What's the cross between a tree hugger and a capitalist?
An investor in sustainable forests.
That's something quite different from-and often more profitable than-conventional timberland investing, a favorite alternative investment vehicle for top-performing endowments like Harvard and Yale.
"Timberland is unique in the investment universe because it's one of the only asset classes where there's real growth that you [can see] and measure," says Eric Becker, chief investment officer at Clean Yield Asset Management, based in Norwich, Vt. "Trees grow at a certain rate. You can figure out what a sustainable yield is from a forest, manage that, and therefore benefit from that financially.
"Most other investments somehow go beyond the limits of growth," he adds. "This is really one of the greenest investments available."
As an asset class, timberland is actually fairly new. During the last 30 years or so, pension funds and other institutional investors have picked up nearly 40 million acres in the U.S., reaping average annualized real returns as high as the high single digits, but more like 6.5% to 10% in the past five years. For the most part, they bought it from forest product companies that, because of unfortunate accounting rules, were forced to carry this increasingly valuable real estate on their books at historical cost. The companies sold the timberland so that shareholders could realize the value of their holdings and then invested the proceeds in mills and other more profitable operations.
Traditional Timberland Investing
So how do the economics of traditional timberland investing play out? In general, there are two sources of returns. First, the income generated from timber sales. Second, the capital gains generated from divvying up large plots of land and selling them in smaller chunks for real estate development. Whereas the income from timber sales can make for a relatively steady annuity, sales of land for real estate development are more cyclical, depending on housing demand, etc.
Here's how it works: If the land is nursing seedlings or pre-merchantable timber, it is generally valued at the price of the bare land, plus the discounted future value of the young trees. If the timber is merchantable-that is, big enough to sell as timber or pulpwood-the price will also include an amount anywhere between 10% and 15%, or up to 45% to 70%, of the value of the merchantable timber. In recent years, that's become extremely volatile. That includes the cost of logging and hauling, which are variable.
As trees grow, their value grows. Harvests yield cash flow. Forest economics also differ substantially by species, and prices for the same species can vary by as much as 25% to 30% between mills in the same micro-market.
For example, Southern yellow pines harvested from the ages of 15 to 20 (for pulpwood and paper) currently sell for $8 or $9 a ton. From the ages of 18 to 24, some of it is used for pulpwood and the rest for construction lumber and 2-by-4's, and sells for $15 to $18 per ton. And from ages 27 to 35, when it's mostly used as structural lumber, it fetches $24 to $27 per ton. (These prices are the lowest in decades, no doubt because of the financial crisis and the slowdown in construction.)