What do the vineyards and wineries in California have in common with over half of the country's forestland?
They are owned by family businesses, and there will be a huge ownership or generational transition-probably in the next 10 years.
For the most part, though, millions of dollars in capital in these businesses is tied up in the land itself. This illiquid asset does not generate a big income or cash flow, so it doesn't allow a family to carry out the generational transfer techniques most businesses use.
Vineyards and wineries are also complex assets. It's well known, for example, that many of them are "lifestyle" businesses and it's become increasingly difficult in recent years to turn a profit from them. Similarly, timberland is for most families "part business, part recreation and part family heirloom," says David Watson, president of D.A. Watson & Company, an independent financial advisory firm in Chesterfield, Mo., that helps families plan the intergenerational transfer of non-traditional assets like timberland, family farms and conservation properties.
"For landowners, their families and family culture-who they are, their worldview-is wrapped up in this piece of property," he says. "And unlike financial assets, this property is not easy to divide."
During the last 30 years or so, vineyards and timberland have become popular alternative assets with endowments like Harvard's and Yale's and other institutional investors like John Hancock and TIAA-CREF. In timberland, these investors have reaped average annualized returns in the high single digits, 6.5% to 10% in the past five years. While historically these returns were high for low amounts of systematic risk, that has changed as more players have jumped into the game, says Clark Binkley, a managing director at International Forestry Investment Advisors LLC, in Portland, Ore.
Though these holdings are considered long-term investments by Wall Street standards, they are short-term holdings if you consider the biological growth to maturity of most trees. In the U.S., that can range from 35 to 40 years for commodity Southern yellow pine to a century or more for hardwood oak growing in the northern Midwest. Because people are holding them as short-term investments, not for their long tree life, they are more correlated to other investments than people think, says Binkley.
"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."
Income from growing trees, Binkley points out, accumulates tax-free. When that quality is taken alongside the non-correlation of returns in properties held for the very long term, forests create an interesting opportunity for intergenerational wealth transfers. He cites a conversation he had with a Hungarian national whose family lands were returned after communism ended in that country. One branch of the family got back a factory that was not only worth nothing but had a big liability due to the high cost of cleanup. The other branch of the family got back a forest. "It was beat up and full of shrapnel," he says. "But it was still worth a lot."
Timber And Vineyard Wealth Transfer
So how do the economics of traditional timberland and vineyard investing play out?
There are two sources of returns in timberland. First is the income generated from the sale of the timber itself. The second source is the capital gains generated when the owners divvy up large plots of land and sell them in smaller chunks for real estate development. Whereas timber sales offer an 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 can also include an amount anywhere between 10% and 70% of the timber's value. In recent years, those prices have become extremely volatile. They are affected by the variable costs of logging and hauling.
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.)
Note the "S" curve: A tree grows fastest physically-and reaps its largest economic gains-during its teenage years. After it reaches maturity, both its physical growth and its financial value grow at a slower rate.
While the principles are the same, timber economics differ by species. Douglas fir and hemlock, which grow in the Northwest, are not merchantable until they reach middle age, during the ages of 30 to 45. (They are harvested for saw logs; pulpwood and paper are residuals.) But at maturity (between the ages of 55 and 70) they are four times as voluminous as a Southern yellow pine. That renders their quality, and pricing, superior.