Except for those of us who have lived or worked in the woods, many would not see timberland as an investible asset class with benefits that are ideally suited to institutional investors. Sure, there are trees everywhere, but not all of them are suitable for investment say Tim Cayen, Director of Business Development at Hancock Timber Resource Group and Eva Greger, Managing Director with GMO Renewable Resources LLC who each recently addressed a gathering organized by the CAIA Association.
According to Cayen’s data, the ten countries with the largest forest area (in 2005) were:
However, transportation costs (which can make many stands uneconomical to harvest), politics, taxes and regulations preclude investments in much of these geographies. The total investible universe is approximately USD 120 billion, with the US representing the largest portion (USD 78 billion or 65%).
In terms of institutional investment in timber, the US is clearly dominant with 10.5 million hectares of timber, with other markets rounding out the Top Twelve as below.
Timber investors can, depending on local regulations and property rights, gain exposure in a variety of ways. The most obvious is outright acquisition (title) with associated harvesting rights, but a multitude of others exist. One might have rights to harvesting only (no title, or a 99-year lease), one cycle (harvest, replanting and growing cycle) or even just one harvest. As with most financial transactions, the limits are only regulatory and other constraints and ones imagination.
Show me the money
Of paramount importance to investors are returns, risk and correlations. Timber does quite well on all counts.
Returns consist of two components: harvesting and (land) disposition. Harvesting, given a portfolio of stands, would represent about 3-5% yield (or cap rate, in real estate jargon). This depends on the types of trees, shipping costs and forest management practices. Some trees grow faster, but may have less profitable uses (e.g., extremely soft woods are best used in pulp and paper production); while harder woods, such as oak and teak, are great for furniture, but grow much slower.
Shipping could be negligible (such as if the mill is on the cut—or where the trees are felled) but for some stands ocean and rail rates factor into their economic viability.
Forest management includes which trees are replanted in an area and how they are cultivated. There are also cases where changing the age of the cut (for example, from 5 years to 9 years) could change the use of the output (from pulp to 2x4s) and increase the price per unit (from $6 to $35—which is a great deal, no matter how you calculate NPV).
Dispositions (acquisitions and NAVs) are usually calculated with the Income Capitalization Approach (or cap rate method), instead of the Cost Approach (since timber is typically on marginal land that has no other economic use) and the Sales Comparison Approach (or comp sales method, since transactions are lumpy).
Since NAVs depend on harvesting proceeds, output (lumber, pulp) prices are a major determinant of values. Trees continue to grow no matter what the market (so long as they have sun and rain) and price spikes, while exciting to day-traders, have a muted effect on long-life assets such as timber. As well, assuming a stated dividend is not required, timber investors can simply let a stand grow during depressed markets—which mitigates forced sales and could lead to even more value as the trees might have another, more profitable, use.
Over the last couple of years, timber has proved itself a relatively low-risk, uncorrelated alternative asset.
And over the longer term it has exhibited middle-of-the-road risk and return characteristics…
…with low correlations (the highest being with inflation).
Timber is a good inflation hedge because virtually all sale contracts are based on spot price which is determined daily. Given that investors are short inflation on their liabilities, timber seems a natural asset class to investigate and invest in.
Outlook for timber
Timber demand is generally expected to increase, with muted or negative growth in developed countries (such as Japan) out-weighed by brisk demand in emerging markets including China and India and rebounds in newly-emerged economies such as South Korea (which now has developed status according to FTSE).
China has emerged as the 800-pound gorilla with huge amounts of timber required for its growing economy and export-manufacturing industry. Russia, China’s natural source for wood, has slowed its shipments to the country, requiring China to scour the world to secure supplies of lumber, cellulose and chips (sound familiar?).
So how much should the Woodchuck Pension Fund Investment Board (the “WPFIB”) allocate to timber investments? It depends on their time horizon. But to ignore timber as a portfolio diversifier is to miss the forest for the trees…