By Ellie Winninghoff

Imagine investing in a dividend yielding business where the balance sheet grows when times are tough.

Timberland, of course, has been a favorite alternative investment vehicle for top-performing endowments from the likes of Harvard and Yale. But due to million dollar-plus minimums required by the specialized private equity firms known as timberland investment management organizations, or TIMOs, that manage these hard assets on their behalf, individuals generally have not been able to partake.

An intriguing option, one that offers dividends and liquidity as well as a low barrier to entry, is timberland owning publicly-traded REITs.

The Forisk Timber REIT (FTR) Index, which tracks publicly-traded timber REITs, rose 88% between 2000 and 2011 versus a 2.4% drop in the benchmark S&P 500. In contrast, private timberland values rose 68% during the same time period, based on the NCREIF (National Council of Real Estate Fiduciaries) private timberlands index.

This means that publicly-traded timber REITs beat the S&P 500 by an average of 8.19% per year and beat private timberland by an average of 1.81% per year during that period.

"A useful exercise in our equity research has been comparing the relative per-acre administrative loads of TIMOs and publicly-traded timberland owning REITs," Brooks Mendell, president of Forisk Consulting, wrote on the company blog of his Athens, Ga.-based timber investment consulting firm. "At the end of the day, the earnings potential of timberland assets varies more by location than by ownership structure, assuming structures of comparable tax efficiency."

He says the best locations are in the Southeast and the Northwest. The Southeast is traditional southern yellow pine country, which is a fast-growing commodity timber. Trees in the Northwest take longer to grow, but are of higher value when they reach maturity and many of those tress are going to China, a thriving market.

Branching Out
There are four publicly traded timber REITs: Plum Creek Timber (PCL), Weyerhaeuser (WY), Potlatch (PCH) and Rayonier (RYN.) Rather than representing direct ownership of hard assets, these securities are a claim on the earnings of timber-growing and selling businesses. Together, they account for 20% of the privately-held U.S. timberland versus 37% owned by 27 U.S.-based TIMOs, according to Forisk Consulting. As of March 27, the market caps of these REITs ranged from $1.3 billion for Potlatch to $11.8 billion for Weyerhaeuser.

As REITs, these firms must pay out 90% of taxable REIT income. And as of March 27, the group's dividend yields ranged from 2.70% for Weyerhaeuser to 4.10% for Plum Creek Timber. Unlike with most REITs, their dividends count as capital gains.

All four companies are timber REITs, but their similarities end there because while 75% of their assets must be real estate assets, they can own other businesses in their taxable REIT subsidiaries (TRS).

For example, about 70% of Rayonier's revenues derive from cellulose pulp, a value-added specialty pulp used in the manufacture of products like pharmaceuticals, LCD screens and diapers. And while this is a forest product, it is not a tree. "You can call it pulp, but it's way beyond pulp," says Steven Chercover, senior research analyst at D.A. Davidson in Portland, Oregon. "It's not a commodity; it's closer to a chemical business."

As such, says Mendell, the company is more akin to a traditional manufacturing firm. "Strong earnings from this segment helped Rayonier weather the housing downturn more effectively than any other timber REIT," he says, pointing out that exports account for 60 percent of the firm's specialty cellulose fibers.

Plum Creek Timber, in contrast, has relatively few manufacturing assets. As the oldest timber REIT (since l998), it is the largest and most geographically diverse timberland owner in the group. Potlatch, meanwhile, is the smallest of the four firms, with most of its timber assets in the upper Midwest.

And then there's Weyerhaeuser, which converted to REIT status in 2010. It's the most diversified of the four firms with TRS assets including wood products manufacturing, cellulose fibers, and five home building subsidiaries.

Weyerhaeuser's broad diversity, however, is a "plus-minus," says Mendell, who explains that one of the biggest advantages of adding timberland to a client's portfolio is diversification. "But if you want to add a timber REIT to your portfolio and that business is already diversified, you don't get the benefit of adding timberland to your portfolio."

Is This Alternative?
Many people argue that timberland isn't correlated with other financial assets and is therefore an alternative investment. Others disagree. Clark Binkley, managing director at International Forestry Investment Advisors LLC, in Portland, Ore., posits that these investments, while long-term by Wall Street's standards, are short-term relative to the biological growth to maturity of most trees. In the U.S., that can range from 35 to 40 years for Southern yellow pine to a century or more for hardwood oak growing in the northern Midwest.

"The argument is that trees grow while the sun shines, but they do not read the Wall Street Journal," he says. "If you buy bare land and plant the trees, 100% of the return will come from tree growth. But are investors doing that? We believe the only structurally uncorrelated component of returns from timberland is tree growth."

Binkley manages tree farms in places such as Chile that include super fast-growing trees. So he plants and waits for the biological growth for harvest. In that sense, he says, his fund is uncorrelated because they are waiting out the entire biological growth cycle of its trees.  

Theoretically, publicly-traded REITs are also waiting out the entire biological growth of their trees, so in a sense if somebody wanted to invest and hold on for a lifetime their return may well be uncorrelated--especially for Plum Creek Timber, which is fairly close to a pure-play timber operation.

That said, timber REIT share prices got buzzsawed in 2008, making them highly correlated with the S&P 500. And investors who bailed on these REITs during that period locked in that correlation on the downside.

Meanwhile, Mendell says, publicly-traded timber REITs and privately-held timber assets have converged during the past 11 years. This suggests timber is more correlated to traditional asset classes than people think.

The other part of the story, though, is the extraordinary flexibility that owning timber offers. Case in point: the mortgage meltdown.

When housing starts plummeted 72% between 2005 and 2010, Mendell says, timber REITs shifted the harvest from the higher-value saw timber (the older logs that are used for manufacturing lumber and building houses) to the pulp and pulpwood used to make paper and paperboard, where prices remained stable. Overall, though, they thinned and deferred harvests.

The result? "Unlike capacity rationalization decisions associated with manufacturing, which reduce the capacity to produce volume in the future," Mendell says, "forest harvests effectively increase capacity to produce in the future as trees continue to grow."

Timber REITs are unique animals and they perhaps can be considered alternative investments to some extent because their balance sheets--i.e. trees--keep growing even when the economy tanks. Operationally speaking, this makes them less risky than many publicly-traded companies.

Ultimately, the debate about whether or not timber REITs are an alternative investment is secondary to whether or not these vehicles merit a place in one's portfolio. Based on their track record during the past 11 years, plus their dividends, they're worth a look.

Ellie Winninghoff can be contacted at: ellie.winninghoff (at) gmail (dot) com.