There are three elements that drive a timberland investment: biological tree growth, timber price changes and changes in land value. Biological tree growth simply means that as trees get older they increase in both volume and value and move through three product classes (trees grow from pulpwood size, to small sawtimber size, to large sawtimber and plywood log size). Biological growth accounts for 65% to 75% of investment growth because increasing volume and value over time are independent of financial market conditions. Timber price changes account for 25% to 30% of investment growth and result from several economic factors such as population growth, interest rates, GDP per capita, construction rates and overall economic activity level. Typically, land value only represents a small percentage of timberland investment growth and is related to local market conditions.
Four main themes dominate the discussion about what makes timberland an attractive investment: its strong historical risk-adjusted returns; its limited volatility; its negative or low correlation with other traditional asset classes such as stocks and bonds and even commercial real estate; and its apparent positive correlation with inflation, which makes it an inflation hedge. Timberland has shown low and negative correlations with other asset classes. The correlation between timberland and the Consumer Price Index is -0.07 over the last 20 years, making timberland a partial hedge against inflation.
Institutional investors continue to increase acres of timberland owned, buying hundreds of thousands of acres at a time. Prices are in the range of $1,500 to $1,900 an acre. Keep in mind this is for land and timber (much of the timber mature) and involves a "quantity discount" for large acreages.
TIMOs, REITs and ETFs
A TIMO is a management group that assists institutional investors in locating, evaluating and acquiring timberland. Once it is acquired, the TIMO actively manages the investment. This is how pension funds, endowments and foundations invest in timberland. Pension funds usually do not pay taxes, so taxes are not an issue for many TIMO owners. Private owners would pay capital gains tax rates like other timber owners.
REITs and ETFs should not need an explanation. There is a tax advantage that encouraged the conversion of forest industry lands to timber REITs. A REIT can distribute significantly more cash directly to its investors in the form of a tax-efficient dividend. This is because REIT earnings are exempt from corporate income taxes and the REIT must pass on to its shareholders 90% of earnings in dividends. An additional advantage is that most REIT income from the sale of standing timber under contracts is treated as long-term capital gains by the shareholders. So REIT dividends tend to be large and reliable, and better yet are taxed at the long-term capital gain rate.
Plum Creek is the largest and most geographically diverse private landowner in the nation; it is also the first and largest publicly traded REIT. It owns 7.4 million acres. Two other national timberland REITs are Rayonier and Potlatch. They both earn significant income from manufacturing, so they don't represent as much of a pure timber investment as Plum Creek. Rayonier controls 2.2 million acres and Potlatch controls 1.6 million acres. All three REITs trade on the New York Stock Exchange. Wells Real Estate Funds recently launched the first public, nontraded REIT investing in timberland.
The first-ever timber ETF made its debut late in 2007 and is offered by Claymore Securities. The Claymore/Clear Global Timber Index ETF is listed on the American Stock Exchange as CUT and invests primarily outside the United States. It is not strictly a pure timberlands investment since it is based on forest products companies that own and manage significant timberland. But to be included in the index, the company must harvest the timber use in its business. An investor can now buy an ETF that will produce results that correspond to the S&P 500 Timber and Forestry Index. The iShares Global S&P 500 Timber and Forestry ETF promises exposure to the shares of approximately 25 leading forest products firms worldwide. Both these ETFs are similar in that their exposure to timber is global and indirect through the forest industry. Two other ETFs are Phaunos Timber Fund and Cambium Global Timberland.
If you would like to read Part II, please click here.
Thomas J. Straka is a forest economist at Clemson University in South Carolina. Another article by Straka that discusses the tax advantages of timber investing can be read at www.fa-mag.com under the November issue.