Timberland Investment; A look into timberland investing in the Northeast Part 2

In part 1 of this two part post we talked about the aspects revolving around how timber appreciates including;

• Biological growth
• Price appreciation
• Grade improvements
• Species composition
• Vegetation control and integrated pest management
• Timber sale administration
• Regeneration

^{(get caught up on topics covered in Part 1 here)}

But there is also the bare land to consider.

Land; Historically, the land component of a timberland ownership has been relatively slow to appreciate in value.   However, a well-maintained forest with a good road system and identified boundary lines will greatly enhance value.  Furthermore, the increased demand for recreation properties and leases has started to improve the market for rural real estate in our region.

Costs;  Like any investment, timberland costs money.  Besides the initial investment, there are also annual costs associated with the ownership of timberland.  There are recurring items such as real estate taxes, forest management costs, road development and maintenance and general property maintenance that need to be provided for on an annual basis.  Although these annual costs can be sizable, in perspective they are reasonable in relation to the investment value.

At this time, in our area, we are experiencing “bare land” values of $100 to $500 dollars per acre for timberland.  On the other hand, timber values can range from $500 to $3,000 per acre, and in some cases in excess of $5,000 per acre is not unusual.  Generally speaking, annual real estate taxes range from as low as $3 per acre in some areas of Pennsylvania to as high as $20 per acre in some areas of New York.  Similarly, property management costs can range from $5 per acre to as high as $25 per acre or more. Accordingly, a timberland investment may cost as much as $45 per acre per year to maintain.   If a tract contains $2,000 per acre in timber and the timber is appreciating in value at 10%, this is a gross annual return of $200 per acre.  Assuming this example tract costs $5 per acre per year to operate, a reduction of $45 per-acre yields a net annual appreciation of $155 per acre or a rate of 7.8% rather than 10%.  Oftentimes, annual costs are offset by lease income, as annual recreation (hunting) leases can range from $3 to $15 per acre.  Conservation easements also can add to expense offsets, normally with substantial upfront payments that generally range from $100 to $300 per-acre.

Tax Advantages; There are income tax advantages to owning real estate and timberland in particular. The occasional sale of real estate qualifies for long-term capital gains. Also, the sale of timber qualifies for capital gain treatment, either as the sale of a capital asset or with a Code Section 631 election, which provides capital gain status for the sale of timber, coal and iron ore and ordinary deductions of business expenses if certain requirements are satisfied.

Ownership of real estate also lends itself well to the like kind exchange provisions of Section 1031 of the Internal Revenue Code. Without going into details, Section 1031, provides great flexibility to taxpayers that want to transfer a property, yet reinvest the proceeds into other real estate. With the correct steps and intermediaries this “exchange” can be accomplished tax-free.

The Future; The preceding information is largely historical.  It is more difficult to look to the future, but there are numerous long-term trends that support private investment in timberland and hardwoods in particular.

Our region of Western New York and Northwestern Pennsylvania is blessed with some of the finest hardwoods in the world. The highest quality black cherry in the world is grown within a 100-mile radius of Kane, PA or roughly from Pittsburgh to Buffalo and Cleveland to Elmira. Our region is also known for its high quality red oak, sugar maple, red maple, and white ash.

Another favorable trend in hardwood demand and the ownership of timberland is the changing demographics in the United States.  Despite the impact of the recent economic recession (as can be seen below in the chart),  the U.S. population continues to grow and,  as we mature, we are more likely to purchase hardwood products in the form of furniture, cabinets and flooring.  The following table and chart are prepared from  USDA – Forest Service data, and shows domestic hardwood lumber  production and consumption  in billions of board feet (Int ¼”)  for the period 1965 through 2011.

^{“BBF” = Billions of Board Feet, Int 1/4″
source:  “US Timber Productivity, Trade, Consumption & Price Statistics 1965-2011,”
James Howard & Rebecca Westby,2013; USDA Publication FPL-RP-676}

It is evident that, despite the effect the recent recession had on both productivity and consumption of hardwood lumber, production has closely mirrored demand, and in the most recent years we are seeing demand beginning to outrun production which is currently creating upticks in most hardwood stumpage and lumber markets across the board.

Intangible Factors; There are many other reasons to own real estate and timberland in particular.  An investment in timberland provides portfolio diversity and reduces risk. Furthermore, the timberland itself is a diverse asset of many components (timber products, recreational opportunities, subsurface leasing opportunities, etc.)

There is also a high degree of satisfaction in owning real property; a place to go, woods to visit, a recreation site, in short – a hard, tangible asset. Timberland is considered to be environmentally friendly, as trees absorb carbon dioxide (a “greenhouse” gas).  This is called “carbon sequestration,” and may have financial benefits to timberland owners in the future, as there is discussion of trading the environmental benefits of reducing greenhouse gases with other operations that want to increase emissions of greenhouse gases.  There have been some successful sales of carbon credits on substantial forestland ownerships in the United States over the last few years, and the trend seems to be continuing.

In short, timberland investing is worth considering as an alternative portfolio product, providing not only solid financial returns but tangible asset enjoyment opportunities.