates.

Price appreciation; Though renewable, timber is still a geographically limited natural resource that has experienced increased demand. Accordingly, the price of timber (hardwood timber prices in particular) has increased over time. Since the mid 1980’s, the Pennsylvania State University, School of Forest Resources has published a quarterly Pennsylvania Woodlands Timber Market Report.  During the period from December 1985 through December 2013, though there have been fluctuations due to the health of our general economy, reported timber prices have generally increased significantly, with sugar maple experiencing an 513% increase, red maple a 409% increase, and black cherry a 348% increase.  Other valuable hardwood species have seen significant increases as well.

Below is a table comparing average stumpage prices by species in Northwestern Pennsylvania for December 1985 and December 2001. Total and annually compounded increases are displayed, which when combined with the annual growth rate yields a Total Annual Increase for each species.  Please note that well-managed timberlands will typically exceed the listed growth rates and stumpage prices listed below.

Using the US Forest Service growth estimates and the Penn State price data, the combination of growth and price indicates a species-blended annual appreciation rate of 8.72%.

To get an idea of how timber investments may compare to investments in several stock market indices, an investment of $100 (in December 1985) in a timber asset made up equally of the 7 species mentioned would be worth approximately $1,039.12 after 28 years, while a $100 investment in the DJ Index would be worth approximately $1,071.77, and a $100 investment in an S&P 500 Index would be worth approximately $874.87

^Sources:

^{Dow Jones Index: http://measuringworth.com/datasets/DJA/index.php}

^{S&P 500 Index: http://www.measuringworth.com/datasets/sap/}

^{S&P 500 Index:http://www.fedprimerate.com/s-and-p-500-history.htm}

Grade improvements; Timber also increases in value because of grade improvements, which are usually accomplished through planned silvicultural thinnings.  This increases growth on the higher quality trees, and helps them increase in diameter quicker.  As they do, their quality or “grade” typically increases, and subsequently their value does as well. For instance, one thousand board feet (1 MBF) of twenty-four inch diameter trees are worth considerably more than one MBF of eighteen- inch diameter trees, which in turn are worth more than one MBF of twelve-inch diameter trees.  Furthermore, veneer grade trees (trees peeled for furniture-grade veneer surfacing) are worth considerably more than sawlog grade trees (trees cut into lumber).  Similarly, a straight tree with little branching is more valuable than a poorly formed stem.

Good forestry produces grade improvements in at least two ways. First, poorly formed and unhealthy trees are removed from the stand through intermediate thinnings, thereby allowing the straighter, healthier trees to remain and take better advantage of the growing site. Secondly, a well-managed stand grows faster and is more likely to regenerate with genetically superior seed source.

One method of estimating value return through grade appreciation is to consider the reported price ranges found in a publication such as the Pennsylvania Woodlands Timber Market Report.  In their quarterly report they indicate price levels both one standard deviation unit above and below the average price.  Statistically, this range of prices includes two- thirds of all reported prices for that species.

Using this reasoning, if the timber sold from the property can increase in price one standard deviation unit because of grade change due to good forest management practices, an additional 1.23% of annual appreciation over this same twenty-eight year period would apply.

Species composition; Another means of enhancing the value of a timberland investment is to improve the species mix on the property. Good forestry often dictates the removal of undesirable species while retaining species diversification. This factor is difficult and impractical to estimate.  Existing conditions and landowner considerations play major roles in this alteration of species composition. But obviously as can be seen by current stumpage prices, a change from a red maple  stand to a black cherry or oak stand will yield a considerable change in value per acre.

Vegetation control and integrated pest management; Proper control of competing vegetation and tree pest control will increase the growth rate and density of timber on a tract. There may be times during the management of timber that pest or vegetation control needs to be considered. A cost benefit analysis can be performed for the ownership unit to aide in this decision.

Timber sale administration; Timber sales can be timed and presented to maximize value.  A prospectus requesting sealed bids can be prepared and mailed to many potential timber buyers. With some flexibility, timber sales can be accelerated or delayed to match market conditions.  Sawmills with special needs (shortages, species demands, etc.) can often be matched with the subject timber offering.

Also, investments in timber are often purchased and subsequently sold in different markets.  In theory, an investor purchases timberland at “wholesale” and sells timber from that property at “retail”.

Regeneration; The key to sustainable forestry is in providing for the forests of tomorrow. The ability to naturally regenerate a forest by using proper silvicultural techniques is the cornerstone for ensuring that a timberland investment remains productive long into the future. This is where the involvement of professional foresters comes in.  When an investor harvests timber under a forester’s guidance, one of the many beneficial results is the natural development of a new stand of trees, with better quality attributes  than the previous stand.

Summary of timber appreciation; Combining all of these factors – growth, price, quality, management, and proper marketing – an annual appreciation rate for timber in the hardwood forests of the eastern US can exceed 10+ %.