Forest investment outline

A Forest Investment Outline

John Gordon and Richard Howard

I. Forests as investments

· Punch line: buy low, buy direct (see part III). Right now (late 2008) it is easy to pay too much, we think, for forestland. Small, well-located parcels that can be owned by a single retail investor are at or near all time high prices in most places, foreign and domestic. But it is still preferable, usually, to own your own land without an intermediary and the attendant fees and risk of poor management.

· Always evaluate real estate development potential. So-called “higher and better use” (HBU) is now priced into most US forestland. The savvy investor strives to understand how much this contributes to the sale price and how realistic the expectation is. In places of great beauty and recreational potential, ready access and closeness to cities HBU can be real. For many millions of acres of forestland without those attributes extreme caution regarding imputed HBU values is warranted.

· Be wary of pooled funds. The major issues are fees, control, and buying a pig in a poke (with or without lipstick), meaning the land is purchased after your money has left home. With forests it is mandatory to know exactly what you are buying.

· Forest appraisal: art or science? Forest appraisal is an excruciating blend of art, science and guesswork. Truly comparable sales are often scarce, future timber prices are hard to predict, and see “HBU” above. Unless you are completely satisfied with inventory and location stay far away from a potential investment, regardless of the appraised price.

· Look at arguments in favor of investing carefully: long term timber and land price appreciation vs. your or your fund's investment period (often fairly short term). For example, the last year has seen lumber prices approximately halved in the Pacific Northwest. “Leveraged” forestland (purchased with a large debt component) often forces owners to sell into a down market to service the debt, meaning that you are “averaging down” on timber prices for the life of the investment.

· Analogy with the stock market seems to hold with forestland, with fairly high returns over the long term, but in the long term we are all dead. Be very realistic about how long you will own the land. The “grandchild” test isn’t a bad one: can you envision the investment period lasting until your grandchildren are your age? Even “intensive culture” forests are relatively slow in comparison with a human life span.

· Major ownership changes in industrial forestland ownership seem mostly to be over, at least in the sense of the large, vertically integrated companies selling off their land. Now REITS (real estate investment trusts such as Plumb Creek and Rayonier), TIMOS (timber investment management companies, such as Hancock and Forestland Group) are major owners, but for how long? How will the market be when you want to sell? Will they be selling too?

· Forest investments make money and lose money, just like other investments. The returns reported for the TIMOS (above) have fallen steadily for a decade.

II. Managing forests as investments

· Initial condition and price are the key to selecting good investments. The amount and timing of in-growth (the timing of trees “growing in” to a higher value category), species and tree quality, growth rates/site quality, risk from weather, insects, disease and fire, access, proximity to a variety of markets, and, particularly, the regulatory and tax environment which varies by countries, states and counties. Reliable LOCAL information is essential, particularly for the regulatory and tax matters.

· “Bookends” for styles of forest management are 1)very intensive management (high capital investment, high and fast gross returns) or 2)very extensive management (just cut trees, relying on natural regeneration), providing lower (and often slower) gross returns but much lower investment and carrying costs, which can reward this “extensive management” with net returns that are higher than the intensive kind. All gradations of “management intensity” are observable and available to investors. The key here is to avoid the “fallacy of the middle”: relatively high initial investment, modest growth, a long time to carry up-front costs and concomitant low returns.

· Plantations tent to have high initial cost, and faster growth. With more invested early, more is at risk longer than in naturally regenerated forests; but returns per unit time and area can be much higher than natural forests, particularly if the plantations produce a high value added product (veneer for example).

· For natural forests it is imperative to know merchantable volume now and in future, ease of regeneration, and, particularly, regulatory risk. Basically, “regulatory risk” means will some governmental body or social convention keep you from cutting and selling your trees when it is time to do so.

· Sustained yield and certification schemes can work for the investor to reduce market and regulatory risk. Buying the right forestland at a reasonable price and engaging the competent managers with deep local knowledge of forests, regulations and markets is the right formula.

III. How to invest in forests

· Make forest investments fit your own specific time and life style goals and fit them into your overall investment portfolio or picture. It is easy to “fall in love” with a piece of forestland. When that happens, make sure your head as well as your heart is engaged in the evaluation process. There is nothing wrong with owning forestland because you like it. Just don’t confuse that with making money.

· Pooled funds vs direct ownership: pooled funds have "experts" who buy the land, but they buy it with cash in their pocket (moral hazard); direct ownership more work, but more control and higher returns with lower fees are possible if you want to do the work

· REITS, TIMOS and limited partnerships: pay careful attention to management fees and the role of the managing partner; know what was paid for the forestland when acquired versus market rates when you buy in; know the time horizon for real gain.

· Integrated (forestland owning) forest products companies: you buy the whole company (board, management, factories, liabilities, etc) not just their land and its products; you benefit from value added to wood by company activities in so far as it is reflected in their stock price and dividends.

· Invest where valuable trees grow readily, not necessarily rapidly since competition with brush and weeds often limits regeneration and growth where trees grow most rapidly.

· Invest in accessible land (good existing roads) with high site index value (good soils and microclimate)

· Assess "natural" risks before buying: insects, disease, fire, ice, wind

· Assess political risks before buying: environmental and transportation regulations, political attitudes toward the timber business.

· Above all, learn all you can, get the best impartial advice, and look for a "premium to knowledge"; forests are the least well understood major asset category.

· Initial price and condition are key to future gains or losses, but good price and condition alone do not guarantee success: management, politics, markets, larger world forces such as demographics and wars profoundly affect all long term investments, including forests.

Timber REIT Rayonier Pays Steadily Increasing Dividends

Rayonier (RYN), a forest products real estate investment trust (REIT) with three core businesses, has a history of raising its regular quarterly dividend. Its regular quarterly dividend has increased from 8 cents in March 1994 to 50 cents in June 2008. More...

S&P Global Timber & Forestry ETF Includes Dividend-Paying Forest and Paper Products Stocks

S&P Global Timber & Forestry (WOOD), an exchange-traded fund (ETF), includes 25 of the largest publicly-traded forestry, paper products and paper packaging companies. Top holdings include: Plum Creek Timber (PCL), Rayonier (RYN), Sino-Forest (TRE.TO), Weyerhaeuser (WY), OJI Paper (3861.T) and West Fraser Timber (WFT.TO). More...

Put Domtar on Your Stock Watch List

As the stock market continues to the downside, it creates some great bargains. One such company is Domtar (UFS), a large paper and pulp company with operations in the U.S. and Canada. More...

Forestry 101 for New Investors, Part 3.

“And there is more complexity to come in Part 3, when we finally get down to plantations versus natural forests as investments. Genetics, regeneration, insects, disease and fire will all appear in our forest investment future.” That is where we left it at the end of part 2. So brace yourself for complexity and uncertainty. Forests contain plenty of both. We will talk about the genetic makeup of trees, and the classic threats to forests: insects, disease and fire separately, but they all interact, they all leave a historical signature in any group of trees, and they are all complicated subjects in themselves. Indeed, the central notion necessary to invest in forests is that they have more components per unit area than a space ship, and the pieces are all connected.

Often when I talk with people who are new to forestry and the workings of forest, I find their main concern is potential destruction of the forest by fire, insects and disease. These are very real threats. In dry areas, or seasons, fires started by lightning or people are constant threats to a forest’s existence. Most of the time, plantations of trees are established so that, among other things, they are easier to protect from fire than natural forests. This is because they include roads, fire breaks and have firefighting capability nearby. These same attributes mean insect and disease outbreaks are easier to combat. But where plantations are of non-native species they may be at special risk from local diseases and insects. As the biological contents of the world are increasingly shuffled around by human activity, the threat of new bugs and diseases to existing forests, planted or natural, increases. All that having been said, losses of planted forests to these agents is relatively small, way less than 1 percent per year on a world scale. Extensive, remote natural forests in remote areas are another matter. In the western United States and Canada, losses to fire and the others have been large and increasing for the last few years. Some blame this partly on human-caused climate change that makes some areas warmer and drier in the summer.

So what is an investor to do? First, make sure that the people who manage the plantations and forests you invest in have thought long and hard about these influences, and that they take proactive measures to prevent them from destroying the investment. That having been done, look for relatively wet places (for example the Pacific Northwest, of North America, west of the mountains) and species with good track records of insect and disease resistance (for example, Douglas-fir and associated species).

The genetic make-up of individual trees and forests determines how they respond to their environment, including fire, insects and disease. Over the last 50 years or so a lot of time and effort has been put into “tree breeding”, attempts to produce genetically better trees. These improved trees grow faster, and may be more resistant to insects and disease. In North America, the chief species worked on in this way have been Southern pines, Douglas-fir, and poplars, but many more species have had some level of attention. The main thing here is that these improved trees are grown from seed or vegetative tissue of their parents in nurseries and then planted in the field, so that they only appear in plantations of one kind or another. So if you want to benefit as an investor from this vast effort, you will need to invest in plantations. However, the future of all forests is determined to some considerable degree by their genetic makeup. Thus, if in natural forests only the best trees are cut and poorest left, the genetic makeup of the forest can be impaired. So how forests are managed can be a form of genetic improvement, or at least “genetic maintenance”. Ask the managers of your investment forest whether they practice “high grading”, particularly in the mixed forests of the Eastern united states and watch their reaction.

On September 15, 2007 the National Commission for Science and Sustainable Forestry (NCSSF) released "Conserving Biodiversity Through Sustainable Forestry: A Guide to Applying NCSSF Research" to highlight the practical significance for practitioners and managers of the research the organization has sponsored on biodiversity and sustainable forestry. The fully illustrated Guidebook offers practical tools to apply science in the field and is accessible for anyone interested in forests and the practices associated with forest management. The goal of this publication is to help improve forest management by making forestry and biodiversity science easier to understand and illustrating on-the-ground applications. This is about the most accessible source for a fuller story that you will find. Go to www.ncssf.org to get a copy.

Timberland Returns Are Mixed But Still Beat Stocks

Some investors have diversified their investment holdings with timberland because in recent years timberland has tended to outperform stocks. But is buying and selling timberland always more profitable than buying and selling stocks? To help answer this question, I (RAH) examined the annualized returns for timberland and stocks from 1987 to 2007, using annualized returns of four holding periods (5, 10, 15 and 20 years) as the measure of performance.

Timberland values were measured using the NCREIF Timberland Index and stock values were the closing values of the S&P 500 for the last day of each year from 1987 to 2007. To learn how I computed the timberland index and annualized returns, see the companion spreadsheet.

More...

Silvics of North America

Silvics of North America describes the silvical characteristics of about 200 forest tree species and varieties growing in the United States and Puerto Rico. The handbook includes Volume 1: Conifers and Volume 2: Hardwoods.